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The month ended with the German State of North Rhine-Westphalia (NRW) bank successfully issuing a AAA Green Bond to refinance ‘environmentally friendly water and energy projects’ in the region. This includes the ‘renaturation’ of the Emscher river, water management boards in the state, as well as their reservoirs and water treatment plants.
On the demand side, the good news is that more than half of the investors were totally new investors – a useful anecdote to share with potential issuers.
The bad news was that NRW decided to issue the bond without 3rd party certification or even linking to accepted criteria (as proposed by the Green Bonds Framework, for example). The better news is that as this is all refinancing – all the projects were identified to investors during the roadshow.
We assume that the investors who bought the bond are qualified to make a call on whether the projects are green or not, but we also think using external standards on water is especially important given the tricky nature of water investments. The provision of clean water is an important social goal, but from an environment/climate perspective water treatment can be highly energy-intensive and not really a green investment at all. We’re not saying this is the case with NRW, but we can’t be sure either way because there would not seem to be easy access to details of what’s in the bond.
So it was a big month for “labeled” green bonds, with a 50% rise in bonds outstanding. Various bankers have been saying it was a tipping point, and we’ll no see a lot more. I suspect they’re right.
To ensure this market doesn’t fragment and the deflate like a failed soufflé, we reiterate the need for:
- Transparency around specific assets involved and around criteria for inclusion.
- Linkage to credible and standard definitions.
- Third party review.
Until the next crop ….
While we knew the bond was in the pipeline, we didn’t quite expect a EUR1.4bn bond ($1.9bn) and it could have been bigger! Apparently it was two times oversubscribed.
This bond shifted the market firmly away from the AAA space and demonstrated that there is plenty of demand further down the ratings scale to A+.
The bonds are tied to the company’s renewable energy business, EDF Energie Nouvelles. The bond was reviewed by french ESG company Vigeo, who worked with EDF to come up with project-level ESG criteria for EDF. This covered a broad array off issues, such as human rights, environmental impacts and supply chains. Deloitte will then provide the tracking and sign off against the developed criteria.
We’re broadly happy with the credentials of this bond, primarily because we know it’s going to be used only for the Energie Nouvelles business, so it’s visibly ring-fenced.
However, we were a bit worried that Vigeo’s criteria did not state which types of projects can be included but rather provided an ESG scoring framework for projects that are already in the bond. We spoke to Vigeo about the types of projects and were broadly happy with their approach; it’s not a climate standard and perhaps not scalable, but it’s in the right direction. We’ve agreed to work together in aligning approaches.
Expect to a lot more EDF in this space.
Bank of America Merrill Lynch (BAML) joined the list of first corporate entities to issue a labelled green bond, and set a new model for commercial banks. We’re expecting this to be the beginning of a long line of commercial bank green and climate bonds.
- The bond is linked to a subset of their $50bn Environmental Business Initiative. The fairly broad lending criteria they use have been developed as part of consultations they’ve held with NGOs and research centres such as Ceres and C2ES.
- An auditing firm provides a further signoff and assists with tracking funds and project selection
- According to the use of proceeds document, eligible green projects include renewable energy ”such as” solar, wind and geothermal. Technically this leaves the bond open to some of the other areas in the environmental business portfolio as defined by the BAML CSR report - that report includes hydropower, biomass and biofuels. However BAML have verbally confirmed that the renewable energy portion of the bond will include only wind, solar and geothermal assets. It would be good to have that in print.
- Energy efficiency projects are included in the bond – at the moment there is (unfortunately) no threshold/hurdle rate for energy/carbon, but performance metrics will be included in reporting.
- Projects/assets funded through the green bonds will be reported on (including performance metrics) in detail via a separate website. Each project will be reported on rather than on an aggregate basis – that’s an excellent precedent for the industry.
BAML’s bond was also one of the first non-development bank bonds to be issued without any explicit mention of a third party certification to assure investors that bond proceeds will be used to fund ‘green’ assets. This got us a little worried as we didn’t want the first bank issuance in the space to open up the possibility of a decline towards greenwashing – we see credible third party certification as essential immunisation against that prospect.
We did speak to BAML about our concerns; the conversation reassured us and we are generally happy with the bond, but we do think better transparency on criteria and certification would set a good precedent for the market.
There are some excellent points about this bond:
- The commitment to project-level reporting – we will follow the progress made on this and hope that others will make similar commitments.
- Renewable energy investments will avoid controversial technologies like biofuels (at least until there are clear standards) and focus on solar, wind and geothermal.
- Auditor tracking of funds sets an important precedent for the market.
What could be better…
- Further clarity on inclusions before the fact rather than after (reporting), including a public commitment (but not necessarily in SEC docs) stating which types of renewable assets are included in the bond. At the moment, the document says ‘such as wind, solar and geothermal’. The broader ‘environmental business’ commitment this bond sits within includes areas which could raise red flags for investors (nuclear, biomass, biofuels etc.), so bond investors either need further criteria on these tricky areas or to know that they aren’t included in the bond.
- Third party sign off on criteria and bond: Currently, some organisations (Ceres etc.) have “input” into broad environmental business inclusion criteria, but they don’t publicly sign off on either the criteria for the bond or environmental business. Inclusions should be in line with trusted, public standards and verified as such by an independent body/auditor, so there are no surprises down the line.
- Specify exclusions, especially if there are any in the energy efficiency business – e.g. unlike the World Bank Green Bond, we don’t know here whether coal power retrofits could be included or not within the energy efficiency criteria.
- EE investments should have hurdle rates for efficiency improvements – IFC and others have them because:
- Very low % improvements in energy/carbon are barely enough to offset the lifecycle emissions of the technology installed (manufacturing etc.)
- For many projects (e.g. EE retrofits in buildings) EE investments may only take place once in a decade or longer – so if only minor retrofits (with minor climate impact) are made, these are likely to remain static for decades before further improvement takes place – this can leave a building hopelessly out of line with what is required for a low carbon economy.
It’s a good start to the commercial bank green bond market, but in future we would hope to see clearer criteria and third party review for BAML and for any other commercial banks joining the party.
Energy efficiency can be a tricky area. LEED and BREEAM are great but these are materials standards, not building performance standards. As CICERO‘s Second Opinion on the bond notes, LEED and BREEAM “fall short of guaranteeing an environmentally-friendly building”. That means that they don’t necessarily predict the energy performance of a building, which is they key issue for energy efficiency metrics. The LEED points system, for example, allows a building to get points for reducing noise pollution or having bicycle parking.
CICERO‘s report recognises these limitations; they worked with Vasakronan to provide additional assurance to investors. This included adding site selection criteria (LEED doesn’t have site criteria and therefore you could build a very green home far away from any transport thus necessitating car use) and putting some mechanisms in place (Green Lease programme) to avoid the rebound effect. It is also worth noting that Vasakronan’s corporate energy use that is 47% below the industry average.
CICERO has recognised exactly where all the issues lie so have ensured that Vasakronan provide additional assurances. This is great for this bond but possibly a little case-specific for rapid growth in the market. The detailed bespoke bespoke nature of CICERO‘s work with Vasakronan is not easily scalable – we’re not sure what would happen if 100 new bonds knocked on the door tomorrow. One way to get around this could be to have performance standards/hurdles in place for buildings which are monitored and reported over time – this way, even if the building is LEED, investors can still see whether the building is actually saving energy/carbon or not.
Nov review 3/7: Kommunalbanken’s $500bn green bond funnels proceeds to Norwegian Govt-mandated local govt climate projects
The Norwegian development bank Kommunalbanken (KBN) followed swiftly behind the heels of the IFC with a $500mn bond to finance ‘climate friendly’ projects. KBN provides low cost finance to the local government sector in Norway. The eligibility criteria are determined internally, but the bond was reviewed by Oslo climate science research centre, CICERO.
CICERO doesn’t provide a certification of the bond, but rather a “Second Opinion” on what it thinks of the KBN criteria and it notes areas where there is some uncertainty. KBN’s eligible projects include mitigation projects (such as energy efficiency and renewable energy), adaptation projects (such as ‘climate-resilient growth’) and ‘projects relating to sustainable development’.
KBN has said it will provide investors with an annual list of the projects financed and further information about selected projects; the commitment to reporting is great.
CICERO is a highly trusted 3rd party, so we’re broadly happy – especially because KBN has taken a great step in making CICERO’s Second Opinion public (unfortunately not yet the norm with CICERO opinions tied to SEB underwriting).
But a reading of the Second Opinion does throw up a niggle, in that we’re not sure what exactly will be in the bond. There are a list of example projects, but some of them are a bit vague. The web site suggests that funds will be flowing to projects that fall under the Norwegian Governments new mandatory requirement for local governments to develop energy and climate plans. That would work – but if so this needs to be more clearly explained.
From new issuer to an old faithful, the IFC issued the second bond of the month, which was also their second USD1bn bond in 2013. The first USD1bn bond was a watershed moment in the green bonds market as its size stirred a great deal of interest from both investors and underwriters. This second bond was apparently priced and sized in response to market demand – which is a great signal of market demand for this type of product. Rumour has it that they’re planning a further few billion per year in the future.
IFC have been issuing green bonds for some time and although their reporting could still be even better, they are a great role model with their criteria published online and a third party review provided by CICERO.
Having said that, we do still find their general criteria a bit vague (for example, they have ‘biofuels’ in there without specifying further criteria to address worrying issues around feedstock etc.). However, their guidance notes explain that all of their projects also go through a carbon accounting and must achieve certain hurdle rates in order to be included as ‘climate lending’. That would, we believe, would exclude a lot of biofuels projects and other controversial areas.
The guidance notes also indicate they use a 15% hurdle rate for energy efficiency projects, which is much better than the ‘any improvement is better than nothing’ approach that is still the norm. (FYI: If we’re to achieve needed emission reduction targets from energy efficiency measures we have to be ambitious in our efforts; because people tend to only make improvements periodically, if you only do a small improvement you may lock out further improvements for a long period).
Unfortunately these quite important IFC guidance notes are hidden deep within the IFC website (we had to get help from the IFC to find them). Would be good to link them more directly to the IFC Green Bonds web pages.
The month was kicked off with a bond from a new issuer to this space – the Dutch development bank FMO (Financierings-Maatschappij voor Ontwikkelingslanden). They issued a EUR500m “Sustainability” Bond to support the financing of ‘green and inclusive finance projects’. This includes renewable energy, energy efficiency, responsible agriculture, food production, transport, waste supply and access as well as microfinance. So pretty broad then.
The broad array of potential investments is great. We’ve been saying for a while now that climate investments are about so much more than just energy, so the fact this bond recognises the role that all sectors play in a low carbon economy is fantastic.
Problem is, it’s not so clear how they’re defining some of the areas – ‘responsible agriculture’ is one such area. Similarly, some water and agriculture investments can be negative in terms of addressing climate (e.g. water treatment can be highly energy intensive) and it isn’t clear in FMO‘s offer materials that their exclusion criteria address these issues. Another niggle is that the criteria around energy efficient retrofits includes lending to “improving of power plants and power infrastructure and cogeneration”. Our worry is that this leaves open the inclusion of fossil fuel fired power plants. We do know that FMO has been out of the coal-fired power lending game for awhile, but they do still have loans on their books for retrofitting at gas-fired power plants – we’re reasonably sure they exclude these, but it would be great to be clear.
FMO is a blue-chip development bank, and everyone will be very comfortable with the credibility of their approach in terms of climate; but to help grow a larger market it would be great to provide better definition around inclusions. Next time perhaps.
A review of November’s $5bn Green Bonds craze – when it rains it pours. Standards will now be the key to avoid greenwash
It’s been a crazy month for “labelled”* green bonds. At the beginning of the month, there was approximately $10bn outstanding (just under $13bn has been issued but some matured) consisting of mostly of AAA multi-lateral development banks and (depending on how you count) a few municipalities.
Now, as November closes, we’re looking at approximately $15bn outstanding with the first few corporate issuances released! One month on and it’s a different world. Here is a brief summary:
- Labelled green/climate bonds market grows by 50%
- 8 bonds issued in November– 7 over the magic $300m mark
- First corporate green bonds issued: 3 in one week!
- Demand is HUGE – most bonds were oversubscribed.
- Biggest green bond ever issued – EDF with EUR1.4bn ($1.9bn)
- 2 bonds issued without 3rd party standards/certification
- Houston we have a problem with Standards!
- Refinancing vs new assets – some of the bonds
FYR: what’s the diff between climate and green bonds?
- Climate bonds are those where funds are linked to assets that contribute to a rapid transition to a low-carbon and climate resilient economy. There are some $350 billion outstanding globally, of which $28 billion are renewable energy bonds.
- Green Bonds are corporate-style bonds where funds are ring-fenced for green – largely climate – projects. There were some $15 billion outstanding at the end of last month. They are included in our annual market report on Bonds and Climate Change.
So, it’s been a busy month and the growth is fantastic to get capital flowing. The explosion has shown just how much demand there is out there with most bonds oversubscribed, some several times over. The big game changer has been the entrance of corporate into the space – we’ve been saying for a long time that while MDB issuance is great, the big capital shifts will come when corporates get involved – first by issuing corporate asset-linked bonds and later down the line asset-backed securities. We hope that this is the start of a trend.
Another notable feature is the mix between bonds for refinancing of existing assets vs the financing of new asset. There’s been a bit of debate about whether investors want only new assets (EDF) or to finance existing assets (NRW, Vasakronan). The fact that investor demand has not discriminated between types shows that, at this stage, investors are happy with both. This is good news from our point of view, although refi might not be as sexy, we’ve long been saying that refinance is essential part of the financing pipeline. It allows banks to get loans off their books and lend more – the easier the loans are to offload, the more likely they are to make more of them. It also allows institutional investors to take part in the market post-construction phase when the risks are much reduced.
With such fast growth, however, there is also a risk that the market gets ahead of itself, forgets about standards and greenwash prevails. In our view, the best way to avoid greenwash is to have very clear, public standards in place that each bond can be certified against (by a credible third party).
Our view is that even trusted organisations need to use recognised standards to identify which projects are ‘green’. For the trusted issuers, the issue is less about whether the money goes to the stated investment area as it is about whether the stated investments are green in the first place. Even the World Bank understands that having third party review bolsters their case – a fact they have recognized in their use of third parties to review inclusion criteria.
As the market expands from trusted development banks towards corporates, then money needs to be tracked and that’s when bonds need to be certified by auditors or third parties. (It would be great if development banks all used third party certification for this, simply to set a precedent for the market.)
Unfortunately, it’s not yet certain that markets will head that way as the record-breaking month saw two new issuers issue bonds without third party certification or clear reference to published standards. Of course investors don’t seem to be too concerned at this stage as even uncertified bonds were oversubscribed. It does make one wander – do we have to have a big scandal for investors to be asking the right questions and demanding standards?
As the market continues to grow, this is something we’ll be banging on about– soon you’ll be saying ‘standards, standards, standards’ in your sleep!
Following is a bit more detail on each of November’s 7 Green Bonds.
UK Greater Gabbard wind-grid bond, 19yr £305m ($496m), is 3 x oversubscribed. Whacko! EIB Proj Bonds Initiative helps it get magic A3 rating; shows the way for future Proj Bonds credit enhancement
A successfully placed 19 year, £305.14 million ($496m) bond to fund the acquisition of a large offshore wind energy transmission connection shows how the EIB’s Project Bond Credit Enhancement Initiative can make a real difference.
Balfour Beatty, Equitix and AMP Capital Investors today announced financial close on a £317m offshore transmission project connecting Greater Gabbard Wind Farm to the UK grid. The consortium was awarded the Ofgem tender to own and operate the high-voltage transmission link to Greater Gabbard (owned by Scottish and Southern Energy).
The acquisition is part-funded through the issuance of a £300m bond, priced last night at 125 basis points over benchmark gilts. That’s a very good outcome.
The grid-connection-to-wind-energy assets involved qualifies it as a climate bond according to our Climate Bond Standard Taxonomy.
The Sterling bond was largely placed with a wide selection of the UK investor community, but also had strong interest from Canadian and Euro investors.
The bond has received an uplifted credit rating through the European Investment Bank’s Project Bond Credit Enhancement Initiative, allowing it to achieve an A3 rating from Moody’s. This is one notch above what it would have achieved without the enhancement and gets it just over what is the European investment-grade border nowadays (it’s usually seen as Baa3/BBB-, but the demanding climate in Europe is leading many people to say A-/A3).
According to UK energy regulator, Ofgem, this is the first Offshore Transmission Owner (OFTO) project to be funded through capital markets. It’s also only the second EU project to be funded under the Project Bond Credit Enhancement Initiative.
We’ve been a great supporter of the Initiative as a credit support tool; it’s a guarantee pool that doesn’t actually involve funds drawdown unless something goes wrong, so it’s a very efficient use of EU capital. But we’ve been frustrated by the European Commission’s unwillingness – so far – to narrow eligibility criteria so as to exclude high carbon assets. The first investment supported was for a huge gas storage facility in Spain (no, we do not count that as low-carbon).
Rumour has it that a bunch of motorways are coming through the system next; not exactly low-carbon either – the EU needs help with emissions not encouraging more car use. The Greater Gabbard deal, on the other hand, is exactly what the facility should be used for.
Hopefully, when the European Commission confirms that the Project Bonds facility is being continued beyond its pilot, they’ll also amend the eligibility criteria to ensure low-carbon assets are the priority.
In the meantime, congratulations to HSBC as lead arranger and their joint bookrunner Banco Santander SA.
COP19 snippets #2: new rpt shows climate finance flows flat @$359bn p.a. vs $1tn needed / IEA says we have to make EE ‘cool’ / OECD platform to support Green Banks / World Bank: could EM megacities issue green munis to fund green transition?
Climate Policy Initiative has launched a useful Climate Finance Landscape web site.
Key finding: climate investment plateaued at $359 billion in 2012, far short of the need. In contrast, the IEA projects that an additional investment of $5 trillion (above business as usual) is required between now and 2020 for clean energy alone, to limit warming to 2°C. Work to do.
- The global solar PV capacity grew 42% last year and wind energy capacity by 19%.
Great result; but long way to go. A few years ago I was involved in a study for WWF by Climate Risk to model growth rates required by low-carbon industries to avoid catastrophic climate change. Based on past examples, the maximum growth rates we can expect over an extended period are 25-30%; modelling showed we needed every low-carbon sector. See our Taxonomy of the Low-Carbon and Climate Resilient Economy for a sense of what those sectors are.
- On current plans, by 2017 the world will have built all the fossil fuel infrastructure we can to get the maximum emissions allowable in 2035.
So in three years we have to stop building all new coal and gas infrastructure. That’s why we can’t retrofit existing coal-fired power stations to extend their life, let alone replace old ones with “more efficient” ones – unless they are made zero-carbon by deploying carbon capture and storage. We’re losing this one in China, where 450 coal plants are in planning.
- We’re currently on a path to global warming of 6°C. Of all the energy-related activities we need to undertake to keep temperature increases to a maximum of 2°C, 42% are energy efficiency.
That will mean a lot energy efficiency work; yet efforts to scale up energy efficiency measures are not meeting policy targets anywhere. New thinking is needed. Philippe is of the view that we need to build a social compact around energy savings, in the same was that renewable energy has. He essentially means making energy saving “cool”.
Click to see the summary of their Energy Efficiency Market Report 2013 (or pay EUR100 for the whole bedazzle).
The OECD says there are now 14 dedicated Green Banks around the world. The OECD is launching a coordination ‘platform’ so they can all learn from each other. Excellent.
In coming years we’d like all development banks join the platform. As World Bank VP Rachel Kyte says, measures to address development and climate change need to be fully integrated. That means development banks need to also be seen as Green Banks, focusing both on sustainable (green) growth and on ensuring adaptation issues are addressed in all development work.
From the World Bank’s cool “Building Low Carbon Cities” initiative:
- If the world’s cities embark on a low-carbon development path, global green house gas emissions could decrease by 30%.
- Only 20% of the 150 largest cities have even the basic analytics needed for low-carbon planning.
- Of the 500 largest cities in developing countries, only a small percentage are deemed creditworthy.
If we work on that last point, developing country cities could be issuing climate bonds to fund low-carbon development. Now there’s a project for 2014.