www.ifc.org/ThoughtLeadership Note 25 | December 2016 MOBILIZING PRIVATE CLIMATE FINANCE—GREEN BONDS AND BEYOND The international market for green bonds—securities that raise capital for specific climate or environmental sustainability purposes—has experienced tremendous growth and could reach an annual market value of over $100 billion dollars this year. As part of this growth, new market tools, skills, and capital have been introduced into the green bond market to reduce greenhouse gas emissions and more broadly address the problem of climate change. The first green bond was issued in 2007 by the European programs. With a few exceptions, the bonds are full recourse to Investment Bank, under the label Climate Awareness Bond, as the issuer, meaning they are backed by the issuer’s entire a structured bond with proceeds dedicated to renewable energy balance sheet so that investors are not exposed solely to the risk and energy efficiency projects. The World Bank issued its first of the bond’s underlying projects. green bond in 2008, a SEK 2.3 billion bond with a maturity of six years for a group of Scandinavian investors. And in March 2013 IFC issued a $1 billion benchmarked bond. Growth of the Green Bond Market Multilateral Development Banks were the sole issuers of green bonds until 2012 when the first corporate green bonds were issued. Since then the market has exploded, from nearly $10 billion in 2013 to over $40 billion in 2015, and is projected to exceed $100 billion in 2016.1 The emergence of green bonds has been recognized by the United Nations as “one of the most significant developments in the financing of low-carbon, climate-resilient investment opportunities. 2 And a G20 communique in September 2016 called for development of and cross-border investment in local green bond markets. 3 The rapid growth of the international green bond market is demonstrating how capital market mechanisms can enlist private capital to address global climate change and channel private sector funds to developed and emerging economies. Source: Climate Bond Initiative – HSBC What is a Green Bond? Green bonds are fixed-income securities, both taxable and tax- exempt, that raise capital for use in projects or activities with Widely recognized types of green bonds include: specific climate or environmental sustainability purposes.  Use-of-proceeds bonds—proceeds from these bonds are These bonds are structured the same way as standard bonds, earmarked for green projects but are backed by the issuer’s with the same characteristics as standard bonds in terms of entire balance sheet. seniority, rating, execution process, and pricing, but with  Use-of-proceeds revenue bonds—proceeds are assigned to proceeds dedicated to climate or environmental projects. The eligible green projects. Bondholders have recourse to a bonds carry the same rating as an issuer’s other debt and are specified revenue stream (which may be unrelated to the often structured under the issuer’s medium term notes eligible green projects) but not to the issuer.  Project bonds—proceeds are invested in a specific green process to determine how the projects fit within the eligible project and the investors have direct exposure to the green green projects categories identified, it should determine the project itself. criteria under which projects will be eligible for use of the  Securitized bonds—the relevant revenue stream is green bond proceeds, and should specify the environmental generated by a group of green projects or assets. sustainability objectives of those projects. It is important to note that there is no legal definition of a green  Management of Proceeds addresses handling of funds bond. Since these bonds’ appearance on the market, issuers that await investment. The Principles encourage have determined whether their bonds were green and have transparency in tracking the proceeds from the green bonds marketed them accordingly. Recently, however, several via either allocation to a specific sub-portfolio, or use of an countries including China and India have opted to regulate the auditor or another third party. green bond market with issuance guidelines. 4  Reporting addresses frequency of reports on use of proceeds, project descriptions, and expected environmental Standardization Efforts impact. In the absence of uniform standards, a number of general principles and certification programs have been developed, of which the most used currently are the Green Bond Principles and the Climate Bond Standards. The Green Bond Principles are a set of voluntary guidelines that have been developed by a group of investors, issuers and underwriters. They are relatively non-prescriptive and are designed to encourage the growth of the market without imposing overly obstructive barriers to entry. The Principles do not provide specific environmental impact targets or impose limits on the categories of projects and activities that can be financed by green bonds. Instead, their purpose is to promote integrity in the development of the green bond market by clarifying the approach for issuance of a green bond. The Principles are coordinated by the International Capital Market Association. There are currently over one hundred members of the Principles, all of whom have issued, underwritten or placed, or invested in a green bond..5 The Green Bond Principles were initially released in January The Green Bond Principles also recommend that issuers use 2014 and a revised set was published in June 2016. There are external assurance to confirm alignment with the key features four components: of green bonds. It identifies three possible assurance or audit  Use of Proceeds. The Principles explicitly recognize methods: several broad categories of potential eligible green  Second party opinions on the selection process used by the projects, including but not limited to renewable energy, issuer to select the projects for investment energy efficiency (including efficient buildings),  Unrelated third party certification/verification of the green sustainable waste management, sustainable land use bonds (including sustainable forestry and agriculture),  Use of an auditor to verity certain aspects of the green bond biodiversity conservation, clean transportation, sustainable proceeds, such as the internal tracking method and water management, and climate change adaptation. allocation of funds  Process for Project Evaluation and Selection addresses the decision-making process to determine which projects The Climate Bond Standard, or CBS, is a voluntary will be funded. The issuer should set up a transparent certification initiative aligned with the Green Bond Principles 6 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. and developed by the Climate Bond Initiative, a nonprofit with a high degree of transparency, independent valuation, and organization. The Standard provides sector-specific eligibility reporting. criteria for asset classes and projects, for example solar, wind and low carbon buildings. The objective of the CBS is to allow Valuation investors to screen a bond to assess its environmental impact. Second opinions will be usually given by an independent third- Subject to third party verification, a bond that satisfies CBS can party institute or consulting firm on a non-reliance basis, where be awarded certification. The quality of the experts certifying the third-party firm either employs its own grading rubric or the bonds—and the criteria they employ—are critical to this applies a voluntary standard among the ones mentioned above, process. and may then base their opinion on information provided to them by the issuer.7 Alternatively, instead of performing an The requirements of the CBS are separated into pre-issuance independent evaluation, such a third party may directly help requirements, which need to be met by issuers seeking structure and validate the issuer´s green bond framework. certification ahead of issuance, and post-issuance requirements, which need to be met by issuers seeking continuing certification Second opinions are encouraged so that they verify an issuers’ following the issuance of the bond and the allocation of the green credentials, its ability to identify and select low carbon bond proceeds. and climate resilient projects, and more generally attest to a bond’s “greenness.” However, use of second opinions is not Pre-issuance requirements focus on the actual use of proceeds, consistent and these opinions vary widely in quality. Some ongoing eligibility of the projects and assets, use of funds not remain private and some are issued by the same verifier that yet allocated, and the adequacy of and output from the i ssuer’s helped the issuer develop the green bond framework. 8 internal systems. The Climate Bond certification may only be maintained if post-issuance certification is confirmed within a Another option for green bond issuers is to rely on external year after issuance of the bond. third-party auditors to assess and report on proceeds management and tracking, to prepare annual impact reporting for the projects funded by the green bond, and to assess the Most Recent Green Bonds, by Settlement Date issuer’s ongoing compliance with its green bond commitments. Reporting There is a current focus on how best to standardize the quality of impact reporting of green bond issuances. While issuers are publishing more detailed reports on an annual basis and including impact metrics in them, it remains difficult to compare such reports with those issued by international finance institutions such as IFC. These institutions aim to establish robust, industry-wide criteria to improve confidence and comparability across markets. A group of international organizations, led by the European Investment Bank, IFC, the World Bank, and Agence Française de Développement, recently published a framework for harmonizing green bond impact reporting. 9 It contains clear and robust reporting guidelines designed to make it easier for investors to compare issuers and bonds.10 Impact reporting is an essential way for an issuer to Source: The Green Bond Database disclose the impact of the projects funded by green bonds, with as much detail as possible. However, significant differences between projects render comparability extremely Transparency – Disclosure, Verification, and Reporting difficult and present another reason for reporting harmonization Stakeholders in the green bond market generally agree that it that can allow investors to compare and better analyze bonds. should not be subject to overly prescriptive standards so that a framework can be developed without undue constraints. Low Other tools being developed by third-party market developers barriers to entry should attract the widest pool of issuers and to provide more granular information and deeper analysis of investors, eventually moving green bonds into the mainstream green bonds include: bond market. However, low barriers must be counterbalanced  Green indices, including those launched by S&P and Barclays, which provide fundamental performance data, This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. increase transparency, and drive demand India Says YES to Green Bonds  Green market segments developed by stock exchanges, including those in London, Luxembourg, and Oslo India, the world’s third largest country in terms of annual  Green ratings by rating companies—Moody’s publishes an greenhouse-gas emissions, is gradually reducing its assessment methodology for green bonds11—and by dependence on fossil fuel sources of energy. The goal is secondary market ratings.12 ambitious: to have cleaner energy sources account for 40 percent of total energy generation capacity by 2030. This means nearly 300 gigawatts of renewable capacity must be Why Issue a Green Bond? generated, of which solar is estimated to comprise 209 The Paris Agreement of December 2015 seeks to mitigate gigawatts. To achieve these goals, a green bond market greenhouse gas emissions and establish a low carbon economy. needed to be developed that could support the long-term It is expected to cause rapid growth in the green bond market. financing needed for projects involving climate change. YES Bank, India’s fifth largest private sector bank and a The landmark agreement establishes an objective of holding the local leader in climate financing, responded to the challenge global temperature increase to less than two degrees Celsius and in 2015 issued a green bond with $50 million in IFC above pre-industrial levels. The agreement does not establish investment. firm greenhouse gas emission reduction targets for developed countries, but instead establishes the foundation of a new Environmental Finance, an online news and analysis international climate policy through a bottom-up approach in service, awarded the transaction the Special Award for which each signatory to the agreement voluntarily produces and innovation. In 2016, the Climate Bond Initiative, an shares nationally determined contributions to address climate international investor-focused nonprofit developing the change every five years. Climate Bond Standard, awarded YES Bank the Green Bond Pioneer Award for its work in instituting an emerging The Paris Agreement also recognizes carbon markets by market green bond—the first of its kind for both India and creating “internationally transferred mitigation outcomes” that IFC. can be traded by signatories and can be put toward national contribution goals, similar to the emissions trading provisions With IFC’s support, YES Bank is scaling its investments in established in the Kyoto Protocol. renewables, while including an added focus on expanding While the Paris Agreement does not establish binding financial access to climate-related financing for women-owned small requirements on developed countries, it clearly sets and medium enterprises. expectations that they “mobilize climate finance from a variety of sources, instruments and channels, noting the significant role of public funds,” and that “such mobilization of climate finance IFC’s Experience should represent a progression beyond previous efforts.” IFC began issuing green bonds in 2010 because the bonds’ Whether it is because of the political push of the Paris framework was consistent with its priorities. Green bonds allow Agreement or just the increased awareness of climate change IFC to raise funds in capital markets for environmentally among investors, the truth is that investors now favor green sustainable projects and to raise awareness about climate bonds over traditional bonds when the price and terms are the change in the investor community.14 They also channel funds to same, because green bonds offer the additional environmental projects in emerging markets. component that many investors seek. Since 2010 IFC has issued over fifty green bonds in multiple Many institutional investors (particularly pension funds and currencies including US dollars, Euros, Australian dollars, New not-for-profit organizations) have committed to divestment Zealand dollars, Turkish Lira, Brazilian Reais, Chinese RMB, from fossil-fuels companies and are beginning to consider Peruvian Soles and, more recently, South African Rand and exposure to carbon as a risk to be considered when making an Indian Rupees. These bonds totaled the equivalent of investment decision. This is particularly the case in countries approximately $4.4 billion. Last year IFC issued eighteen green where tougher regulations on carbon emissions are introduced bonds—three times the issuances of the previous year—and has and may leave investors and issuers with toxic or stranded begun to tailor issues to match investor needs in terms of size, assets.13 Most investors are primarily concerned with returns, currency, and format. and the growing impact of carbon risk exposure on their portfolios can be costly. IFC has also started to invest in other issuers’ green bonds including, recently, an issuance by YES Bank, the largest private sector commercial bank in India. The proceeds of the This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. bond will be used to fund renewable energy projects including emissions from deforestation and forest degradation, and also solar power and wind power projects in India. To finance the generates a number of socio-economic benefits through various purchase of the YES Bank Green Bond (approximately $50 community initiatives. million), IFC issued the first Green Masala Bond (an off-shore bond denominated in Indian Rupees), which is listed on the While Forests Bond proceeds are not earmarked for green London Stock Exchange. projects, IFC has committed to purchase from the project on an annual basis an amount of credits at least equal to the coupon As mentioned, IFC, together with other multilateral payable annually to the investors, effectively earmarking an development banks and international financial institutions, has amount equal to the annual coupon for the project. been actively involved in establishing a harmonized framework Additionally, unlike traditional green bonds, the Forests Bond for impact reporting. Given the importance of transparent offers investors the option to take project risk. They can take reporting of climate financing, including the impact of projects issuer risk, similar to ordinary green bonds or, if they choose, in the green bond program, IFC publishes an annual green bond connect directly with the project by taking delivery of the impact report with the commitments and disbursements for carbon credits generated by the project. In this sense the Forests eligible projects. The core criteria for such projects are annual Bond combines in one instrument the simplicity of a traditional energy savings, annual greenhouse gas emissions reduced or green bond with the complexity of a project bond. avoided, annual renewable energy produced, and capacity of renewable energy plants constructed or rehabilitated.15 Finally, the Forests Bond puts a price on carbon. The price for the carbon credits is a fixed price that has been set out at bond Finally, IFC is now supporting the development of local green issuance. If carbon markets for forestry credits bloom over the bond markets by helping its clients navigate the launch of next few years, many investors in the Forests Bond are likely to credible green bonds in line with the Green Bond Principles. choose to receive carbon credit coupons instead of cash. Conclusion The Forests Bond Green bonds are simple fixed income instruments that resemble In November 2016 IFC issued a first-of-its-kind, five-year bond traditional corporate bonds with the added benefit that they called the Forests Bond. It gives investors the option of getting finance environmentally sustainable projects. repaid in either carbon credit coupons or cash, and it raised $152 million to support private sector development and prevent Simplicity is key to these bonds, as investors need to clearly deforestation. The bond was sold to major global institutional understand the risks they are taking and must be able to easily investors and was listed on the London Stock Exchange. allocate the instrument in their portfolio. The bonds must also be easy to replicate. Investors opting for the carbon credit coupon will receive Standardization in terms of transparency, independent tradable verified carbon units representing a right to claim the verification, and reporting is critical for the growth of the green achievement of a verified reduction or removal of one ton of bond market. To fully participate in the market investors need carbon dioxide equivalent (CO2e). They can retire the credits to have confidence in the environmental credentials and to offset their own corporate greenhouse gas emissions or sell performance of the bonds. Green standards recently published them on the carbon market where governments, companies, and in China and India represent real progress toward this goal. 17 individuals can purchase them to mitigate their own emissions. Such carbon credits are traded over-the-counter and often As the Paris Climate Agreement is implemented it is critical to directly between the project developer and buyer. remember that the push to reduce emissions and switch to clean energy sources will also necessarily include the greening of the To pay investors a carbon credit coupon, IFC will buy carbon global financial system. credits generated by Kenya’s Kasigau Corridor Project, a 500,000-acre nature preserve near Mombasa. The carbon credit Flavia Rosembuj is global co-lead for Blended Finance and will be issued under the Verified Carbon Standard, an Climate Business at the Legal Department of the International internationally recognized standard for the voluntary market of Finance Corporation, part of the World Bank Group carbon credits. Also, the project complies with international (FRosembuj@ifc.org). Climate, Community and Biodiversity Standards that confirm Sebastiano Bottio is Principal Financial Officer at the the community benefits and sustainable practices of the International Finance Corporation (sbottio@ifc.org). project.16 The Forests Bond is an innovation on green bonds in that it has both a green and a social impact. It is intended to reduce This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.  1 9 Climate Bond Initiative, HSBC World Bank Group, Green Bonds: Working Towards a Harmonized Framework for Impact 2 Climate Change Support Team of the UN Secretary General, Trends in private sector Reporting, (Dec. 2015), climate finance, (October 9, 2015), http://www.un.org/climatechange/wp- http://treasury.worldbank.org/cmd/pdf/InformationonImpactReporting.pdf 10 content/uploads/2015/10/SG-TRENDS-PRIVATE-SECTOR-CLIMATE-FINANCE-AW- The World Bank and the International Finance Corporation publish separate reports at the HI-RES-WEB1.pdf end of the fiscal year (June) which provide guidance on impact reporting, including details of 3 Ministry of Foreign Affairs official website, G20 Leaders' Communique Hangzhou Summit the renewable energy and energy efficiency results of each green bond eligible project (Sep. 6, 2016, 12:05AM), http://g20.org/English/Dynamic/201609/t20160906_3396.html financed by the World Bank or by IFC. These are regarded as best practice. 4 The Securities and Exchange Board of India (SEBI) has issued in January 2016 the final 11 Moody’s is now also providing a methodology to assess the greenness of the bond. It has guidelines on the issuance of green bonds establishing that green bonds shall be subject to published in January 2016 a proposed approach and methodology to the Green Bonds the SEBI Issue and Listing of Debt Securities’ Regulations, 2008. The Board has not stated a Assessment (GBA). GBAs are not credit ratings, but forward looking opinions of the relative blanket definition of green bonds but it will specify it from time to time. The People’s Bank effectiveness of the issuer’s approach for managing, administering, allocating proceeds to and of China (PBoC) and a Green Finance Committee set up by the PBoC wrote standards in reporting on environmental projects financed by green bonds. According to Moody’s, GBAs December 2015 to help green China’s finance system. The set of standards set out which assess the relative likelihood that bond proceeds will be invested to support environmentally assets and projects are eligible to be financed using green bonds. Kenya has also announced beneficial projects as designated by the issuer. 12 that it will have a green bond policy in place in early 2017. Institutions such as Oekom Research are issuing sustainability bond ratings. 5 13 Since the launch of its first Green Bond, IFC has been actively participating in publishing The Financial Stability Board established the industry-lead Task Force on Climate-related the Green Bond Principles. financial disclosures on December 4, 2015 with Michael Bloomberg as its chair. Source: 6 Other initiatives include the Statement of Investor Expectation for the Green Bond Market www.fsb-tcfd.org to support the development of the green bonds market which is composed by a major group 14 Elizabeth Coston, Esohe Denise Odaro, Evelyn Hartwick & Jamie Jones, Next Season’s of investors in green bonds, including pension funds, insurance companies and asset Green Bond Harvest: Innovations in Green Credit Markets , (International Finance management groups. The Statement supported the development of the GBPs. Corporation, 2015) http://www.ceres.org/press/press-releases/investors-encourage-further-transparency- https://www.ifc.org/wps/wcm/connect/83eb088044647c9a82b38ec66d9c728b/Next+Season' standardization-to-spur-green-bond-market-growth s+Green+Bond+Harvest.pdf?MOD=AJPERES 7 15 The main second opinion providers include Cicero, Vigeo, Oekom, Sustainalytics or DNV Thomas Kerr, Olga Khlebinskaya, Zauresh Kezheneva, Berit Lauridsen, Rusmir Music, GL. Their basis for assessment are not standardized and therefore each of them has a Esohe Denise Odaro & Esther Rojas-Garcia, Green Bond Impact Report 2015, International different approach. Some provide a second opinion based on the assessment of the issuer’s Finance Corporation, framework and guidance for assessing and selecting eligible projects, others take a more http://www.ifc.org/wps/wcm/connect/18cbfe004a92050c8d7acd9c54e94b00/IFCGreenBond holistic approach where climate change mitigation is considered alongside social and ImpactReport_Final_11-11-15.pdf?MOD=AJPERES governance considerations and others assess the bond’s alignment with the GBPs. 16 Issued by the Climate, Community & Biodiversity Alliance, a partnership among NGOs to 8 About 42% (on a volume basis) of green bonds that have been issued so far have second promote land management and mitigate climate change. opinions while 84% of the green bonds issued in Europe in 2015 have second opinions. The 17 The adoption of the standards has resulted in Chinese issuers issuing 40% of the green difference is even more noticeable in corporate bonds as 98% of green corporate bonds in bonds so far in 2016. Europe were issued with a second opinion compared to 14% of non-European corporate bonds. Bloomberg, Credit Agricole CIB.