Wkly blog: MS $500m inaugural GB ups ante with a rare US 2nd opinion, but v odd approach to pool; Brazil BRF’s €GB has great potential, but …; Latvia utility upsizes first GB; Terraform $150m GB tap

Corporate green bonds

Morgan Stanley inaugural green bond term ($500m, s/a 2.2%, 3 year, A-), introduces second opinions to the US bank bond market (excellent) but then does an odd thing with their pool: they will not maintain full value of a  pool of green assets for the full bond

Morgan Stanley is the latest large bank to join the green bond party having issued its inaugural green bond last week, although the bank has been active in this space as an underwriter and co-founder of the Green Bond Principles.

The $500m green bond has a semi-annual coupon of 2.2% and is rated A- by S&P. The bond has a tenor of 3years. Morgan Stanley was the sole underwriter.

Proceeds from the green bond are earmarked for wind, solar and energy efficiency loans. The energy efficiency loans will take the form of investments to improve waste/heat recovery systems reduce transmission losses, lighting and heating/cooling mechanisms. All good, although as you know we believe energy efficiency improvements need solid hurdle rates to prove their value to addressing climate change. But hey.

And it’s great to see MS has excluded any retrofit or upgrades to fossil fuel generation power plants.  Climate scientists are telling that all coal has to go go go, unless it has 100% CCS operational. Zero of those so far.

DNV GL provided a second opinion on the bonds adherence to the green bond principles.

But there’s a whacko aspect to this bond. When we looked closer we found that Morgan Stanley’s green bond allocates proceeds to eligible green projects BUT not for the whole bond term.

According to the DNV GL second opinion: “Once released, no proceeds will be returned to the Green Bond Account. If an investment in a green bond eligible asset redeems before the maturity date of the Green Bond, and where funds are released from the Green Bond Account, the proceeds will become fungible with other capital resources.

Hmm, this means that there is potential for proceeds to be allocated to a green loan for a short period (say 1 month) which then matures/defaults. These proceeds can then be used for ANYTHING for the rest of the bond term.

This is a kind of reverse of many corporate bonds for future projects. There they can allocate funds to a neutral account pending deployment. Under the Climate Bonds Standard deployment has to happen within two years, preferably one.

With bonds issued against existing assets, like ANZ Bank’s Certified green bond a couple of weeks ago, the issuer is expected to maintain the value of the pool of underlying assets at or equal to the value of the bond for it’s full life. A bit like a cover pool for a covered bond.

In Morgan Stanley’s bond they start off with a pool of assets (loans to qualifying assets in this case) but as and if the loans get paid down they don’t top up the pool. In theory by then end of the life of the bond you could have $500m outstanding but zip all actual green assets attached.

This is weird. Why? Other banks who have done this simply ensure they have more loans in their pool of underlying assets than needed to cover the value of the bond (again, like a cover pool for a covered bond). Morgan Stanley has more than enough assets to do this.

Of course they could argue it’s just a reverse future projects bond … but they don’t do an equivalent of what the World Bank and others do and say funds will be invested in neutral accounts until deployed. In theory they can use the funds for anything.

Fortunately MS’s green bond has a short term of three years – so this may not be academic if none of the green loans mature early (fingers crossed). But, it could happen and what’s more it sets a precedent, which cannot be ignored.

The updated Climate Bond Standard coming out this summer will clearly talk to requirements on use of proceeds in cases such as these (currently covered in Part A 2&3). The Green Bond Principles may wish to revisit this topic to tighten up language as well.

We gotta talk about this one! So please let us know what you think @ClimateBonds or info@climatebonds.net

First Latvian green bond from Latvenergo upsizes to EUR75m ($84.8m) due to investor demand, Baa2, 1.9%, 7yr tenor

State owned Latvian power utility company Latvenergo’s first green bond is upsized from EUR 50m to EUR75m (US$84.8m). The bond was rated Baa2 by Moody’s, has a fixed annual coupon of 1.9% and a tenor of 7 years. The sole underwriter was SEB and CICERO gave a second opinion on Latvenergo’s green bond framework.

Over half of the investors in the deal were Latvian (54%) with the remaining going to near by countries (18% Estonian, 15% German, 11% Lithuanian, Finland 1%, Austria 1%). Asset managers accounted for 71% of the book and the reaming taken by banks (28%) and a small amount to insurance (1%).

Proceeds from the bond will finance renewable energy, energy efficiency (in the electricity grid), environment preservation and (maximum of 10%) biodiversity/sustainable environment R&D. Full review of these categories coming next week!

Brazilian food giant BRF SA joins the green bond market (EUR 500m ($562m), 2.75%, 7yr, BBB). Nice one - but bond needs more disclosure to confirm green credentials

Good news: Brazil joins the green bonds market! This will be the first of many – good on BRF for cracking the ice. But according to the press, investors weren’t that impressed with the green credentials of BRF’s green bond. Proceeds from the bond can finance eligible green projects in the areas of energy efficiency, renewable energy, water and waste management, recyclable materials, sustainable forestry, GHG emission reduction and raw material reduction. All sounds okay so far, so we did some digging around the eligible projects to find out why investors felt left in the dark about the green credentials.

To put these eligible projects into context, BRF is a large food company specializing in frozen foods, meat (poultry, swine and processed meats) and dairy. A large amount of energy is used keeping the food cold: that means a big chunk of energy is taken up with refrigeration of products. So replacing current refrigeration units with more energy efficient models sound like a brilliant use of green bond proceeds. The only trouble is – we don’t know how efficient these models are. On the grape-vine we heard some could lead to energy savings of up to 20% compared with the current baselines. That’s incredible! If only BRF has disclosed these potential saving investors may have been more positive about the green credentials. We’ll have to wait for the first green bond report next year to see the impact.

As a large consumer of energy BRF have included renewable energy projects such as wind, solar, hydro and biomass in eligible projects. In terms of green credentials wind and solar are fairly uncontroversial and the hydro project included is to improve efficiency of an existing small run-of-river hydro power plant (not building an extension). The biomass boilers will use feedstock from a sustainable forest. Okay, but we need to qualify “sustainable forest".  Feedstock standards from Forest Stewardship Council (FSC) or equviliant give credibility to such assertions. See our recent Bioenergy standard blog for more details.  

GHG reduction seems like a fairly wide category to us. It’s narrowed down to projects that reduce methane emissions from industrial processes. Okay we can get behind that but it would be still good to have more detail. An example given in the second opinion is a project is using activated sludge on waste-water.

Finally, we come to raw materials reduction projects aimed at optimizing animal feeds to reduce the use of raw materials. At first glance this looks more like an efficiency project than anything green. At a minimum we’d expect to see details of the type of raw materials being reduced. Fortunately we’ve been assured that the raw materials reduction projects are likely to be a smaller part of the green bond use of proceeds with the main chunk going towards energy efficiency, water and renewable energy projects.  

So overall, it looks like BRF missed a chance to show off how green this bond is actually going to be. Some of the projects, in particular raw material use reduction and sustainable forestry look dubious, but overall it has potential especially in energy efficiency to have a impact on emissions. We’re already looking forward to the green bond report on his one to see how proceeds are actually allocated to proceeds – bring on June 2016!

Terraform Power Operating tap green bond for further $150m taking total issue to $950m

Following the success Terraform Power Operating’s inaugural green bond in January this year the green issue has been tapped for a further $150m. Terraform Power used the green bond to finance the acquisition of renewable energy assets. The green bond matures in 2023 and a rating of BB-/B1 from S&P and Moody’s respectively. Lead book runners for the tap were Barclays Capital, Citi, JP Morgan, Macquarie Capital and Morgan Stanley.

Unlabelled climate bonds

Italy’s Metro 5 issues a EUR150m ($165m) unlabeled amortizing project bond for metro extension in Milan; tenor 20.7yrs, floating coupon Euribor+300bps, no rating

Metro 5 SpA issues a €150MM ($165MM) unlabeled climate project bond to finance the extension of Metro 5 line. The project bond has a tenor of 20.7 years but is amortizing beginning in 2016. The private placement has a floating coupon linked with Euribor +300bps. The underlying project received revenues under a public private partnership agreement with the Municipality of Milan. Rail project have clear climate projects due to the significantly lower emissions profile rail has over road.

Market Developments 

Tax incentives for green solar bonds in India will feed through to lower cost loans to solar developers. State-owned firms will be able to issue tax-free bonds to finance solar projects in India according to Live Mint. This means Power Finance Corp., Rural Electrification Corp., and IREA (Indian Renewable Energy Development Agency) will be issuing the tax-free solar debt and passing on the savings by providing lower interest rate loans to solar developers. Great work India!

NASDAQ launches a sustainability green bond list with requirements of use of proceeds and second opinion. Following the success of Oslo Bors green bond list the Stockholm NASDAQ OMX just launches it’s a green bond list to make it easier for green bonds to be traded. This new list, similar to the Oslo list, has requirements that the green bond has a second opinion but it differs from previous lists because it allows sustainability bonds which use proceeds for a mix of green and non-green (social) purposes. 

Four pillars needed for energy success at COP21

IEA sets out four key pillars for to make COP21 a success from an energy perspective. These focus points for the COP21 participants to work towards:

1) setting the conditions to achieve an early peak in global energy-related emissions

2) create a five-year revision cycles to national climate targets

3) translate the world's climate goal into a collective long-term emissions goal

4) establish a way to track the transition to a low carbon and climate resilient economy.

If adopted all of the pillars would help boost the green bonds, which can be used to finance the low carbon transition. Look out for more demands for outcomes at COP21 in the coming months.

FT asks: Are green bonds useful for climate investments? We say Yes! Here’s why…

FT’s Sophia Greene called into question whether green bonds are a useful way of investing to limit or mitigate climate change in her recent article “The dark side of green bonds”. The article calls on the additionally argument that bonds may not actually be financing new projects.

Sophia’s right in a way – and that’s because bonds in general are more of a re-financing and a project finance tool. Only 5-10% of debt financing for projects is in the form of bonds, and that’s unlikely to change – partly because project financing requires specialist risk understanding that is more common among bank lenders than bond investors.

In the capital pipeline we need the construction or early stage financing to come from those asset classes traditionally used; project finance and equity. Once a project is up and running, with stable revenue streams, then bonds can be used to refinance. Green bonds alone are not a silver bullet for climate change investment, they are part of a wider climate finance tool kit  which investors have to address climate risks in portfolios.

A large and liquid re-financing market allows equity investors and banks to be confident they will be able to get their capital back quickly after construction, allowing them to move on to the next crop of projects.  This role is essential not something to apologize for. For that reason you’ll see us shouting from the rooftops out support for the re-financing of existing assets inn the green bond market.

Before the first green bonds came along in 2007 there was little that could be showed, other than exclusions based on the entity level ESG score, of integrating environmental risks into bonds. This differs from equity where ESG integration has taken hold in the last decade. ESG works in equity because shareholders can engage with management and vote at shareholder meetings to highlight environmental concerns. In the debt market this is not the case as the bondholder only has rights to the capital not ownership of the issuer. Green bonds enable bond investors to take a green option.

As for the pricing question, let’s not forget that this is still a relatively young market, having kicked off with corporate issuance only 2 years ago. Pricing differentials will come with time. Until then, we as media should be encouraging green bonds and financing of green assets because we need scale and liquidity in this market.

Green Bond Gossip

Toyota Finance returns to green market with 2nd green bond ($1.25bn): backed by (non-green) car loans and leases but proceeds to grow green assets. Toyota Auto Receivables has issued its second green asset backed securitization. Similar to it’s inaugural green ABS proceeds will finance green car loans and leases; though the bond is backed by a mixed pool of green and non-green assets. More details on the deal in next week’s blog.

Another milestone for the market as World Bank issues 100th green bond! Since it’s inaugural issue in 2008 the World Bank has now completed its 100th green bond. The retail green bond is for US retail investors is linked to the Ethical European equity linked. As with all World Bank green bonds CICERO provides a second opinion. BNP Paribas are the sole arrange of the deal. This follows the World Bank’s largest ($600m in March) and longest tenor green bonds earlier this year. Brilliant work!

First SRI Sukuk issued by Malaysian Sovereign Wealth fund Khazanah Nasional leads the way for green sukuk. We’ve made the case for green sukuk before in the blog; it’s a big opportunity waiting to happen. Now we’ve gone a step closer to seeing it become a reality with a MR 100M ($27M) thematic SRI sukuk issued in the market by Khazanah Nasional. Proceeds will finance educational projects in Malaysia. Great to see this SRI sukuk hit the market; and we are still left wondering….who will be the first green sukuk issuer?

Our blogs are written by a team: Sean Kidney, Tess Olsen-Rong, Beate Sonerud, with a bit of help from Justine Leigh-Bell.