Essay: Investments in climate change

To mitigate the climate change catastrophe, “investments in low-carbon energy technologies will need to at least double, reaching $500 billion annually by 2020, and then double again to $1 trillion by 2030”.1
Green investment gap is very wide as a result of morose macroeconomic environment following 2007 crisis which led to a sluggish economic activity in the high income countries.2
And with the capital and liquidity constraints commercial banks are facing, it has become difficult to receive bank loan with long maturity for infrastructure projects.3 With the restrictions on bank to finance the long term projects after the crisis of 2008, green bond financing has been developed as a valuable way to ensure investments.4
In the $100 trillion present global bond market, the investments into the green bond is almost negligible.5
Present financial market provides an excellent opportunity for green bond financing as investors’ consider projects having stable revenue stream.6 With the green bond issuance of $42.4 billion in 20157, its increase will be a good fit with investors (especially institutional investors’) with long term liabilities.
Yet we find institutional investors hesitate when it comes to investment in green bonds particularly because of dearth of information & expertise and regulatory framework has not been well established to attract investors.8 As an immature industry, green investment increases the risks regarding market development & technology growth and it has not been transparent & predictable as it should have
1 Cf. IEA (2012), p.49. 2 Cf. Campiglio (2016), p.222. 3 Cf. Kaminker/Stewart/Upton (2012), p.1. 4 Cf. Basu/Brown/Felsen/Hedley/Menon/Zaman (2015), p.5. 5 Cf. Kidney/Sonerud (2015). 6 Cf. Dorji/Ordonez/Uzsoki (2015), p.5 7 Cf. Moody’s (2016 a). 8 Cf. Kaminker/Stewart/Upton (2012), p.4.
2
been and is still heavily reliant on public support.9 Further risks of greater regulations, green washing or green frauds are holding investors back as enough policy actions are not implemented.10
A much better plan and structure is essential for such green finance.11 Since green projects are getting more public support and many of the institutions already pledging their commitment to the green infrastructure, it has become almost necessary to search for a source of sustainable financing. Even greater response is necessary in well-designed policies in surmounting both the real and perceived risks and launch green investments in large scale.12 It is no doubt that green bonds which are issued today and paid in future will make future generations not only beneficiaries but also responsible for the part of the cost of mitigation while the present generation not only will be financially well off but also will create a better environment for the future generations to live in.13
As banks are facing problems financing the long term projects, alternative of using green bonds seems understandable. Further, companies are looking alternative ways to ensure funding of new projects or refinancing the undergoing projects. But, investors still lack confidence in investing in green bonds as we lack expertise on these type of bonds.
If green bonds play a role in climate mitigation and adaptation, can it be a significant part of global debt markets? This thesis will examine green bonds from 5 different perspectives which will be supported from insights from its history and its present trends. With several questions still vague and unanswered this thesis is a timely approach to address some issues.
9 Cf. Campiglio (2016), p.222. 10 Cf. Ludvigsen (2015). 11 Cf. Arboledo/Botero/Gonzalez (2016), p.181. 12 Cf. Buchner/Heller/Wilkinson (2016), p.1. 13 Cf. Flaherty/Gevorkyan/Radpour/Semmler (2016), p.1,11.
3
1.1 Relevance
This thesis will provide an insight into the green bond financing mechanism and will be helpful for bond market players to understand the ongoing market system. It can also be helpful for investors in understanding the risk and benefits of green bonds. Further, this simple but elaborated research will help newcomers to understand the green bond market. Relevant research into this sector is very less which examines the opportunity to finance projects through green bonds. Hence, this all-purpose research is considered relevant.
1.2 Research Question
With a short history of only 9 years, issuance of green bonds is still doubted by investors and the market is not well established. As an immature market, academic research regarding green bonds is very limited. So a need of thorough investigation into this topic seems very realistic.
Hence this paper presents a detailed study regarding green bonds and further how it can enhance the capital debt market concerning green projects. This proposes following research question to be analysed:
 Financing of sustainable projects via Green Bonds
This main question will be answered by identifying and analysing following criterions.
1. Law and Regulatory Environment
2. Transaction Costs
3. Liquidity
4. Credit Enhancement (Credit Ratings) and Tax incentives
5. Investors’ Base
The above mentioned criterions will include the relevant definitions, their types, present scenario and their effects. Comparison with financing via bank loans will
4
be done whenever necessary. Analysing these criterions will help us know the scenario in this sector along with its flaws and strengths and as a conclusion it will help us determine whether green bonds are suitable means of sustainable financing or not.
1.3 Research Method
This thesis is divided in two parts to provide clear understanding.
First part begins with background information regarding project financing and introducing the bond markets. It is then followed by green bond market analysis including its maturity structure, issuer and investor base and information regarding green bond ratings.
In the second part we will qualitatively analyse the five criterions that affects the green bond market. The research is based on documentary analysis where an extensive study of publication, journals, articles and reviews is done to analyse these criterions.
1.4 Limitation
The limitation of would be not combining this research with other methodologies like data analysis, survey or questionnaire. This research does not aim on providing a definite conclusion rather it aims to develop understanding and explore insights regarding green bonds. Rather than taking a position on a specific form of financing it will explore on what is being used and what are its merits and demerits.
5
1.5 Literature Review
With the growth of green bonds in recent years, it is not so surprising scholars and researchers have shown interest into this. But as a very immature topic specific literature is not so abundant and enough scientific studies have not yet been performed.
There has been growing environment concerns in the society as a result of which green infrastructure projects are on rise since half a decade ago. Green investments these days are seen as socially responsible investing techniques. Investors are more concerned regarding their investments and also companies highlight such need to improve their CSR. When companies disclose such investments, it was found to be well approved by the investors.14 Falsen & Johansson (2015, p.35) supported this view by researching that green bonds can increase green investments because it can increase company reputation and provide capital access to issuers. In one of the study performed by Langhelle (2016, p.5,60), the data analysis showed that there has been a significant role of change in preference of issuers, investors and regulators. The paper argues that such change has been significant in growing the green bond market even though there are additional costs associated with it. My thesis will try to focus more on the preferences of issuers and investors in the present context. Further, support in the case of preference comes from China where a study of 100 companies showed that there has been pressure from stakeholders which has led to green innovations within the companies and also led to profitability.15
Scholtens (2011, p.231) provides example of Netherland where private investors motivated by tax incentives invested in green funds which ultimately contributed to environmental protection. This is one of various techniques that can be used for the growth of green bond market. More growth opportunities will be discussed in my thesis as well.
14 Cf. Martin/Moser (2015), p.1,15. 15 Cf. Cao/Chen/Huand/Li/Ren/Zheng (2016), p.46.
6
Although, green bonds can be successful in addressing a company’s CSR, but there is lot of uncertainty within this sector. One of the challenges remain in defining what constitutes a green investment. Stakeholders and investors define it according to their needs. This problem was demonstrated by Inderst, Kaminker & Stewart (2012, p.6) where they tried to propose a general definition for green investments but instead argued that it has multitude approaches. Adams & Fraenkel (2015, p.1,23) discuss about the current state of ambiguity concerning the definition and application of green bonds. They further mention that a framework should be developed so as to measure money being spent in the process of GHG reduction. I will try to fill this information gap by thoroughly analysing laws and regulations concerning green bonds.
Although investments in green bonds produces environment benefits, various studies have shown that it doesn’t produce any extra financial benefits. Am & Yu (2013, p.246) studied climate bonds issued by EIB in 2007 and Petrova (2016, p.1,27) compared green bonds indices with mainstream bonds. Both of them didn’t found green bonds perform better. Further at present the green bond sector is very volatile.16 But since the market of green bond is still very small there are not enough stories behind green bonds to analyse its success or failure.
The main benefit of green bonds is that it is socially responsible and carries a lot of significance at the time challenged by climate change. Investment managers in Europe have shown positive inclination towards green bonds investing as a sense of responsibility towards protection from climate change.17 Need for green investments has risen since last decade globally and is macroscopic in nature influenced by factors such as growth rates, public policies, energy policies, etc.18 But this need is only properly addressed when various concerns associated with it is simplified and standardized.
16 Cf. Pham (2016), p.1,25. 17 Cf. Amenc/Goltz/Tang (2010), p.6,40. 18 Cf. Clemens/Eyraud/Wane/Zhang (2011),p.4,26.
7
2. Basics
2.1 Terminologies
Green finance: Different institutions have their own way of defining green finance. The following definition is more related in the context of our paper.
“Green finance is a broad term that can refer to financial investments flowing into sustainable development projects and initiatives, environmental products, and policies that encourage the development of a more sustainable economy. Green finance includes climate finance but is not limited to it. It also refers to a wider range of „other‟ environmental objectives, for example industrial pollution control, water sanitation, or biodiversity protection.”19
Securities: “A security is a negotiable financial instrument. Negotiability refers to the fact that its legal ownership is readily capable of being transferred from one owner to another by delivery or endorsement. While any financial instrument can potentially be traded, a security is designed to be traded on an organised exchange or “over the counter”, although evidence of actual trading is not required”.20
Bond proceeds: Amount of money generated by a bond issuer from investors as part of issue of the bonds.
Risk return profile: In simpler terms, this is the trade-off between risk and return of an investment. Before investing, an investor usually considers the returns of the investment and the risks associated with that investment. Usually, low level of risk is associated with low returns and investor has possibility for more returns only if they are strong enough to accept the losses.
Bond underwriter: Underwriter is one who introduces new securities of a company to the market. It can be either a company or any other entity.
19 Cf. Fekete/Gilbert/Höhne/Khosla (2012),p.7. 20 Cf. BIS/ECB/IMF (2009),p.4.
8
Underwriters perform their operations by receiving underwriting fee from the issuers.
ESG: There is no single accepted definition of ESG factors. We take the definition from Financial Services Commission of Ontario: “ESG factors can be described as a broad term that encompasses a wide range of environmental, social, and governance factors. Environmental factors relate to a company or industry’s interactions with the physical environment, social factors concern the social impact of a company and/or industry on a community or society, and governance factors typically relate to how companies and/or countries are governed”21.
2.2 Project Financing
Nevitt and Fabozzi (2000, p.1) define project financing as “a financing of a particular economic unit in which a lender is satisfied to look initially to the cash flow and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan”.
In project financing, sponsors own and invest in a single purpose asset which is independent and is financed from non-recourse debt.22 The debt is generated from different sources and are arranged in a same capital structure and in such financing the debt repayment is made from the same source along with the same security package.23 Recent history has shown that project financing as an important financing mechanism for the public sector. Global debt raised through project financing increased from $131.7bn24 in 2000 to over $277.7bn25 in 2015.
As project financing, involving multisource, can be a complex financing following points26 must be considered with great details
21 Cf. FSCO (2015), p.2. 22 Cf. Christov/Esty (2002), p.2. 23 Cf. Brown/Dickens/Nordstrom/Stirling (2012), p.37. 24 Cf. PFI (2000), p.47. 25 Cf. PFI (2015), p.48. 26 Cf. Rossi/Stepic (2015), p.13.
9
 Sustainable economic performance of the project and bankable financial structure  Country and political stability  Stakeholders interest and consequently their involvement  Sufficient accessible long term financing  Identifiable risks and sufficient mitigants  Transaction nature should be suitable for project financing
For large scale capital intensive project, project financing is one of the method in which the cash flows generated act as the source for loan repayment and where the project assets are used as a collateral for a non-recourse loan.27 “Project finance transactions can be placed on a continuum, with recourse to project sponsors ranging from nonrecourse to almost complete recourse, as is increasingly common in structured project finance”.28
There are at least two parties in project finance, the project sponsor and the party providing funds either in the form of loan or bonds. But in practical, role of various actors such as intermediaries, insurance brokers and risk analysts come into play to deliver the results.29
Project finance differs from regular corporate borrowing and asset based finance as projects are independent and lenders have legal claim only to project cash flows and project assets but not on the corporate cash flows or assets.30
27 Cf. Akbiyikli/Eaton/Turner (2006), p.67. 28 Cf. Hoffman (n.d.), p.4. 29 Cf. Kaiser (2013), p.730. 30 Cf. Esty/Harris/Krueger (1999), p.2.
10
The history of project finance dates back to 1299 where a leading merchant bank was accessed for funds to develop a silver mine.
Figure 1 History of project finance31
A debt capital of US $3.7 billion was raised for 28 projects in 1983 and since then the no. of projects has been significantly raised with over 596 projects being financed using project financing with a raised debt capital of US $204.9 billion at the financial closing of year 2013.32
31 Cf. Chu (2007) cited in Chu/Merna/Thani (2010), p.2. 32 Cf. Moody’s (2015), p.5. See Appendix 1 for detailed data.
11
2.2.1 Characteristics of Project Finance
Figure 2 A typical project finance structure.33 We cannot find a single definition of project finance agreed by all parties. Rather it is easier to identify project finance with some of its basic features:
 Financing is typical for projects for around 15-25 years. Such projects have lengthier construction and operation period.34  There is high leverage as 70-90% of capital is provided by debt financing, so this high debt to equity ratio can reduce the blended cost of debt to equity and as a result the overall financing cost of the project35.  For this type of financing, risk identification and assessment is one of the primary tasks.35  A project company called Special Purpose Vehicle (SPV) is formed by project sponsors which is legally independent35,36.
33 Cf. Bernabeu/Verdu/Vitoria(2015),p.162. 34 Cf. Yescombe (2014), p.7. 35 Cf. Ashong (2016), p.4. 36 Cf. Bernabeu/Verdu/Vitoria (2015), p.161.
Special Purpose Vehicle (SPV)
Equity Investors
Lendors
Constructor Individual Consultants
Supplier Client Operator Insurance Companies
O & M agree ment
Insuran ce Policies
Debt
EPC Contract
Due Diligence
Equity
Put or pay agreement
Off take agreement
12
 The lenders have very limited claim for their investments if the collateral is not enough to pay their debt in case of a default. So, as there are no guarantees it is basically a non-recourse financing.37,38,39  Contractual arrangements are done with various risk management parties for the management of risks like completion and operation risk, revenue and price risk, etc.40
2.3 Bond Theory
Bond market was accessed by project sponsors in the early 90s and since the crisis of 2008, bond market has become more popular as a more liquid source of funding.41
In bond theory, there is an issuer and a bond holder where the issuer is owed to the bond holder for a certain amount called principal which is to be paid at a certain maturity date and regular interest to the bond holder in the form of coupons.42 In general, bond market is called the debt market and bonds are split and traded in the primary and secondary market.43
Some of the common types of bonds based on issuer are:
Corporate bond: These are the bonds issued by corporations. According to Fabozzi (2000): In general, they are classified in 4 types based on the type of user: utilities, transportation, industries and banks & finance companies. Here the bond holders have more preference than stockholders to both the assets and income of the corporation for the debt in case of a default. The contracts between the issuers and bondholders are called indentures. Most corporate bonds are term bonds which run for a time, become due and then payable. Such term bonds may
37 Cf. Yescombe (2014), p.7. 38 Cf. Bernabeu/Verdu/Vitoria, p.161. 39 Or it can be limited recourse finance when there may be limited investor guarantees. 40 Cf. Kleimeier/Versteeg (2010), p.49,51. 41 Cf. Boudrias/Kotkin/Suisse (2012), p.111. 42 Cf. Haafst (2016), p.9. 43 Cf. Fabozzi/Fabozzi/Feldstein(1995), p.3.
13
be retired earlier then the maturity date if provision is included in the indenture. Some bonds which are due under 10 years from the issuing date are called notes. Some corporate bond issues are arranged so that specified principal amounts become due on specified dates. Such issues are called serial bonds. For security, either real property (using a mortgage) or personal property may be pledged to offer security beyond the issuer’s general credit standing. (p.144).
Municipal bond: According to Fabozzi (2000): these are the bonds issued by local and state government and by other government entities. Some municipal bonds are tax exempt where interest on bonds are tax exempt from federal income taxation and may or may not be taxable at state or local levels. Municipalities issue short term bonds to cover seasonal and temporal disproportion between expenditures and inflows from taxes. Municipalities issue long term bonds to finance infrastructure projects like schools, roads, bridges and to address long term budget deficit generated from current operations. (p.177,178).
Investors in municipal bonds face the additional risks that their holdings can be adversely affected as a result of changes in tax law than that of corporate bonds.44
Government bond: Those debt obligations which are issued by a government are government bonds.45 Compared to corporate bonds, government bonds tend to have lower credit risk which is suitable for investors wanting secure and stable cash flows but these bonds also tend to have lower yield as a result of lower risks involved.46
Some of the basic features of bond include:
 Generally, the amount is repaid at a certain fixed maturity date and no payments are made during the term.
44 Cf. Fabozzi/Fabozzi/Feldstein (1995), p.3. 45 Cf. Government Securities (n.d.). 46 Cf. ASX (2016), p.9.
14
 Coupon payment is made by the issuing company either annually or semi-annually.47  The price of bond depends on the changes as per the market interest rate and they respond by moving in the opposite direction of change.48
2.3.1 Green Bonds
“a sustainable financing strategy is critical for enhancing the development of infrastructure projects and investment that will help to avert dangerous climate changes as well as improve the coverage”.49
History of large scale infrastructure financing through bonds is not new. However, since 2007 a market for bonds specifically “self-labelled” or designated as “green” has emerged which are differentiated from regular bonds with its additional label of “green “. 50 Green bonds 51 are different from conventional bonds only in the case of use of proceeds.
The investments made in green bonds are to be designated only to financing or re-financing of such projects which play a role in environment protection and reducing the effects of climate change. The world bank launched the first labelled green bond in 2008 in the amount $440million.52,53
47 Cf. Carrera/Trombetta (2015), p.1. 48 Cf. Thomson Learning (n.d.), p.193. 49 Cf. Arboledo/Botero/Gonzalez (2016), p.181. 50 Cf. OECD (2015), p.5. 51 See Appendix 2 for current different types of green bonds. 52 Cf. WB (2015), p.25. 53 Although the first labelled “green bond” was issued by WB in 2008, the first climate awareness bond was issued by EIB in 2007. The bond issued amounted to €600 million which focused on Renewable Energy and Energy Efficiency. The bonds were not fixed coupons but rather linked to an equity index which are referred commonly in bond market as structured bond.
15
Green bonds presently lack common definition around the globe. This has become one of the hindrance to the growth of the market. To address this issue to some extent, Climate Bonds Initiative, a NGO based in UK has developed a taxonomy54 to create a common definition all across the global markets so it can help for a particular united bond market.
3. Market Analysis
3.1 The Green Bond Market
Investor are being attracted to the growth of green bonds in the capital markets. Figure below shows the growth in issuance of green bonds since 2008.
Figure 3 History of green bond issuance.55
54 See https://www.climatebonds.net/standards/taxonomy for details. 55 Climate Bonds Initiative website
16
When it comes to the issuer, development bank and corporates are leading the way for green bonds issuance. The figure below shows the issuance of green bonds for the past 4 years according to the issuer type.
Figure 4 Annual Green Bonds Issuance.56 See the recent 10 green bonds (as of August 25) issued as per the issuing date below.
Name Amt Issued Currency Issue Date Maturity Massachusetts Water Resources Authority 104,260,000 USD Aug-16 OPIC 49,300,000 USD Aug-16 Jul-40 Upper Mohawk Valley 8,770,000 USD Aug-16 IFC 5,650,000 USD Aug-16 Aug-21 China Energy Conservation & Environmental Protection 1,000,000,000 CNY Aug-16 Aug-21
56 CBI (2015a), p.1.
17
CABEI 1,032,000,000 ZAR Aug-16 Aug-20 OPIC 2,000,000 USD Aug-16 Aug-26 City of Aurora, Colorado 437,025,000 USD Aug-16 Greenko Investment co 500,000,000 USD Aug-16 Aug-23 ADB 500,000,000 USD Aug-16 Aug-26
Table 1 Green bonds data57,58 Green bonds are different from regular bonds that their proceeds are only used for green infrastructure projects which has significant impact in reducing climatic effects. These proceeds are largely used for energy followed by building and industry.
Figure 5 Green bonds market cover59 Multi-sector constitutes of bonds with mixed use of proceeds for different projects.
57 Cf. Labelled (n.d.). 58 For more analysis, visit http://www.climatebonds.net/cbi/pub/data/bonds?items_per_page=100&order=field_bond _blog&sort=desc 59 Cf. CBI (2016), p.7.
49%
27.80%
9.20% 7.30% 6.20% 0.40% 0.10% Sectors
Multi-sector Energy Building & Industry
Transport Water Waste & Pollution
Agriculture & Forestry
18
Growth of green bonds has been increasing all around the world. Countries like India, Brazil and Mexico joined green bonds in 2015..
Figure 6 Green Bonds Issuance around the world in 201560 Development banks play a huge role for the growth of green bond market. They remain the large issuers of green bonds and also meet the demand for AAA-rated bonds. Until now, The EIB has issued the largest amount of green bonds (over $17bn) and also was the biggest issuer of green bonds in both 2014 and 2015.61
60 Cf. CBI (2015a), p.2. 61 Cf. CBI (2016), p.6.
19
Figure 7 Investment grade of green bonds.62 Among 82% of the investment graded green bond market, 43% of the bonds fall into the AAA credit ratings. This is particularly because of the involvement of large financial institutions such as World Bank, EIB and IFC. This trend shows that bond issuances from corporations and commercials banks are on rise and new issuers are expected to enter the green bond market in coming years. As of 2015, there were 45 different corporate and bank issuers, a significant rise from just 30 in 2013 and less than 10 in 2012.62
BAML was the top green bond underwriter in 201563, underwriting around $4.57bn in total. It was followed by Credit Agricole CIB with $3.79bn and HSBC with $3.49bn.
62 Cf. CBI (2016), p.6. 63 Bank of America Merill Lynch is the leading underwriter for the first three quarters of 2016.Visit https://www.climatebonds.net/resources/league-table.
43%
15%
15%
9% 4%
14%
Ratings
AAA AA A BBB <BBB No Rating
20
Figure 8 Green bond underwriter league table.64
3.2 Maturity Structure of Green bonds
Maturity is usually associated with the premium and any future changes in the short rate.65 At the date of maturity, the borrower is liable to pay the lender full principal amount along with any interests remaining to be paid. Failure to pay creates default and it affects negatively to the credit rating of the issuer. From an investor point of view, maturity is the primary focus since it has to be in the perspective of investments of an investor. Maturity of green bonds are no indifferent from conventional bonds.66 Flaherty et al. (2016, p.4) argue that green bonds time horizon is likely be longer than traditional or non-climate related bonds because in 5-10 years the climate benefits of investment will not be realized. The average years to maturity of a bond in the S&P Green Bond Index is 5.1 years. The following chart shows the maturity ranges in the index as of June 30, 2014.
64 Cf. Green Bonds Underwriters (n.d.). 65 Cf. Park (1999), p.1407. 66 Cf. Natixix (2014), p.18.
21
Figure 9 Maturity ranges of green bonds67
3.3 Green Bond Ratings
According to International organisation of securities commission (IOSCO) and the Committee of the European Securities Regulators (CESR) “A credit rating, typically, is a credit rating agencies’ opinion of how likely an issuer is to repay, in a timely fashion, a particular debt or financial obligation, or its debts generally.68
Rating agencies play an important role in creating transparency in financial markets by reducing the information gap providing information and judging the quality of both the issue and issuer.69 Rating agencies take into account of prevailing and planned investment expenditures characteristics of an issuer firm or institution. On the other hand, vulnerability of an issuer is summarized by issue rating based on the available information (public and reserved). For the investors it can become very expensive and may be inefficient to analyse risks of every bonds they want to buy, so credit rating helps such investors.70
67 Cf. Jauhari/Kochetygova (2014), p.14. 68 Cf. IOSCO (2003), p.1. 69 Cf. Ebenroth/Dillon (1993) and Cowan (1991) cited in Matarocci (2014), p. XVII 70 Cf. Åström/Mortenson (2013), p.28.
22
An issuer can have their green bond rated from competent third parties, which are the specialized rating agencies.71At the present financial system, Standard & Poor’s (S&P) and Moody’s are the best known international credit rating agencies.72
Moody’s assesses green bond basing on 5 factors73: (i) organization, (ii) use of proceeds, (iii) disclosure on the use of proceeds, (iv) management of proceeds, and (v) ongoing reporting and disclosure on environmental projects financed or refinanced with such securities
Assessment Factor Weight Organisation 15% Use of proceeds 40%
Disclosure on use of proceeds 10%
Management of proceeds 15%
Ongoing reporting and disclosure 20%
Table 2 Weightage of Moody’s assessment factors73 On the other hand, S&P Global has proposed a new methodology to evaluate the impact of green bonds. Apart from management and governance of the bond, it aims to estimate the environmental impact of the green bonds. An overall green bond evaluation score will be given by calculating the weighted average of scores in categories transparency, governance, mitigation and adaptation.
71 Cf. ICMA (2016), p.6. 72 See Appendix 3 for an overview of Moody’s and S&P’s ratings scale. 73 Cf. Shilling (2016), p.3.
23
Figure 10 Green bond evaluation methodology74 Further, S & P Green Bond Index was launched in July 2014 and it comprises bonds which are labelled as “green” from their issuers.75 S&P, considers the bonds as eligible green bonds if the issuers have clearly designated the green label and its justification i.e. its planned use of bond proceeds. At present for the bonds to be qualified to be included in index, S&P considers those bonds as green which are flagged as green by “Climate Bond Initiative”.76 Until now, multilaterals have been issuing green bonds with “AAA” ratings. 54% of total market capitalization in S&P Green Bond Index is AAA rated, where supranationals have around 50% issuance followed by corporations with 37%.76
74 Cf. S&P Global Ratings (2016), p.4. 75 Cf. S&P Dow Jones Indices (2014). 76 Cf. S&P Dow Jones Indices (2016).
Transparency
-Information sufficiency
Adaptation
-Improvement in Resilience
Governance
-Compliance with industry standards
-Follow-up reporting
Mitigation
-Buildings
-Energy
-Transport
-Other Infrastructure
Key Relevant eKPIs
-Carbon
-Water
-Waste
-Land use
-Air and water pollution
Key Relevant eKPIs
-Reduction in financial and nonfinancial damages
Hierarchy Overlay
Final score-weighted aggregate of the four categories
eKPI: environmental key performance indicator
24
In recent years, the index has continued a regular growth as shown in internet screenshot below. The index comprises bonds issued all around the world from different issuers like multilaterals, corporates and governments.
Figure 11 Global green bond market performance77
3.4 Issuers and Investors of green bonds
As the green bond issuances is very less compared to that of conventional bonds, labelled green bonds make it visible for investors to identify and invest which otherwise was not possible because of overlapping and if marketed correctly regarding the usage of green bond proceeds it helps in enhancing the public
77 Cf. S&P Green Bond Index. For latest performance, characteristics, yield to maturity and yield to worst of green bonds visit the website http://www.us.spindices.com/indices/fixedincome/sp-green-bond-index
25
image of an organisation which will improve their access to capital.78 As a result of labelling bonds as green, issuers are now able to focus on environment friendly aspects which helps in attracting potential investors who have ESG mandate. This was not easier before because the information available was not enough.
Some of the benefits79 to investors investing in labelled green bonds include
 Transparency regarding the use of proceeds.  Investors will be able to report the positive improvements in climate aspects to their partners or end asset owners.  There will be huge demand creation for green bonds which as a result will give potential investors opportunities to invest in environment friendly developments.
The investor extent is in increasing trend as a result of demand for green bonds. Some of them79 are listed below:
 Institutional investors like Aviva, BlackRock, State Street  ESG specialist and Responsible Investors like Natixis, Mirova  Corporations like Barclays, Apple  Sovereign and municipal governments like California State Treasurer
Further rapid growth in China where Chinese electric car and wind power companies raised around $8.8bn collaborating with banks shows the increasing market of green bonds around the globe.80 Green bond also gives an opportunity to that special pool of investors whose funds are to be designated towards environment friendly infrastructures and provides issuer the access to such investors whose primary focus is on ESG related aspects of the project.81
78 Cf. Ng/Tao (2016), p.6. 79 Cf. Investor appetite (n.d.). 80 Cf. Tu (2016). 81 Cf. SEBI (2015), p.2.
26
Some of the principles82 are needed to be followed by the issuer for the issuance of green bonds
 Issuer should clearly define and make public their criteria for funding in projects to be considered as green, i.e. the use of proceeds should be distinctly mentioned  Processes applied for selection of green criteria should be mentioned i.e. project selection and evaluation  Processes and controls for the management of proceeds so that it will only be used for specified purposes  Reporting must be done regarding the evaluation process and progress for both environmental and financial criterions.
Presently, government related agencies cover around 60% of green bond universe which certainly has a higher average credit quality than other credit indices but has lower average yield.83
Alfsen et al. (2016) mention that issuance value of around $40bn i.e. 40% of green bonds issued to date has been raised by multinational and national development banks to support the climate change projects primarily in developing countries.p.6
82 Cf. ICMA (2016), p.2 – 4. 83 Cf. Bakshi/Preclaw (2015), p.8.
27
4. Research and Analysis