Is green debt the answer to climate change?

ANZ last week joined a growing list of financial institutions to offer a “green bond”.

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Being marketed now, it will be A$ with a 5-year tenor and proceeds will be used to partially finance an existing pool of what are known as “eligible” assets – in this case wind farms, solar projects and energy efficient buildings – valued at around A$1.1 billion.

"Climate flat earthers aside, there remain those who are sceptical of the marketing of such products and dangers of 'green washing'."
Andrew Cornell, Managing Editor

ANZ is not the first issuer into this market. In Australia, National Australia Bank has also been active while offshore Bank of AmericaTD Bank and Credit Agricole are just a few other names in what is a growing sector.

Green bonds are effectively debt tied to particular projects, in this case projects which can help the battle against climate change by targeting funding at lower carbon and energy efficient projects.

In the finance sector, as in the broader scientific community, no one of any repute doubts climate change is occurring, that it is being caused by increased levels of carbon dioxide in the atmosphere and that human activity is generating that carbon dioxide.

The reality is economies will be increasingly “carbon-constrained” and this will at some point be achieved with financial signals – if not carbon taxes or some like price then active intervention by providers of capital such as endowment funds, sovereign wealth funds (ironically Norway, whose sovereign wealth fund exists because of oil royalties is very active in moving against carbon) or the broader market.

This is where green bonds come in. The idea is to contractually tie capital which has an environmental mandate, for whatever reason, to projects which satisfy that mandate. That funding then can contribute to lowering the carbon intensity of portfolios. The more wind or solar in a portfolio and the less carbon intensive generation, the lower the overall carbon footprint.

Typically the issuers of green bonds seek accreditation from an independent body and maintain an asset register which can be audited. For example, this ANZ issue will be certified by the Climate Bonds Initiative (CBI), a not-for-profit group, and compliance will be independently monitored by Ernst & Young. There are also international indices for these instruments such as the MSCI/Barclays Green Bond Index and the Bloomberg AusBond Composite Bond Index.

The chief executive of CBI, Sean Kidney, was in Australia earlier this year spreading the message this was a sector about to take off as investors seek environmentally conscious assets.

Since the CBI was launched, annual global issuance of green bonds has risen from US$414 million in 2008 to US$36.6 billion in 2014.

The market though is still in its relative infancy and, the climate flat earthers aside, there remain those who are sceptical of the marketing of such products and dangers of “green washing”. In particular, critics point to the fact initial issuance has by and large gone into existing assets rather than the creation of new projects.

That's true but that's also often the case with a market in its infancy. Initially investors want a toe in the water and in this case it is exposure to assets which are operational rather than having an extra layer of project risk.

Paul Curnow, the head of Baker & McKenzie's renewable energy practice in Asia, says the green bond market will mature over time.

The initial challenge for institutions and corporations wanting to issue such bonds is to broaden the investor base and that comes with gradual exposure to smaller levels of risk.

However Curnow argues that while ultimately the funding of new, low carbon projects would be the goal, shifting existing portfolios to a lower carbon base and bringing in new funding is also effective.

He notes that while at present there is no pricing advantage, it is not unlikely as the market develops. The more pricing comes to favour lower carbon intensity, the more incentive there will be for both project developers and debt issuers.

On his trip to Australia, CBI's Kidney told Banking Day “treasury people think it's a good angle [to access funding slightly more easily] while their origination teams like the angle of attracting new clients or offering a more interesting deal to existing corporate clients in the bond market”.

Kidney argues banks will often be among the first issuers not just to attract different investors but to provide a demonstration to potential corporate clients.

The investor base for ANZ's issue is not yet known but NAB's green bond exceeded expectations, launched with a target of A$150 million transaction and closing at a$300 million.

Both Curnow and Kidney argue one of the challenges as the market grows is greater transparency. Curnow says he doesn't have an issue with the asset base or other structures per se but what the investors are getting needs to be very clear. Kidney spoke of a concern "very pale green" bonds might be pushed as "dark green" bonds.

"There are some rules emerging in the market but at the same time there needs to be a way to grow investor demand for green assets," Kidney told Banking Day.

“Green” buildings for example have ranged from “shallow retrofits” to genuinely energy efficient new properties. Industry standards are clearly required for further maturity.

In a briefing note late last year on project bonds and infrastructure projects in Asia, Baker & McKenzie quoted a Bloomberg New Energy Finance (BENF) report that 2014 volumes for the first nine months were US$32.6 billion - more than double the entire volume in 2013 - with full-year volumes predicted to total US$40 billion.

“Leadership in the green bond market has come largely from multilaterals or development banks, such as the European Investment Bank with its 'Climate Awareness Bond' and the World Bank through the International Finance Corporation,” the note said. “However private players and banks are increasingly issuing such bonds.”

It is possible but not certain that the growing trend of divestment by a growing number of investors will fuel the market for green investments and hence the creation of new assets.

Baker & McKenzie said “the key drivers appear to be concerns about the environmental and climate impacts of (the divested) companies' activities, moral and ethical standards, portfolio diversification and the growing spectre of asset stranding (where changing values or investment paradigms increasingly render such assets stranded from prevailing values)”.

The firm noted at the UN Climate Summit 2014 it was announced more than 160 institutions and local governments and over 500 individuals had committed to divesting US$50 billion from fossil fuels within the next 3-5 years and would re-invest in new energy sources. (Bear in mind BENF estimated the global stock market value of fossil fuels assets is over US$5 trillion.)

However, divestment from carbon intensive energy doesn't necessarily mean investment in clean energy.

Capital seeks the highest return, all things being equal. BENF's White Paper argued more green bonds, more yield companies and more special purpose vehicles - together delivering scale, liquidity and positive perceptions about the future of the sector - are needed.

At the end of the day, price signals drive real shifts in capitalist economies. In Australia, the carbon tax did just that. But consider what is happening as the oil price collapses and new gas sources are brought on stream at cheaper costs: certainly coal continues to be punished but investment funds are now flowing to gas – cleaner but not clean – rather than the “green” assets like solar and wind.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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