Guidelines and market trends for green bonds
With increasing demand for, and increasing issuances of, green bonds, it is important for market participants and particularly new entrants to keep up-to-date with the applicable principals, guidelines and standards which are developing alongside the green bond market.
This article highlights global market trends as well as notable examples of existing regimes (such as the ICMA's Green Bond Principles, Climate Bonds Standard and Certification scheme and Moody's Green Bond Assessment) and indices which are tracking the performance of green bonds.
In February this year, Apple issued its first labelled green bond. The launch, which raised US$1.5 billion, was reportedly the largest green bond to have ever been issued by a US corporation and a clear sign of green bonds' increasing popularity in financial markets. Another sign came in July, when the Government of Victoria became the first Australian government to join the growing list of green bond issuers; the AU$300 million issuance by the Treasury Corporation of Victoria is another of a number of notable "firsts" in green bond listings to have occurred this year.
In light of the recent flurry in market activity, it seems timely to revisit the topic of green bonds, for which we provided an overview in Global Financial Markets Insight issue 5 (Q4 2014). The reference to a "labelled green bond" in this article refers to a bond that has been labelled by the issuer as "green".
The term "green bond" remains a generic term used to describe bonds issued for the purpose of financing or re-financing projects that have positive environmental or climate-related benefits. In the absence of a market standard definition of "green", the market is witnessing the organic development of a framework of principles, guidelines and standards.
Such guidance is particularly important to promote transparency and integrity within the market, especially for investors who have to conduct their own due diligence in assessing the green criteria of the bond. Notable examples of these include:
- Green Bond Principles - These are voluntary principles, initially developed by a group of leading banks, and which are now being maintained by the International Capital Market Association (ICMA) serving as Secretariat of the Executive Committee to the Green Bond Principles. The four core components of these principles are:
- use of proceeds;
- proceeds for project evaluation and selection;
- management of proceeds; and
- Climate Bonds Standard and Certification scheme - This standard/scheme is maintained by the Climate Bonds Initiative, a not-for-profit organisation which focuses on mobilising the green bond market. These environmental standards outline the criteria for assessing the "green" credentials of a bond. In conjunction with these standards, the certification scheme provides participants, such as investors, with comfort that bonds meet certain standards regarding climate integrity, management of proceeds and transparency. The previously mentioned bond issued by the Treasury Corporation of Victoria, for example, was Climate Bond Certified pursuant to this scheme.
- Moody's Investor Service (Moody's) Green Bonds Assessment methodology - Moody's finalised its assessment methodology earlier this year after previously issuing a form for comment by market participants. Pursuant to the methodology, a Green Bond Assessment (GBA), ranging from GB1 ("Excellent") to GB6 ("Poor"), will be assigned to issued bonds assessed on five key criteria including use, disclosure and management of proceeds. Such ratings are expected to be updated annually on the basis of reports to be provided by the issuer. Moody's assigned its first GBA of GB1 to Green Storm 2016 B.V., a Dutch green residential mortgage-backed securitisation in May 2016.
- Country-specific guidance - These include the Preparation Instructions on Green Bond Endorsed Project Catalogue published by the People's Bank of China and the Green Finance Committee of China Society of Finance and Banking, and also the official green bond requirements finalised in January 2016 by the Securities and Exchange Board of India. Indeed, the development of these guidelines should be seen as a positive response to the increased green-bond issuance activities in those respective countries.
Importance of a framework
With "green" being a label that issuers give to bonds that they issue themselves, it is critical that issuers are transparent about the process that they use for such self-assessment. Before 2014, issuances by the Multilateral Development Banks and Multilateral Financial Institutions such as the World Bank and the European Investment Bank accounted for the majority of green bond issuances. These entities are therefore more likely to be familiar with market expectations for green bond issuances than, for example, newer market entrants such as corporates and governmental entities. The principles, standards and guidelines, whilst important to all participants, are particularly important for the new market entrants.
Why are they important? To put it simply, from the perspective of both issuers and investors, there is a reputational risk involved in green bond issuances. In connection with this, for the green bond market to remain robust there must be transparency and confidence that proceeds raised are actually used for the intended purpose and that the ultimate outcomes of projects have a positive environmental impact. This means that issuers will need to undertake an additional assessment as to whether their bond meets criteria required for it to be labelled "green", following which they will have ongoing disclosure requirements to track the progress of the project. This additional diligence is necessary, even though it may increase the cost of the bond issuance.
As such, we expect to continue to see further development of such principles, standards and guidelines. It is pleasing to find that existing principles are starting to be cross-referred to each other, bringing a level of consistency in the evaluation process across the market. We note that, for example, the Securities and Exchange Board of India's official green bond requirements reflect some of ICMA's Green Bond Principles.
Green bond indices
Beyond the continued monitoring and reporting requirements referred to above, green bond indices have also been developed to track green bonds' performance.
Green bond indices are maintained by banks and credit agencies, often with input from third parties such as research organisations. They are designed to track the performance of green bonds which have been accepted for inclusion in the relevant index. One example is the S&P Green Bond Index, launched in July 2014. To be included in the index, bonds must meet a set of prescribed eligibility criteria which take into account factors such as disclosure and country/currency, and must be flagged as "green" by the Climate Bonds Initiative for index inclusion. Other indices include the Solactive Green Bond Index and the Barclays MSCI Green Bond Index.
The Climate Bond Initiative tracker showed that as at 15 October 2016 there had been a year-to-date issuance of green bonds of US$59.9 billion (already up from the 2015 end-of-year figure of US$41.8 billion, and the 2014 US$36.6 billion and 2013 US$11 billion figures respectively). It is evident from the figures that the labelled green bond market really started to flourish in 2014, and since then the market has continued to grow.
While the Climate Bond Initiative reported a drop in the volume of green bond issuances in 2015, the aggregate issued amount in that year exceeded that in 2014. The Climate Bond Initiative reports:
- a continued growth in investor demand evidenced by, amongst other things, oversubscription in green bond issuances;
- a significant growth in green bond market size in certain existing participating countries; and
- the entrance by seven new countries (notably Brazil, in the spirit of the Olympics, and India) to the green bond market.
However, eyes are most firmly on the Chinese and Indian markets where each of the respective governments are demonstrating continued investment in going "green". Investments into green initiatives and announcements of targets, such as the Indian government's target to increase its solar power capacity five-fold to 100GW (currently 20GW) by 2022, are becoming increasingly frequent.
One of the more recent developments in the market is the launch of the Luxembourg Green Exchange (LGX) at the end of September 2016. The LGX has been launched for green securities which are required to comply with certain industry best practice criteria.
We expect to see growth in both the demand for and issuances of green bonds, and concurrently the further development in the framework regulating the green bond market.