Climate bonds (also known as green bonds) are fixed-income financial instruments (bonds) linked in some way to climate change solutions.
Climate bonds are a relatively new asset class, but they are growing rapidly. The total volume of climate bonds was estimated at 160 billions of dollars on 2016; of which 70 billions were issued in 2016.
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History
European Investment Bank (EIB) issued an equity index-linked bond in 2007, which became the first fixed income product among socially responsible investments. This "Climate Awareness Bond" structure was used to fund renewable energy and energy efficiency projects. Afterwards, The World Bank became first in the world to issue a labelled "green bond" in 2008, which followed a conventional "plain vanilla" bond structure, contrary to EIB's equity-linked Climate Awareness Bond.
The green bond market has subsequently increased rapidly in issuance. From 2015 to 2016, the Climate Bonds Initiative reports that there was a 92% increase in green bonds issuance to $92 billion, with different types of issuers starting to issue green bonds. Apple, for example, became the first tech company to issue a green bond in 2016, and Poland became the first sovereign country to issue a green bond at the end of 2016.
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Description
Climate bonds are issued in order to raise finance for climate change solutions: climate change mitigation or adaptation related projects or programs. These might be greenhouse gas emission reduction projects ranging from clean energy to energy efficiency, or climate change adaptation projects ranging from building Nile delta flood defences or helping the Great Barrier Reef adapt to warming waters.
Like normal bonds, climate bonds can be issued by governments, multi-national banks or corporations. The issuing entity guarantees to repay the bond over a certain period of time, plus either a fixed or variable rate of return.
Most climate bonds are asset-backed, or ringfenced, with investors being promised that all funds raised will only go to specified climate-related programs or assets, such as renewable energy plants or climate mitigation focused funding programs.
In their UNEP paper on investors and climate change, Mackenzie and Ascui differentiate a climate bond from a green bond: "(A climate bond is) an extension of the green bond concept. Green bonds are issued [...] in order to raise the finance for an environmental project. Climate bonds [are] issued [...] to raise finance for investments in emission reduction or climate change adaptation."
The London-based Climate Bond Standards Board provides a certification program for climate bonds.
Climate bonds are theme bonds, similar in principle to a railway bond of the 19th century, the war bonds of the early 20th century or the highway bond of the 1960s. Theme bonds are designed to:
- Allow institutional capital - pension, government, insurance and sovereign wealth funds - to invest in areas seen as politically important to their stakeholders that have the same credit risk and returns profile as standards bonds.
- Provide a means for governments to direct funding to climate change mitigation. For example, this might be done by choosing to privilege qualifying bonds with preferential tax treatments.
- Send a political signal to other stakeholders.
Otherwise, for operational purposes, theme bonds largely function as conventional debt instruments. They are risk-weighted and credit rated in the usual way based on the creditworthiness of the issuer, and tradable, market conditions permitting, in international secondary bond markets. These instruments can theoretically be issued at all levels of the fixed income market, from sovereigns to corporate.
Benefits of green bonds
The growth of bond markets provides increasing opportunities to finance the implementation of the Sustainable Development Goals, Nationally Determined Contributions and other green growth projects. Green bonds are becoming an increasingly prevalent form of green finance, particularly for clean and sustainable infrastructure development and their large funding needs. They offer a vehicle to both access finance from the capital markets and deliver green impacts that can be verified against standards. In developing countries, green bonds are already financing critical projects, including renewable energy, urban mass transit systems and water distribution.
Green bonds mobilised over $93 billion in 2016 to projects and assets with positive environmental impacts. At the current growth rate, they could mobilise over $200 billion in 2017.
Of total global bond issuance, however, this is still around just 1%.
According to a report by the Climate and Development Knowledge Network (CDKN) and PricewaterhouseCoopers, a green bond market has three key benefits to a country and its environmental goals and commitments.
- It increases the finance available for green projects, therefore incentivising an increase in their number. Today, green bonds mainly finance projects within renewable energy, energy efficiency, low-carbon transport, sustainable water, and waste and pollution.
- It is a viable vehicle for enabling the increasing pool of sustainable investors to access environmental projects. Bonds are an instrument and an approach with which foreign investors are familiar, so these institutions need little new understanding or capacity. Investors are also interested in placing money where the environmental impact achieved is highest per unit of currency, and emerging and developing economies have the potential to offer this where lower project costs exist.
- It can be a catalyst for further development of the domestic capital market and financial system more broadly beyond environmentally related projects.
Demand for green bonds
The Business and Sustainable Development Commission describes at least US$12 trillion in market opportunities for business from sustainable business models.
The United Nations estimates an annual funding gap of $2.5 trillion is needed for the achievement of the Sustainable Development Goals (SDGs), and within this, US$1 trillion is needed annually for clean energy alone. A large number and broad range of projects and assets that contribute to achieving the 17 SDGs need this funding for their development and operation.
One of the SDGs where 'green finance' has been successfully mobilised is on clean energy and climate action. The Paris Agreement on climate change entered into force in November 2016, after 196 countries committed to reducing greenhouse gas emissions. Significant quantities of finance are now needed to convert country commitments (Nationally Determined Contributions, NDCs) to implementation and a low-carbon, climate-resilient economy.
Despite recent increases in volumes of climate finance, a significant funding gap will arise unless new sources and channels of finance are mobilised.
Existing international public finance dedicated to climate change is unable to achieve the rapid change required in meeting the finance gap alone. Furthermore, public sector balance sheets do not have the capacity to fund the amounts needed, and so an estimated 80-90% of funding will need to come from the private sector.
Bank balance sheets can take only a proportion of the private finance needed so the capital markets have to be leveraged, along with other sources such as insurance and peer-to-peer.
According to GUIDE: New markets for green bonds, the demand for green bonds has grown quickly on the investor side, with asset owners and managers diversifying their investment portfolios and seeking positive impact beyond financial return. In the light of the global commitment to shift to a green and low-carbon economy, the green bond market has the potential to grow substantially, while attracting more diverse issuers and investors.
Source of the article : Wikipedia
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