Many Clean Yield clients have balanced accounts. To meet the fixed-income requirement, we draw from a variety of vehicles, including government agency bonds, municipal bonds, community development financial institutions (CDFI) promissory notes, preferred stock, and alternative investment notes. Previously, community notes were the only fixed-income vehicle to address sustainability, but that has begun to change with the advent of green bonds.
What Are Green Bonds?
If you haven’t heard of green bonds, don’t feel bad; the first bond was branded green less than a decade ago, and it’s not like they’ve had their own show on Comedy Central.
The European Investment Bank (EIB) issued the first Climate Awareness Bond in 2007, effectively launching the green bond market. As the chart to the right shows, worldwide, green bonds have exploded exponentially in the past three years. In 2013, $11 billion worth of green bonds were issued, and by 2014, volume had more than tripled to $36.8 billion. The pace has been brisk in 2015, with $22.48 billion issued as of August. The nonprofit Climate Bonds Initiative believes 2015 issuances could hit $50–100 billion.
In the U.S., green municipal bonds grew 25-fold, from $100 million in 2013 to $2.5 billion in 2014.
To some extent, this explosion in growth can be attributed to simple re-branding. Using municipal bonds to finance environmental projects isn’t new, but calling them “green” is. This can help the issuer expand the buyer base by appealing to investors interested in environmental benefits. A decade ago, green fixed-income options were almost non-existent, and institutional investors struggled to meet sustainability mandates in asset classes outside the equity market. Initially, green bonds were available only to institutional investors — where the greatest demand came from — but more and more new issues are now available to the retail market. Issuers of green bonds include the government, publicly traded companies, and development banks.
All the credit characteristics of green bonds are the same as non-environmental bond issues. Covenants, guarantees, and payback terms are similar as well. Investors who buy green municipal bonds, in most cases, are paid interest and principal from the same revenues as other municipal bonds. The same forms as traditional muni bonds are used, including general obligation bonds (GOBs), revenue bonds, and securitized bonds. The distinction between a traditional bond and a green bond is that the proceeds are pledged to assets or projects with positive environmental benefits. These can include solar and wind projects, clean energy and energy efficiency, and the carbon offset mechanisms such as those being developed by the Oregon-based Climate Trust.
GOBs are earmarked for green projects with full recourse to the issuer, and they therefore have the same credit rating as the issuer’s other bonds. In 2013, Massachusetts became the first state to offer a green muni bond, in the form of a GOB. Proceeds from the $100-million issuance were earmarked for pollution remediation, water quality improvement, and energy efficiency. The issuance was such a success that in 2014 the state issued another $350 million in bonds, earmarked for projects that included clean-water, energy efficiency, river revitalization, and open-space protection projects, as well as a marine terminal to support the construction of offshore wind projects.
Revenue bonds are backed by revenue streams (such as taxes or fees) which provide repayment for the bond. Earlier this year, the Iowa Finance Authority issued $321 million in green bonds to be used for water and wastewater projects. Securitized bonds are also coming to market, wherein funds are earmarked for a specific green project or multiple underlying green projects in the same way that a mortgage-backed security is secured by a collection of mortgages. One example of a securitized bond is the recent $150-million bond issuance by the state of Hawaii, which is backed by a “green infrastructure fee” that will be applied to the bills of the state’s electric utility customers; it will be used to provide loans for the installation of distributed solar panels, connectors, and energy storage.
World Bank green bonds support projects focused on energy efficiency, water management, climate-resilient infrastructure, renewable energy, and forest management. The Bank’s most recent “impact report” boasts of $1.5 billion in bonds to nine renewable energy projects expected to result in 2,284 megawatts of renewable energy capacity. Other highlights of the report include $3.5 billion committed to improve public transportation in 30 cities in emerging countries — including seven projects in China that will increase ridership by 680,000 passengers per day.
Corporate green bonds
To date, the majority of green corporate bonds have been issued by banks or utility companies. Bank of America claims to have issued the first corporate green bond in 2013 to finance renewable energy and energy efficiency projects. Consumer products giant Unilever issued its first green bond in March 2014 to fund projects to reduce greenhouse gas emissions, water consumption, and waste. Power producer NRG Yield — which operates 95 fossil fuel and nuclear plants — issued its first corporate green bond in August 2014 to help finance the acquisition of the 947-megawatt Alta Wind facilities located in Tehachapi, California. Bonds like these can afford investors the opportunity to encourage and reward green activities from companies whether or not they would otherwise invest more generally in the company through a stock purchase.
According to analysts at Standard & Poors, corporate green bond issuance in 2015 could reach $30 billion.
Separating the wheat from the chaff
Massachusetts sparked controversy by using green bond proceeds to build a university parking garage in Salem.With anything labeled “green” comes the risk of being greenwashed. How is an investor to know?
Last year, Massachusetts sparked controversy by using green bond proceeds to build a university parking garage in Salem. Its defenders maintain that the project has environmentally friendly impacts, but others see it as promoting more cars on campus. Another controversial project was the $2.8-billion green bond issued by GDF Suez in May 2014, ostensibly to fund renewable energy and energy efficiency projects, but which also funded an already operational — and controversial — hydropower project that has had negative impacts in indigenous territories, including deforestation and the near-extinction of several species of migratory fish.
Clearly, some standards are needed. The World Bank, IFC, and the nonprofit Climate Bond Initiative have each developed their own criteria. The CERES Investor Network on Climate Risk is developing green bond standards; its Statement of Investor Expectations addressed general best practices, including criteria for green project classification, regular reporting on use of proceeds, and project impacts that are supported by independence assurance.
To create a successful marketplace, a full suite of complementary products needs to be further developed, including indexes, which play an important role in driving demand among institutional investors. Last year saw the launch of several green bond indices from S&P and MSCI. To date, only Calvert Investments offers a bond fund that is exclusively focused on green bonds.
The green bond market is still a young one, still relatively small, and highly fragmented. Demand is so high that almost every issuance is oversubscribed, and the market remains highly illiquid. This makes it easier for some purveyors of green bonds to stretch the meaning of “green” wide enough to fit around a parking garage.
In a best-case scenario, as the market matures, selective investors will demand more transparency and accountability. Voluntary codes of conduct, reporting, and third-party verification systems will take on more prominence, and this could open up opportunities for more issuers with creative ideas to attract capital for projects that might have previously gone overlooked. (One such example was a public/private green bond partnership in Morris County, N.J., in which the risks and opportunities of a solar project were shared with private developers.) Green bonds are off to a good start… and an even brighter future.