Green Bonds have come to town

In brief

Green Bonds have been part of the international capital markets landscape for some time, and recently the World Bank announced the first A$ 'Green Bonds' to be issued into the Australian debt capital market. If developments in the European Green Bond market are a good indicator, there is potential for this environmentally and socially responsible asset class to develop significantly in Australia, including issuances by corporates. Partner James Darcy, Senior Associate Nick Church and Lawyer David Lewis explore the nature of Green Bonds, who issues them, who invests in them and identify some key considerations for structuring Green Bonds.

What are Green Bonds?

In essence, Green Bonds are aimed at tapping into pools of private-sector wealth to fund 'green' projects that are aimed at delivering positive environmental or social benefits.

Generally speaking, 'green' projects encompass developments that aim to provide solutions to climate-related issues. More particularly, 'green' projects supported through the issuance of Green Bonds typically include:

• cleaner energy technologies (such as power generation from renewable energy sources);
• energy and material efficiency projects (such as energy efficient office buildings, power grids, industrial processes);
• the development of waste management systems;
• food security projects;
• flood prevention projects; and
• forest management projects.

Some issuers of Green Bonds, such as the supranational entities, are also focused on issuing Green Bonds that fund 'green' projects that have a broader social benefit in developing countries (such as alleviating poverty or helping with the development or sustainability of local industry).

To date, issuers of Green Bonds have employed a variety of different metrics to assess the green credentials of a potential project. In recent developments, some emerging standards appear to be gaining traction, and we discuss these in greater detail later in this article.

Who is issuing Green Bonds?

Supranational entities and government instrumentalities

Significant issuers in this asset class are supranational entities and government instrumentalities.

The World Bank has been active in encouraging the development of the Green Bond market globally, and issues Green Bonds under the auspices of its Strategic Framework for Development and Climate Change. Its bonds have raised funds for investment in a variety of projects such as solar and wind installations, greater transport efficiency, waste management, food security improvement and sustainable forest management. Since November 2008, the World Bank has raised more than US$5 billion in Green Bonds in more than a dozen currencies (including Australian dollars and New Zealand dollars).

Most relevantly for the Australian market, on April 15 this year, the World Bank mandated its first Green Bond issuance in the Australian domestic bond market, with an A$300 million five-year deal. This follows a €300 million three-year Green Bond issuance by the World Bank in March 2014, and a growing trend internationally for Green Bond issuance.

Other supranational entities that have issued Green Bonds include the European Investment Bank, the European Bank for Reconstruction and Development and the International Finance Corporation (a part of the World Bank group).

In addition, export credit agencies have issued Green Bonds, including the US$500 million five-year Green Bond issuance by Korean Export-Import Bank (K-EXIM) in 2013 to fund low-carbon initiatives including clean water and renewable energy projects.

Corporate Green Bonds

While Green Bonds have most notably been issued by a number of supranational entities and government instrumentalities, this is not exclusively the case. Importantly, Green Bonds have also been issued by private banks and corporations and the trend in Europe points towards increased activity in this area.

It has been reported that approximately US$10 billion of Green Bonds were issued by corporates in 2013. Bloomberg New Energy Finance has estimated that the rapidly expanding Green Bonds market to have reached approximately US$8.75 billion in value in the first quarter of 2014.

Here is a sample of recent Green Bond issuances by corporates:

• On 8 April 2014, Spanish utility company Iberdrola issued a €750 million Green Bond program to refinance existing projects and to finance new projects, all of which involve renewable energy production or energy efficient power distribution grids.
• On 28 March 2014, the Toronto-Dominion Bank launched a C$500 million three-year senior deposit note issue, the proceeds of which will fund environmental projects.
• On 24 March 2014, Toyota Financial Services launched a US$1.75 billion asset-backed Green Bond issuance, with proceeds used to fund financing of sales and leases of hybrid vehicles.
• On 19 March 2014, Unilever issued a GBP250 million bond program for greenhouse gas emission reduction and waste management processes.
• There was a spate of issuances of Green Bonds in November 2013, including the following issuances:
  • the French energy group électricité de France (EDF), which raised €1.4 billion through the issuance of Green Bond for clean energy (the largest corporate issue to date);
  • Vasakronan (a Swedish property company), which issued a SEK 1.3 billion Green Bond; and
  • The Bank of America's US$500 million Green Bond issue.

Having regard to recent Green Bond activity, Andrew Duncan, Director Capital Financing at HSBC, said: 'The recent offshore examples from Unilever, Toyota, EIB, EDF, and the recent HSBC-led green bond liability management exercise from Iberdrola, all highlight how quickly green bonds have become a mainstream option for leading borrowers. Issuers get the benefit of tapping into a new and discreet investor base at competitive pricing, while at the same time highlighting their green credentials.'

The recent announcement by the World Bank of its highly rated A$ Green Bond issued into the Australian capital market provides an important pricing benchmark for other issuances into the domestic capital markets – a crucial step in the growth of these bonds in Australia.

As the market develops in Australia, the expectation is that Australian corporates will also look to attract investment from environmentally and socially orientated funds through the issuance of Green Bonds.

Who is investing in Green Bonds?

Green Bonds present a clear opportunity for institutional investors to satisfy mandates requiring a level of investment in environmental and social investment products. Indeed, investor appetite to meet environmental and social aspects of investment mandates are, to a degree, driving the Green Bond market globally.

Many institutional investors such as superannuation and pension funds are keen to pursue environmentally-friendly investments, and those participating in Green Bonds often have as part of their mandate an interest in supporting green initiatives due to demand from their underlying clients. Many institutional investors participate in Green Bonds to place the investment into portfolios managed according to socially responsible investment principles, including investors that would not have otherwise invested in ordinary (non-green) bonds issued by the relevant issuer.

In the recently announced World Bank issue into the Australian domestic capital market, it was reported that 15 investors participated, demonstrating the depth of appetite for the product in Australia. Similarly strong demand is reported for bonds issued in other markets.

Investors in Green Bonds are obviously attracted by the purpose for which the funds are used – clearly, the credit metrics of a Green Bond remain important to investors, and issuances by highly-rated institutions (such as the World Bank, which is AAA-rated) have been well received by the market.

Types of Green Bonds

Green Bonds may be structured in a number of different ways. At present, four general types of Green Bonds are available, but more may emerge as the market for them expands.

Green Project Bond

A 'green project bond' is a Green Bond issued in respect of specific green projects. The proceeds are used for the particular project or projects. From a credit perspective, the investor is directly exposed to the revenue stream and risk of the identified project or projects.

This type of green project bond has been issued particularly successfully in the United States, where there are federal income tax exemptions for income derived from Green Bonds issued by states and municipalities for the development of approved energy-efficient commercial buildings.

Green Use of Proceeds Bond

A 'green use of proceeds' bond is issued by an issuer such as a bank that uses the proceeds of the capital raising to fund a portfolio of 'green' projects. This type of bond provides recourse to the issuer at a corporate level, and is not linked specifically to the revenue stream of the projects for which the funds are to be used.

Green Use of Proceeds Revenue Bond

A 'green use of proceeds revenue bond' is similar to a 'green use of proceeds' bond in that the funds raised by the issue fund a portfolio of 'green' projects. The key difference is that it does not provide recourse to the issuer at a corporate level, but rather the investor is exposed to the credit risk presented by the underlying projects for which the funds are raised.

Unlike a 'green project bond', however, an investor in a 'green use of proceeds revenue bond' benefits from a more diversified portfolio and so this is potentially more attractive than a green project bond (which exposes the investor to the credit of a single green project).

Green Securitised Bond

'Green securitised bonds' include covered bonds and asset backed securities. The revenue stream for this bond is paid from the cash flow of the supporting assets and the investors have the protection of security over the assets, and are intended to have priority claims in the event of a default.

How 'green' is a Green Bond?

For the Green Bond market to develop, it has been recognised by market participants that a key criterion for a Green Bond issue must be the standard for determining whether the use of proceeds are sufficiently 'green' to earn the tag of a Green Bond.

A working paper issued by the OECD considered various criteria of the 'green' characteristics of investments. The paper concluded that, unlike some other investment types such as 'Green Equities', Green Bonds suffered from a general lack of consensus as to a standard of what is 'green'.

As noted above, issuers of Green Bonds have, to date, employed a variety of different metrics to assess the green credentials of a project but, in recent times, some emerging standards appear to be gaining traction.

Climate Bonds Initiative

One step to better define the Green Bond market was made by the Climate Bonds Initiative, an investor-focused non-government organisation. In November 2011, the Climate Bonds Initiative launched a Climate Bond Standard for the funding of projects that contribute to the low-carbon economy.

In order for a project to receive the approval of the Climate Bond Standard, it must contribute to the development of low carbon industries and technologies or an essential adaptation to mitigate against the consequences of climate change. Initially, Climate Bond Standard only extended to wind energy generation, but this has since expanded to encompass solar energy generation as well. The Climate Bond Standards Board intends to continue augmenting these criteria to include other technologies and developments.

Green Bond Principles

More recently, on 13 January 2014, a consortium of investment banks (including HSBC, Bank of America Merrill Lynch, Citi, JP Morgan Chase, Deutsche Bank, Morgan Stanley and Goldman Sachs) announced support for the 'Green Bond Principles'. This is a set of voluntary guidelines for the issuance of Green Bonds.

The Green Bond Principles do not themselves propose a standard for what may be considered sufficiently 'green', but they emphasise the importance of a Green Bonds issuer having a clearly disclosed procedure for selecting projects for which the proceeds of issuance are to be used. The Green Bond Principles also recommend that issuers of Green Bonds offer to the market independent assurance of the green credentials of the projects in which funds are invested, and the Green Bond Principles support the certification of Green Bonds according to independent standards as those standards become more prevalent and widely accepted.

Management of use of proceeds

It is vital to the integrity of a Green Bond program that investors' funds are only used for the green projects for which the funds have been raised. For all types of Green Bonds, it is important that the project or projects ultimately funded or assets securitised meet the 'green' criteria disclosed to investors.

In the case of 'green use of proceeds' bonds or 'green use of proceeds revenue' bonds (described above), there is, however, a preliminary consideration picked up in the Green Bond Principles – being that proceeds raised from investors should be segregated from the general operations of the issuer.

This principle recognises that there may be a time gap between the issuer receiving an investor's funds and the allocation of those funds to a project within the 'green' portfolio. During this time, the unallocated proceeds will need to be invested in some way.

It is incumbent on the issuer to inform investors clearly how their funds will be invested in this period. Even temporary investment in projects that are contrary to the green purpose of the bond could detract from its green credentials.

Moreover, the Green Bond Principles highlight the importance of tracking proceeds to ensure that they are efficiently allocated to the green portfolio. This tracking process needs to be publicly disclosed and preferably externally audited.