This is the proposal prepared by Bank of America Merrill Lynch and Citigroup. It was first published in EuroWeek's recent Special Report on Sustainable and Responsible Capital Markets.
Framework for Green Bonds
This paper puts forward a proposed Framework for Green Bonds to be applied by issuers looking to bring Green Bonds to the market and investors looking to maintain the integrity of their investments as they attempt to allocate funds towards a greener economy. The paper suggests the establishment of a Green Bond Working Group and encourages comments and feedback to the Draft Framework proposed here.
Green Bonds Working Group
The Green Bonds Working Group (GBWG) should be a collaboration of investors, issuers, and financial institutions that seek to promote a Framework that will establish and protect the credibility of the Green Bond asset class by promulgating a set of practices relating to Green Bond issuance that encourage transparency, ethics, and integrity.
Establishing a Framework that enjoys widespread acceptance requires open collaboration. This will include but not be limited to collaboration with:
- Institutional investors in bonds including insurance companies, bond investment funds, pension funds, and others;
- Multi-Lateral Institutions, agencies, corporates and other institutions that issue bonds;
- Underwriters and lead managers that are active in the Green Bond market;
- Rating agencies and other professional services providers to the bond market;
- Regulatory agencies that oversee the bond market;
- NGOs such as Climate Bonds Initiative (CBI), CERES and others that contribute to thought leadership on energy, environment, climate change, sustainability and finance;
- Academic institutions such as LSE (Grantham Climate Change Institute), Oslo (CICERO), Columbia, Stanford, Tsinghua, and others that conduct research on energy, environment and climate change;
- Government agencies at the national, regional and local levels.
Green Bonds Framework
The Green Bonds Framework is a written set of voluntary guidelines by which investors, issuers, banks, investment banks, underwriters, placement agents and others may communicate about the characteristics of any given Green Bond. The Framework has seven (7) parts:
- Definition of Green Bonds
- Criteria for Use of Proceeds
- Issuer’s Process for Project Evaluation
- Management of Proceeds
- Additional Assurance
- Central Forum
The Framework allows issuers to claim “Green Bond” status and then obliges the issuer to report on and create transparency on the actual use of funds. Various parts of the Framework are described in the following sections.
1) Definition of Green Bonds
In general, a Green Bond is one for which the issuer declares that the proceeds will be applied (either by ring-fencing, direct project exposure or securitization) towards climate and/or environmental sustainability purposes. The issuer is expected to report on the actual use of proceeds either at the time of issuance or on an on-going basis over the life of the bond. A Green Bond is hereby defined in three categories:
- Green Use of Proceeds Bond: a standard Full Faith and Credit (FF&C) senior debt obligation for which the bond proceeds shall be allocated within treasury to a special sub-portfolio for which the balance will be reduced only by amounts invested in Green Projects. Pending such investment, the sub-portfolio will be invested in money market instruments.
- Green Project Bond: a Project Bond for a single or multiple green project(s) for which the investor has direct exposure to the risk of the project(s). Examples: Shepherd's Flat Wind Farm Project Bonds, Desert Sunlight Project Bonds, and others.
- Green Securitized Bond: a corporate or institutional bond, including but not limited to Covered Bonds, ABS, CLO’s, CDO’s and other such structures, collateralized by one or more specific projects. The first source of repayment is the project(s) in the collateral pool. This category covers, for example, asset-backed securitizations of rooftop solar PV and/or energy efficiency assets.
2) Criteria for Use of Proceeds
The cornerstone of a Green Bond is the declaration on how the proceeds of the bond will be applied, that is, the list of eligible Green Project Categories to which the issuer will allocate proceeds. This is where environmental and climate NGOs and agencies will expect to have input and be heard, by publishing Taxonomies for eligible Green Project categories.
It is intended that Green Bonds, as an asset class, shall be managed "by the market" with no single authority or gating-keeping function. It is important that the market is open to commentary by all players. The Framework recognizes a wide array of eligible Green Bond Categories including, but not limited to:
- Renewable energy
- Waste management
- Land use
- Clean transportation
- Energy efficiency
- Clean water
- Other mitigation
3) Issuer’s Process for Project Evaluation
The issuer of a Green Bond should outline the investment decision making process to which it commits when choosing to invest in a Green Project. For example ADB, AfDB, EIB, EBRD, IFC, KBN, NIB, World Bank, and most other International Finance Institutions (IFIs) have adopted multi-step processes to ensure that environmental and social criteria are considered for each project to which they will dedicate funds. For example, for project finance, some established investment evaluation processes include the World Bank Environmental and Social Safeguard Policies, the International Finance Corporation’s Performance Standards, EIB Environmental & Social Practices Handbook, the European Principles for the Environment, the Equator Principles, and the OECD Common Approaches.
4) Management of Proceeds
Another aspect of the Green Bond Framework is to declare how the proceeds of the issuance will be managed. For example, Green Use of Proceeds Bonds placed to date provide for the proceeds to be accounted for separately. The Green Bond market may allow certain issuers, such as multi-lateral institutions and government agencies, with the appropriate track record and reputation to set its own process for allocation of funds and disclosure of this allocation to the market.
To date, most issuers of Green Bonds have established their own internal mechanism for tracking the flow of funds from Green Bond proceeds to individual eligible projects (example: IFC, EIB, KEXIM, Massachusetts, World Bank). However, as the Green Bond market expands over time, investors may require that auditors verify the flow of funds from Green Use of Proceeds Bonds to eligible Green Projects.
5) Additional Assurance
Some issuers may choose to supply additional information or assurances, internal or external, about the integrity of their Green Bond programs.
At the point of this publication, there are no Green Bonds in the market with external certification. However, some issuers have chosen to obtain a third party opinion such as CICERO, whilst others have successfully brought Green Bonds to market without this additional assurance. As the market develops, more forms of additional assurance may evolve and this Framework accommodates those future developments.
In addition to reporting on the allocation of Green Bond proceeds to specific Green Projects, many Green Use of Proceeds Bond investors expect issuers to report at least annually, if not semi-annually, via newsletters, website updates or filed financial reports, on the specific Green Projects which received Green Bond funding. In this reporting, investors encourage the use of metrics which measure (where feasible) the impact of the specific Green Projects (e.g., in terms of actual tons of carbon avoided or number of people provided with access to clean power or clean water or number of cars kept off the roads, etc.). It may also become best practice for the issuer to report on the flow of funds from Green Bond proceeds to eligible Green Projects as part of its audited annual report.
7) Central Forums for Use of Proceeds Taxonomies
The Green Bonds Working Group would like to see established a range of Taxonomies that can be used to describe the eligible Green Project Categories to which Green Bond proceeds can be allocated. The Green Bonds Working Group requests that interested parties (e.g., CBI, CERES, CICERO, PRI Initiative, and others) submit a Taxonomy for inclusion in the Appendices of the Framework and each maintain its Taxonomy in its own Central Forum.
For the benefit of both the issuer and investor community, the GBWG recommends that each Central Forum collate opinions from environmental experts (e.g., LSE’s Grantham Research Institute on Climate Change and the Environment, and/or CICERO, and/or Stanford University’s Global Climate & Energy Project) on the “Greenness” of the eligible Green Project Categories named in each proposed Taxonomy.
These central warehouses of expert environmental opinions would enable investors to become aware of and educated on the degree of environmental benefit (or harm) of various proposed eligible Green Project Categories permitted under each Taxonomy. Investors could then base their decision to invest in a particular Green Bond on these expert environmental opinions.
These Central Forums would also present a valuable resource for issuers looking to come to market, by debating which of their proposed eligible Green Project Categories are viewed as viable by the environmental community. The issuer’s decision about which eligible Green Project Categories to include in the Use of Proceeds for their Green Bond could be guided by these expert opinions.
The GBWG looks to amend the Appendices over time with as additional interested parties submit additional Taxonomies.
This draft paper presents a Framework for establishing a Green Bond asset class, covering definition, investment criteria, certification, management of funds, investment decision making processes, reporting and a central forum for information and on-going refinement. The purpose of the Framework is to establish and protect the credibility of the Green Bond asset class by promulgating a set of practices that encourage transparency, ethics, and integrity.
Framework for Green Bonds, Version 2.0
Appendices to the Framework for Green Bonds
A Green Bonds Taxonomy aims to suggest to those issuers looking to bring Green Bonds to market some acceptable Green Project Categories. It aims to aid investors in understanding the integrity of their investments as they attempt to make a positive contribution towards a greener economy by driving funds to this sector.
Organization of Economic Development and Cooperation (OECD) Draft Green Bonds Taxonomy
Reference: Appendix 1 pp. 73-78 of Kennedy, C. and J. Corfee-Morlot (2012), “Mobilising Investment in Low Carbon, Climate Resilient Infrastructure”, OECD Environment Working Papers, No. 46, OECD Publishing.