By: Michael Megarit
A new green bond market has been created and is expanding at a rapid pace. Global green bond issuance reached a record high of $269.5 billion by the end of last year and could reach $400-$450 billion this year.
In 2007, green bonds were a concept. Green bonds are a growing category of fixed-income securities that raise capital for projects with environmental benefits, such as renewable energy or low-carbon transport.
The green finance market has reached its most substantial milestone yet, with US$ 1 trillion in cumulative issuance since market inception in 2007.
Green bonds will support new low-carbon or climate-resilient investment in the energy, buildings, transport and water sectors. Originally spurred by development banks, green bonds are now issued by utilities, car manufacturers and a host of other corporates. In 2020, many of the most significant positive developments spurring the green bond market have arisen in emerging economies.
Bank of America has closed approximately ten deals under the Catalytic Finance Initiative (CFI), totaling around $1.5 billion, of which $250m was from its own balance sheet. More than 25 per cent of the deals closed (by value) were in emerging markets. The investment strategy of the CFI covers four key categories: investment-grade loans for clean energy infrastructure in OECD and emerging markets; senior and mezzanine debt for smaller-scale opportunities in emerging markets; green project bonds and green asset-backed securities; and philanthropic funds as catalytic first-loss capital to promote investment in energy access.
CalSTERS, APG and Pension Danmark have collectively invested around $29 billion in low-carbon investments, an increase of around $11 billion in just one year. This includes investments in renewable power generation and improving the energy efficiency of property portfolios.
Swiss Re has provided advice to nine sovereigns/sub-sovereigns, and offered around $1.5 billion of climate risk coverage. Of these nine sovereigns/sub-sovereigns, seven are from developing countries, and these have been offered in excess of $1.1 billion of risk coverage. Across all nine, take-up rates of protection have been around one third.
PRIMARY MARKETS: LOW-CARBON AND CLIMATE-RESILIENT INVESTMENT
The finance community has mobilized both well-established and novel primary capital market products and approaches to target low-carbon, climate-resilient investments. Well-established instruments include project finance, corporate and project bonds, commercial lending, equity finance, and consumer finance. These have been supplemented by a number of new products, especially yieldcos, and various types of ‘green bonds’.
GREEN AND CLIMATE BONDS
The emergence of green bonds represents one of the most significant developments in the financing of low-carbon, climate-resilient investment opportunities. Green bonds offer an attractive way to access institutional investor capital as the risk and returns of the bonds are typically determined by the issuer’s full balance sheet, not just the green assets. Essentially, the treasuries of issuing companies have been providing the risk-bridge needed to get green projects and assets to an investment-grade rating that meets the need of institutional investors.
Demand continues to outstrip supply. A number of recent bond issuances have been oversubscribed, leading to an increase in supply. For example, strong demand allowed Yes Bank to double its recent offering to INR 10 billion; while KfW’s first AUD green bond doubled to A$600m. Supported by Citigroup, Bank of America Merrill Lynch and Morgan Stanley, Toyota’s industry-first green bond for low-carbon vehicle financing raised $1.75 billion, and this was quickly followed up with a second issuance in for an additional $1.25 billion. There has also been a rapid growth in the numbers of specialized green bond funds looking to invest in green bonds with, among others, Nikko Asset Management, BlackRock, Calvert and State Street all recently developing and managing green bond funds. This strong demand is also reflected in a series of public statements by investor organizations.
China is at the forefront of the recent green bond developments – with other emerging markets also showing considerable interest. China is developing the foundations of its green finance market, including green bonds, with the Chinese central bank, People’s Bank of China (PBoC), publishing a 14-point set of policy recommendations in April 2015. This included specific recommendations around green bonds, such as an evaluation system for allocation of funds and environmental impacts of green bonds; tax incentives; preferential risk weighting in bank capital requirements; and fast-track issuance for green bonds. Central bank regulations to govern a domestic green bond market was published in October 2015. Furthermore, South Africa, Brazil and Mexico have already seen, have seen green bonds issued.
A further sign of innovation in the low-carbon financing ecosystem is the emergence of yieldcos. These companies aim to exploit the predictable and low-risk nature of operational renewable projects to provide high dividends to investors, often on a quarterly basis, making them attractive to many investors. By establishing yieldcos, the original project developers and utilities can re-invest the proceeds to renewable project development activities, while the increase in liquidity in the market for purchasing operational assets makes initial project development activity less risky.