The signing of the Paris Agreement, which came into effect on 4 November 2016, has again highlighted the importance of climate change to the global community. The Paris Agreement calls for collaborative efforts from the private and public sectors to strengthen the global response to the threat of climate change and to find sustainable measures for economic and social development. This note seeks to highlight some of the recent developments in the 'green movement' including trends such as the issuing of green bonds and the latest criteria from the World Bank.
The Paris Agreement and DFIs
The Paris Agreement calls on Development Finance Institutions (DFIs) to review their mandates and structures to align with changing demands and international imperatives. Although the objectives of the DFIs have evolved over the years, the fundamental focus of these institutions remains to mobilise financial resources for developmental purposes through investing in markets deemed too risky for the private sector to enter alone, but which are essential for the growth of the broader economy and the social development of those markets.
Green bonds are a relatively recent development, which provide an alternative means of raising the necessary financing required by corporates and countries to undertake clean and climate resilient development, including meeting the targets agreed to in treaties.
The World Bank and European Investment Bank were the first to issue green bonds in 2007, followed by several national development banks, certain states and local governments in the United States of America and France, commercial banks followed suit and, by 2013, corporate issuers. Nedbank Capital headed a consortium which led the arranging and managing of South Africa's first institutional green bond issued by the Industrial Development Corporation in November 2012. Funds raised through the IDC’s multiple drawdown 5 billion Rand green bond are ear-marked to finance the growth of green and energy efficient industries and will have a lifespan of 14 years.
What are Green Bonds?
Green bonds are a debt instrument, similar to ordinary bonds, but issued under the Green Bond Principles which require, amongst other things, that proceeds raised from the issuance of green bonds are used for the exclusive purpose of financing projects that have positive environmental or climate benefits (such as renewable energy or clean transportation). The Green Bond Principles are voluntary guidelines relating to disclosure, reporting and monitoring of the bond’s use of proceeds. Further industry guidelines have been developed, under the Green Bond Principles and Climate Bond Standards, for project evaluation and selection, management of proceeds and reporting in relation to green bond issuances. Issuing green bonds allows the issuer (including governments, multi-national banks or corporations) to tap into global investors that invest only in 'green investments' or gain access to segregated funds ear-marked for green initiatives.
There are four main types of green bonds namely:
- Green "Use of Proceeds" Bonds (also referred to as "asset-linked-bonds") - Proceeds from these bonds must be used to fund eligible green projects, but investors' recourse is not limited to the cash flows and assets of those projects. Investors in these bonds have recourse to the issuer and, accordingly, risk profile of these bonds is the same as ordinary bonds from the same issuer. The majority of green bonds issued to date are Green "Use of Proceeds" Bonds.
- Green "Use of Proceeds" Revenue Bonds - These bonds are similar to Green "Use of Proceeds" Bonds, but this type of bond is secured by taking security over the cash flows or revenue streams of the issuer rather than providing recourse to the issuer.
- Green Project Bonds - These bonds are issued to fund a specific green project or projects. Investors have recourse only to the project assets and balance sheet. In the case of Green Project Bonds the investor thus has direct exposure to the risk of the project's success or failure.
- Green Securitised Bonds - The proceeds of green securitized bonds may be ear-marked for a specific green project or be attributed directly to the existing underlying green projects. The bonds are secured by the cash flows and assets of a number of underlying projects that have been grouped together.
What's the deal with Forest Bonds?
There's a movement for using green bonds to finance initiatives that focus on the avoidance of deforestation. The REDD+ (Reducing Emissions from Deforestation and Forest Degradation - and more) initiative of the UNFCCC has made some progress in the past two years. This initiative allows forest custodians to sell carbon credits in participating carbon markets. The biggest challenge to the success of Forest Bonds remains securing sufficient, reliable cash flows to support the bond.
RE100 is a global initiative by the Climate Group in partnership with a non-profit organisation, CDP, for the collaboration of influential businesses committed to using only renewable energy to meet their electricity requirements and to significantly increase the demand for, and delivery of, renewable energy. 83 of the world’s most influential companies have joined RE100, including global brand names like Google, Unilever and Tata Motors. Companies joining RE100 are encouraged to set a public goal to procure 100% of their electricity from renewable sources of energy by a specified year.
World Bank Safeguard Requirements
After a four-year process of consultation, protest, and compromise, the World Bank’s board of directors approved a new Environmental and Social Framework (ESF) in August 2016. The experience and capacity of many borrowers has improved and the requirements have been updated to reflect the realities of today. The new framework introduces requirements to assess each project’s greenhouse gas emissions and the impact that a changing climate will have on the success of the project. The framework requires prospective borrowers, such as national governments, to address certain environmental and social risks in order to receive Word Bank support for their projects.