Frequently Asked Questions; Standard

The mobilization of investment to address the challenge of climate change is a topic of international urgency.

The International Energy Authority has noted that approximately $1 trillion of investment is required each year until 2050 in clean energy and related climate mitigation efforts – above and beyond “business-as-usual” investment requirements (see “IEA Energy Technology Perspectives 2010”). Not only does this cost not include adaptation measures but also increases each year there is delay in the transition to a low-carbon economy.

Given constrained public finances, the scale of required investment can be achieved only by mobilizing private investment, in particular from the institutional investors who manage the bulk of the world’s private wealth.

The capital-intensive, low running cost and stable revenue features of many climate change mitigation investments make them a good match for the fixed income requirements of long-term investors.  

Without broadly acceptable standards we will have a race to the bottom with environmental-themed bonds.

We already have seen a weakening of the idea of “carbon offsets” because of a lack of standards about acceptable (environmentally rigorous) schemes. In the current market poor quality offsets are, for most buyers, not readily distinguishable from high quality offsets. In such circumstances the poorer quality will come to dominate for price or availability reasons, sparking a race to the bottom, or an abandoning of the sector.

Early intervention is needed to avoid the negative effects of a lack of robust standards and a consequent undermining of the credibility of the thematic approach.  

Standards may emerge after a number of years; but we don’t have time to allow that to happen organically. We need to quickly channel funds where they need to go.

Markets don’t develop standards spontaneously. But standards imposed by appropriate agencies can promote the growth of markets.  

Climate Bond-funded project would be required to secure a Certificate of Compliance as a “low-carbon” project for that particular project-type. That means it complies with adopted standards. Some projects, such as biomass energy generation plants, might require annual certificates of compliance (e.g. evaluating feedstocks utilized).

Prospective issuers of Climate Bonds will be referred to licensed third party verification bodies such as accountancy firms and technical auditing firms. These firms will verify that the projects and accounting practices for the use of Climate Bond funds correspond with the criteria set out in the published standard before reporting back to the Standards Board to recommend certification or not.

Standard approaches for dealing with non-compliance with environmental bond covenants as well as appeals in the event of an unsuccessful application are being developed as part of the Program’s architecture.  

Some projects clearly are associated with reductions in carbon emissions — such as solar and wind power projects. Some are important but must be managed carefully, such as biofuel and bioenergy projects involving land use changes. Some are controversial, such as carbon capture and storage.

The benefit of a standard is that it allows investors to assemble diverse portfolios with confidence about the investor acceptance of their environmental integrity.  

The standard will assess the low-carbon value of the bond’s underlying assets.

Projects such as solar and wind can be expected to have a simple yes/no decision-making model. Project types that require more complex evaluation, such as energy efficiency, may have conditional certifications.  

Yes, Climate Bonds issuers will pay a small fee for verification of their claims and then for certification.  

Three reasons: - Because they can get the “fast-tracked” interest of institutional investors looking for such investments.
- For reputational reasons — to highlight to customers, shareholders, governments and other stakeholders the green investments they are making.
- To develop expertise and profile in what is likely to become a large market, especially once government take a stronger role.  

A Climate Bond Standards Board will oversee development of the Program. Membership of the Board will be comprised of environmental non-government organizations (ENGOs), asset-owners such as pension funds, government officials, and quasi-government institutions such as multi-national development banks.

Members announced so far are California State Treasurer Bill Lockyer, the Natural Resources Defense Council, the Investor Group on Climate Change and the Carbon Disclosure Project. Announcements about further members will be made in coming weeks.

The standard development process allows for a broad and transparent stakeholder consultation period, where interested parties will provide input and comment.  

The Standard Program has been initiated by the Climate Bonds Initiative (CBI), an investor-focused not-for-profit organization promoting large-scale investment in low-carbon industries. More information can be found at www.climatebonds.net. The CBI will staff the Program.

Apart from climate bond standard, The Climate Bonds Initiative is developing:

> Proposals for government architecture — regulatory mechanisms, tax policies, green banks — that will support a rapid scaling up of investment.

> Models for encouraging investment in projects and assets necessary for a rapid transition to a low-carbon economy.

> Projects to demonstrate how to encourage investment.

> Decisions about the standard and its development will be the responsibility of the Climate Bond Standards Board.

The Board is supported by “industry working group”. Members of that group include representatives from the International Finance Corporation (IFC) Standard & Poor’s, KPMG, Calvert Funds Management, DNV and Environmental Capital Management.

Funding for the development of the Program comes for a range of sponsors, including foundations and corporations.

The standard will assess the low carbon value of the bond as it relates to the intentions of the issuer and the assets linked to the bond.

Oil companies re-financing and/or investing in low carbon assets applicable under the standard, such as wind energy, would be eligible.  

The monitoring requirements for compliance with the standard will depend on particular project types with little or no monitoring for straightforward areas such as renewable energy and annual and/or more complicated monitoring requirements for other projects.  

We are concerned with low and zero-carbon assets, and assets that will support the transition to a low-carbon economy. The standard development process therefore prioritizes assets which meet this criteria and have no significant drawbacks attached to them such as renewable energy.

For assets that present more complicated issues, a thorough and transparent standard design process will consider these issues and indeed whether such an asset type is relevant under a low carbon economy.

This applies to nuclear energy assets with waste management and other complications, as well as to biofuel-type assets with land use complications. Decisions about project types will be made by the Standards Board.  

The Climate Bond Standard is not a financial standard or a substitute for financial due diligence procedures.

Over time, certification of environmental credibility may improve the attractiveness of projects and increase demand. But creditworthiness will need to be assessed in the usual manner.  

Each Climate Bond would be covered by a separate agreement in much the same way as a Credit Agency rating is typically given on a deal by deal basis for each bond issue.  

In the first iteration we are certifying project, corporate and portfolio bonds for wind energy related assets. We will seek to consult on whether further clauses will be required for sovereign bond issuance that could be added to the Standard. However, in the meantime, there is nothing to stop some governments to issue bonds that they can say will be used for wind energy investments that we can test certification with.

We are working on eligibility criteria for a wide range of other assets – energy efficiency, bioenergy, broadband, adaptation, forest – that we see as relevant to a rapid shift to a low-carbon economy. As we announce more of those, a government will be able to issue a programmatic bond to fund a wide range of activities. For example South Africa might issue sovereign climate bonds to fund a range of activities under its national mitigation plan. We hope to be able to certify such bonds in 2013.  

We are starting with renewable energy at it is an asset with the most consensus among experts as to their contribution in delivering the Low-Carbon Economy. Solar criteria are about to be announced.  

We see carbon markets as complementary. They can provide an additional cash flow for underlying projects that bonds are issued against.

However, bonds do not have to prove additionality or estimates of emission reductions to be certifiable. Our approach instead is to develop specific criteria as to what characterizes suitable assets for the Low-Carbon Economy and that bonds raise finance or re-finance these solutions.  

In theory, the Standard could be used as tool to track private sector finance flows to developing countries to support the implementation of NAMA plans. We are also pressing for the Green Climate Fund to be used a guarantee pool to leverage pension fund money into climate change solutions – much of that through bonds, best-suited to pension fund liabilities that could be certified as Climate Bonds.  

The Standard and various components will eventually be fully financed by certification fees, but these have been set very low (one tenth of a basis point) so there will first need to be a volume market. The initial development process for eligibility criteria relies on sponsorship and grants at the moment – from National Australia Bank, Bank of America Merrill Lynch Foundation, European Climate Foundation and the Sainsbury Family Charitable Trusts.

The idea of the Standard is to create binary eligibility criteria so as to minimise certification cost; but originators will still need to commission an assurance report from an approved verifier (the first two are DNV and KPMG). That looks to cost $20-50,000 for corporate bonds, possibly less for project bonds. But costs for 50m and 500m are likely to be much the same.  

Use-of-proceed corporate treasury guaranteed bonds are simply corporate bonds where the funds have been ring-fenced to “qualifying” areas of investment.

The corporate bond market is very large, with strong demand for investment grade product. The Climate Bonds Initiative believes that companies could be encouraged to steer effort to low-carbon industries if they were able to tap new investors interested in those low-carbon activities.

For a bank, they can be ring-fenced to existing loan pools, say for wind and solar energy, or to planned project loans. (The Climate Bond Standard specifies that funds must be expended within 12 months or the bond will be de-certified.)

Ring-fencing does not require setting up a special-purpose vehicle or legal separation. It simply requires internal tagging and internal procedures to ensure that the amount of the pool does not drop below the amount of the bond. In that sense a use-of-proceeds bond is similar to arrangements for a covered bond cover pool, but without recourse to the pool.

This is the same model used for the earmarked bonds issued by the World Bank (“Green Bonds”) and the European Investment Bank (“Climate Awareness Bonds”, each linked to low-carbon investments. “Wind bonds” issued by utilities operate on the same principle. The same principle can be applied to corporate bonds more generally.

Special purpose use-of-proceeds bonds have been issued before – such as war bonds in the UK in the 1940s and highway bonds in the US in the 1950s – and could be again for the purpose of investing in the low-carbon economy.

The advantage for the investor with a use-of-proceeds bond is that they have no credit exposure to what are still seen as “novel” assets, but get the reputational and socially responsible investing benefits.

Benefits for issuers?
- Access to new investors interested in the climate theme.
- Reputational.
- Opportunity to educate investors about the cover pool, preparing them for later asset-backed security issuance.  

The process is as follows:
1. Originator/bank commisions an independent approved verifier to review offering. The verifier’s role is to check whether the bond meets the criteria spelt out in the Standard (http://standards.climatebonds.net), including type of investment (wind or solar energy at the moment, but energy efficiency will be added for buildings mid-year).
2. The verification report then goes for final sign-off to the Climate Bond Standards Board. There is a nominal 1/10th of a basis point charge for registration.
3. The originator then has rights to use the “Certified Climate Bond” kitemark and the Climate Bonds Initiative also brings the bond to the attention of a broad investor stakeholder community.
Costs vary depending on the type of bond: asset-backed or project bonds will be less cost than a corporate use-of-proceeds bond like the World Bank’s Green Bond.  

No. The aim of the the Climate Bond Standard is to support corporate issuance in public markets in the simplest way possible (i.e. using existing documentation. The Standard looks for a clear and traceable relationship between the funds and the assets to which they are linked.  

Yes. The question will be whether they fit the stated eligibility criteria; the verifier’s job is to check that nominated projects comply with the published criteria.  

The currency of the Climate Bond does NOT have to be the same as that for the projects. Yes, a Climate Bond could be issued in Dollars while the projects are in Euros. What’s important is that there is a transparent link between the proceeds of the bond and the projects.  

The term ‘labelled’ green bonds refers to bonds marketed by the issuer as ‘green’, where the proceeds are for climate / green assets or projects. 

'Climate-themed bonds' are represented by a broader universe of bonds whose proceeds are for climate projects but that are not (yet) labelled as green. This universe is much wider than the 'labelled green bonds market': $502.6 billion as of June 2014. This includes for example the Chinese rail bonds. Climate Bonds Initiative tracks this universe in the annual Bonds & Climate Change. The State of the Market' report. 

An investor seeking to build a climate-themed portfolio can look to the broader universe. The unlabelled universe indicates where future bonds can be labelled, making discoverability easier.