Climate Bonds - Allianz Climate Solutions

Climate Bonds - Allianz Climate Solutions

Climate Bonds
Karsten Löffler, Simone Ruiz, Thomas Liesch
July 2013
1
Introduction
2
Structure of climate bonds
2.1 Climate-related IFI bonds
2.2 Climate-related municipal bonds
2.3 Climate-related project bonds
3
Barriers for climate bonds
3.1 Underdeveloped structure of the climate bond market
3.2 Barriers on the IFI bond market
3.3 Barriers on the municipal bond market
3.4 Barriers on the project bond market
3.5 Barriers on the investor side
4
Possible approaches for the development of the climate bond market
5
Summary and outlook
Acknowledgement
Comments
Literature
Climate Bonds
1 Introduction
The resolutions passed at the annual UN Climate Change Conference 1 are aimed at achieving a
stabilization in the concentration of greenhouse gases in the atmosphere in order to prevent
average global warming of more than 2°C above the level seen prior to the industrial revolution. 2
In order to reach this target, global greenhouse gas emissions will have to be cut to 50 % the
2000 level by 2050.3
Possible reduction measures are focusing on the further expansion of energy generation from
renewable energy sources and investment in energy efficiency measures. Without significantly
greater efforts, global energy consumption would be likely to climb by around 80 % by 2050,
with conventional energy sources accounting for a share of approx. 85 %. Carbon dioxide (CO2)
emissions4 from energy generation would increase by around 70 %.5
The world's industrialized nations have promised to mobilize at least USD 100 billion a year for
climate financing for developing countries in the period leading up to 2020. 6 It is estimated that,
between now and 2030, around USD 1 trillion or 2 % of gross domestic product (GDP) will
have to be invested every year in order to decarbonize the global energy infrastructure.7 Since
the required funds cannot come from stretched public-sector budgets alone, financing using
private capital, particularly via the capital market, e. g. via climate bonds, will have a very
important role to play.8
Climate bonds are an alternative to conventional bank loans or project financing when it comes
to covering the long-term financing needs of climate-friendly projects. Climate bonds could tap
into the bond market, which has been used relatively little to finance projects like these to date,
and at the same time attract groups of investors with long-term investment horizons, e. g.
pension funds and insurance companies.
The issuers could include international finance institutions (IFIs), municipalities, the corporate
sector and special project companies. The market segment got its name as a result of pioneering
bonds issued by IFIs, such as the European Investment Bank (EIB) – Climate Awareness Bonds
– and the World Bank Group – Green Bonds.
According to the most common definition, climate bonds are used to finance projects aimed at
preventing CO2 emissions that harm the climate (e. g. by replacing fossil fuels with energy
generated from regenerative sources and energy efficiency measures) or to finance adaptation to
climate change (e. g. to improve protection against extreme natural catastrophes such as flooding
and drought).9 Investors generally expect transparency on the manner in which the funds are
used; sometimes, this even has to be verified by independent third parties.
The outstanding volume of climate bonds was put at around USD 346 billion in mid-2013.10 Of
this amount, USD 163 billion or 42% are qualified for institutional investors (Investment-grade
2
Climate Bonds
rating, currency eligible on benchmark indices and issuance size over USD 100 million), with
the lion's share (83 %) issued by "green" corporations (e. g. solar and wind power industry, but
also railway companies). Municipal, project and IFI bonds account for a market share of 17 %.11
Although the market is growing, it still only accounts for a minuscule share of the global bond
market (estimated size: USD 78 trillion).12
Corporate bonds whose proceeds are used either in full or in part for climate-related purposes,
but which are generally intended to ensure general corporate financing, meaning that they are
not designed for specific projects, are not in the focus of this analysis. The same applies to
investment vehicles whose proceeds are used for specific climate-related measures, but which
are not structured as bonds, but also funds that invest, by way of example, in climate bonds,
companies in the wind and solar energy sector or climate-related projects.
Chapter 2 looks at the different structures of climate-based IFI bonds, municipal bonds and
project bonds. Chapter 3 provides an overview of the barriers that pose an obstacle to the growth
of this market. Finally, Chapter 4 takes a look at the various options for the further development
of the climate bond segment. A summary is provided in Chapter 5.
A series of expert interviews were conducted for this paper.13
2 Structure of climate bonds
The specific legal and financial structure of climate bonds varies to a sometimes considerable
degree. One of the key aspects that bondholders take into account when assessing the bonds in
question is the scope for financial recourse in the event that the issuer becomes insolvent (see
Figure 1). A distinction can be made between two different forms in this respect.
(i)
(ii)
Liability extends to assets that significantly exceed the assets purchased via the project:
Project-specific risks are of little significance, because the bond's credit rating
generally depends on the credit rating of the issuer (e. g. IFIs and municipalities). This
means that, as a general rule, any underperformance of the financed projects does not
have an impact on payments. If the issuers are IFIs or municipalities, the rating is often
a good to very good investment grade rating.
The liability is limited, in principle, to investment vehicles set up specifically for this
purpose, known as conduits or special purpose vehicles (SPVs): Only the financed
assets serve as collateral. Financing via bond-issuing SPVs presupposes a more direct
link between risk and return on the one hand, and the financed projects on the other,
because no other assets are available. The cash flow from the underlying assets and the
scope of risk buffers therefore play a key role in determining the debt servicing
capacity. Experience has shown that a cautious, sufficiently conservative structure is
required to achieve at least a low investment grade level.14
3
Climate Bonds
Figure 1: Different forms of climate bonds, own graphic.
In order to simplify matters, we will make a distinction between IFI bonds, municipal bonds and
project bonds below.
2.1 Climate-related IFI bonds
Since climate change has a particularly heavy impact on developing countries and emerging
markets and since these are the countries that look set to see the most marked increase in energy
consumption, IFIs play a particularly important role in financing climate solutions for these
countries. This, together with the need to mobilize far higher amounts in the future and also
target new investor groups for this purpose, provides strong grounds for the development of
climate-related IFI bonds (see Table 1). They are an important market category because they
combine integrity, a high credit rating and, depending on the issue volume, also liquidity.
IFIs traditionally use AAA bonds for refinancing, because the member states, e. g. the
International Bank for Reconstruction and Development (IBRD), back the liabilities with their
capital commitments, but also because IFIs tend to pursue a conservative financing policy.
The EIB and the third-largest issuer of IFI climate bonds, the Asian Development Bank (ADB),
have started to issue climate bonds in response to demand from investors with a long-term focus,
e. g. Swedish pension funds. These bonds tend not to differ in structure from the standard bonds
issued by these issuers, but the bond returns, which are kept separate from the general
refinancing portfolio, are used exclusively for climate-related projects. Project and country risks
are of minor significance, because the projects are financed directly via the balance sheet of the
4
Climate Bonds
issuing institution. This means that IFI climate bonds have a similar risk-return profile to their
standard issues (AAA rating).
Table 1 – Issuers of IFI climate bonds
Name
Issuer
World Bank Green
IBRD
Volume
(EUR m)
~ 2,650
No.
Ø Term
Currencies
58
Mainly 5, 7 and 10
17 different currencies, incl.
years
USD, AUD, JPY, BRL,
Bonds15
ZAR, SEK, TRY
Climate Awareness
EIB
~ 2,416
16
Mainly 2 to 7 years
Bonds16
e. g. EUR, AUD, ZAR,
SEK
IFC Green Bonds17
IFC
~ 1,654
15
3, 4 and 10 years
e. g. USD, AUD, BRL
Clean Energy Bonds18
ADB
~ 486
2
3 – 7 years
e. g. BRL, TRY
Environmental
EBRD
~ 125
8
4 – 6 years
e. g. AUD, BRL, IDR
Sustainability Bonds19
Exchange rates as of June 14, 2013, own graphic.
To date, the main source of interest in this type of bond has come from Japanese private
investors, Scandinavian institutional investors and also climate-conscious state investors (e. g.
California State Treasurer).20 A climate bond issued by the EIB in November 2012 in SEK also
met with considerable demand from bank treasury departments. 21 The experience that IFIs have
with project selection, control and monitoring fosters greater investor confidence.
The project selection process focuses on measures relating to energy efficiency and renewable
energy. At the World Bank, this also includes the upgrading of power plants and at the ADB,
access to clean forms of energy. 22 So investments in conventional forms of energy generation are
not ruled out as long as they result in lower CO 2 emissions. Some market participants mention a
lack of public transparency regarding the use of the funds, since detailed information is
generally only provided on selected projects in investor newsletters and, where appropriate, on
request.
Commercial banks play an active role in the structuring and distribution of these products: the
first subscribers to the EIB bonds were the Swedish investors SBAB Bank and Apotekets
Pensionsstiftelse, as well as the Korea Investment Corporation.23 The World Bank's “Green
Bond“ was developed in cooperation with Skandinaviska Enskilda Banken (SEB) and
distributed by the latter, among others, too.24 The Japanese company Nikko Asset Management
has launched two Green Bond funds,25 while the asset manager State Street Global Advisors
offers its customers an opportunity to invest in an IFI climate bonds portfolio. 26 The ImportExport Bank of Korea has, with the support of SEB and Bank of America Merrill Lynch, issued
a bond with a slightly lower investment grade rating (Aa3) that has been oversubscribed several
times and serves to finance projects initiated as part of national CO2 reduction programs.27
5
Climate Bonds
2.2 Climate-related municipal bonds
In addition to companies and IFIs, municipalities, particularly in the US but also in Norway, are
the biggest issuers of climate bonds. These bonds, known as "munis" 28, are subsidized in the US
via tax relief or reduced interest rates. The funds are used primarily for energy efficiency
programs in the construction sector and to finance renewable energy.
Whereas companies and municipalities in Europe still tend to resort first and foremost to bank
loans,29 the US bond market has traditionally been more mature. By way of example, US
municipalities successfully use bonds to finance larger-scale climate projects. All in all, these
issues rank among the most significant on the climate bonds market. They often offer favorable
tax conditions and a relatively solid credit rating, which also makes them an interesting option
for institutional investors. The following forms are the most common on the US market: 30
 CREBs and QECBs: In 2005, the Energy Policy Act created a new asset class for publicly
financed renewable energy projects, Clean Renewable Energy Bonds (CREBs). From 2008
onwards, “new“ CREBs, as well as the energy conservation bonds launched in 2011
(Qualified Energy Conservation Bonds, QECBs), received funds from the government
crisis program. Taken together, these programs account for subsidies totaling more than USD
5.6 billion. "Direct pay subsidy bonds" allow municipalities and qualified issuers, e. g.
electricity producers, to finance projects based on subsidized interest rates as opposed to tax
advantages, as in the past. This move has also made these bonds more attractive to taxexempt institutional investors.
 PACE Bonds: A third type of climate bond subsidized by the US central government is the
"PACE" (Property Assessed Clean Energy) bond, which was launched in 2008. These
bonds are used to finance energy efficiency and renewable energy measures in the
construction sector.31 The package includes low-cost financing for building owners which is
paid back via a special buildings tax over a period of 10 to 20 years. The US government
makes additional default guarantees available for the PACE bonds, which are issued by
municipalities. After the collapse of the US real estate market, however, the Federal Housing
Finance Agency (FHFA) was reluctant to insure private real estate loans with a PACE
component, because PACE enjoys priority ranking and the risk control process is flawed. 32 As
a result, the PACE program came to a virtual standstill in the private real estate segment.
Interesting developments have emerged in the commercial construction sector: the first crosscity bonds were successfully placed in 2011.33 An innovative consortium (PCC – PACE
Commercial Consortium) has been brought to life in the Carbon War Room Initiative, which
markets energy savings, makes short-term financing available, insures the savings and plans to
securitize the bundled loans.34 The market will, however, remain restricted in terms of its
development until the rating question has been clarified by the FHFA. A court judgment in
California could bring clarity in the course of this year.35 The CBI estimates that the PACE
market has annual potential to the tune of USD 12 billion as soon as the FHFA changes its
stance on PACE bonds.36
6
Climate Bonds
2.3 Climate-related project bonds
Climate-related project bonds, which are based on individual, or a pool of projects, offer the
largest scope for structuring in different risk tranches and a direct risk relationship with the
financed assets.
Unlike with IFI climate bonds, the debt servicing for project bonds is directly linked to the
performance of the underlying assets. The range of assets on which the climate bonds are based
range from individual projects or assets to a pool of projects that can include various different
project types, such as wind farms, solar parks or energy efficiency measures. Another
conceivable option is for loans granted, say, by banks to finance renewable energy projects, to
be securitized.
Bond
name
Tranche
Table 2 – Examples of project-related climate bonds
CRC
Breeze
Finance
Bonds
(Breeze
II)
A CRC Breeze
Androme
da PV
Parks
Topaz
Issuer and
year of issue
Amount
in EUR
m
Term
in years
Coupon Initial
in %
rating
Use of funds and regulatory
framework
300
20
5.30
430 MWp onshore wind farm
portfolio in Germany and France
(39 projects). Guaranteed feed-in
remuneration and power sales in
both countries for 20/15 years.
BBB
B Finance
2006-2007
C
50
10
6.10
BB
120
20
n/a
n/a
A Sunpower/And
romeda
Finance
B 2010
97.6
18
5.72
Aa2
97.6
18
4.84
Baa3
850
27
5.75
BBB
MidAmerican
Energy
2012
+
Project financing bond for two
photovoltaic facilities in Lazio,
Italy. Total of 51.4 MWp.
Guaranteed feed-in remuneration
for 20 years up to a certain volume,
thereafter sale at market price and
priority delivery right.
Solar power facility (USA), 550
MWp. No government support,
PPA over 25 years with PG&E,
maintenance agreement.
Exchange rates as of February 13, 2013, own graphic.
Project bonds are particularly suitable in countries in which long-term statutory or contractually
agreed purchase obligations are in place with contractual partners with good credit ratings based
on largely fixed prices for the energy fed into the grid. 37
 Innovative but risky - CRC Breeze Finance: This SPV is one of the first moves to use the
capital market to finance renewable energy infrastructure. Initially, the construction of the
wind farms in Germany and France was financed using equity and short-term bank loans. The
facilities were then sold, when 50 % complete, to the SPV. The SPV then issued bonds in
three tranches: the A and B tranches as structured eurobonds and the C tranche as a private
placement. The A tranche was had a monoliner (bond insurer) guarantee. Unexpectedly poor
wind performance, coupled with higher ongoing costs and technical difficulties affecting
7
Climate Bonds
some of the turbines resulted in the credit rating of the A and B tranches being downgraded in
July 2010 and the fall of 2011.38
 With a semi-state guarantee - Andromeda PV: In order to finance the construction of the two
photovoltaic facilities in Italy, two project loans were initially taken out; these were repaid
using the proceeds from the issue of the bond tranches. In this case, a guarantee issued by the
Italian export loan bank helped one of the two tranches issued to obtain a better rating and
lower interest rates. The B tranche was subscribed to in full by the EIB.39
 Leading investors moving closer to the market - Topaz: Warren Buffett's MidAmerican
Energy purchased the 550 MWp Topaz project from First Solar in December 2011. In
February 2012, a bond was issued in the lower investment grade segment, generating
considerable interest among investors. The target of USD 700 million was significantly
exceeded, with a subscription volume of USD 1.2 billion. The issue was then increased to
USD 850 million. Another issuance in June 2013 – aimed at USD 700 million – achieved
USD 1 billion.40 These issuances show, that investors have developed more of an interest in
renewable energy projects. The Topaz project offers good starting conditions with a longterm power purchase agreement (PPA) with Pacific Gas and Electric, a maintenance
agreement with First Solar and the fact that the owner may be prepared to supply equity to
make up for missing debt capital.41
The market of climate-related project bonds was valued at about USD 7 billion in 2013.42 The
market study, however, sees room for growth. It identifies 225 projects in Europe and North
America, that could potentially be qualified as climate bonds at a value of USD 142 billion for
the target group of institutional investors.
3 Barriers for climate bonds
The fact that the volume of the climate bond market has been relatively low to date can be
explained by general factors relating to the climate bond market as a whole, and by factors
affecting this specific type of bond.
3.1 Underdeveloped structure of the climate bond market
Some players have identified a vicious circle that stands in the way of more dynamic market
growth and increased involvement by institutional investors (see figure 2):
1.
Insufficient number of issuers and bonds with an investment grade rating:
Institutional investors prefer a diversified selection of high-volume bonds. The limited
number of potential issuers, by contrast, prevents a climate bond portfolio from being
established due to excessive concentration risks, as well as regulatory or internal limits
(often, max. of 10 % per issuer and max. of 10 % per individual issue).
8
Climate Bonds
2.
Low secondary market liquidity due to relatively low volumes per issue: to date, market
access is obtained primarily by way of private placements. Investors tend to demand
illiquidity premiums. This is generally limits the target group to investors pursuing a buyand-hold strategy.
3.
Lack of investor interest and market knowledge, because this is a young market segment. It
also attracts little attention from buy and sell-side analysts.
4.
This tends to result in limited fund availability for financing projects via climate bonds,
meaning that the establishment of this new market segment is proving to be a very slow
process.
Figure 2: Mutual interdependencies on the climate bond market
3.2 Barriers on the IFI bond market
As described in section 2.1, climate bonds issued by international financial institutions play a
central role in boosting awareness of this market segment. Although there is virtually no
difference between the structure of IFI climate bonds and that of the conventional bonds of these
issuers, the volume placed has shown less dynamic development than the sort of development
that would be desirable from a climate policy perspective.
This can be explained largely by the additional outlay associated with the issue of climate bonds,
as well as supply and demand aspects.
1.
The additional outlay results from the need to select suitable projects, as well as, where
appropriate, the need for external certification and ongoing reporting on the underlying,
distinct project portfolio during the term of the climate bond. Market participants put the
additional outlay at between one and five basis points, depending on the volume of the
issue.
9
Climate Bonds
2.
The mandate of IFI issuers does not necessarily allow them to bear the higher refinancing
costs compared with a conventional bond issue. The "green return", or the advantage of
tapping into new investor groups cannot always be taken into consideration from the
issuer's perspective. Among investors with a corresponding focus, a "green premium"
appears to be of less importance, but the demand among this group is limited. This poses an
obstacle, in particular, to IFIs with larger project portfolios, which, based on the
information supplied by the IFIs themselves, are very favorable for refinancing via climate
bonds. As soon as more investors show an interest, they believe it will soon be possible to
make new issues.
3.
Some IFIs do not see any need for dedicated "green" bonds, pointing out that climaterelated projects can also be financed using conventional issues, saving the additional
expense. Although this reduces the potential project pool for more dynamic IFI climate
bond supply, it does not mean that fewer "green" projects are implemented.
The fact that awareness of the market has been growing is highlighted by recent IFI climate
bond issuances, including the largest bond of this type to date issued by the IFC in early 2013
(USD 1 billion with a term of three years) and the largest EUR-denominated bond issued by the
EIB in mid-2013 (EUR 650 million with a term of six years). Both bonds were several times
oversubscribed. Previously, the total volume of all IFC and EIB climate bonds had amounted to
USD 1.2 billion and EUR 1.7 billion respectively..
In the case of all IFI climate bonds, it is necessary, in order to avoid reputational risks and
guarantee quality assurance, that precise criteria are developed - where appropriate also in
consultation with investors - as to what types of project are suitable and based on what overall
framework.
3.3 Barriers on the municipal bond market
Municipal bonds such as those launched, for example, in the US, are also associated with higher
transaction costs, albeit not necessarily due to the "green" factor, but primarily due to the
increased administrative outlay for access to subsidy funds and the fragmentation of the
underlying projects:
1.
Bundling is particularly difficult in energy efficiency projects, where there is a lack of
aggregators. This means that issue volumes that also attract institutional investors can only
rarely be achieved.43
2.
As far as the CREBs and QECB are concerned, only just under 20 % of the available funds,
around one billion USD, has been used to date.44 This is due to difficulties with
implementation, as well as problems associated with marketing the bonds.45
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Climate Bonds
3.
Municipal climate bonds in the US tend not to meet the highest quality criteria, because
municipalities - unlike in Germany, for example, where the federal government and the
individual states support municipalities in the event of payment bottlenecks – can become
insolvent in principle. As a result, investors demand corresponding risk premiums.
4.
If the risk-return profile of municipal bonds is improved by tax incentives or subsidized
interest rates, it is important to remember that the underlying state programs depend on the
state of the budget. Since these programs tend to run for limited periods of time, state
incentive programs are not a reliable, permanent support measure.
3.4 Barriers on the project bond market
The market for climate-related project bonds offers the greatest potential for mobilizing the
capital market for climate financing. It requires investors to take more of a risk than with
IFI/municipal climate bonds, but offers an interesting opportunity for portfolio diversification. It
also provides a response to the increasingly short-term focus of bank lending practices due to
regulatory developments, e. g. Basel III.
1.
The rating of project bonds depends, in general, on the debt servicing capacity of the
projects. Payment can be disrupted by a worsening in cash flow, e. g. due to regulatory
changes, operating problems, market changes or weather influences. This is particularly
relevant in the case of investments in measures or technologies for which no long-term
experience is available as yet, or which still have a relatively long way to go before they
become cost-effective under market conditions, e. g. in the case of offshore wind power
plants or energy storage technology.
2.
Only a small number of bonds have achieved the sort of issue volumes that institutional
investors often impose as a prerequisite, namely running into several hundreds of millions
of euros, to date. Lower volumes tend to result in illiquidity premiums and, as a result, in
higher capital charges.
3.
In addition to what may be higher financing costs (interests) compared with bank financing,
the higher transaction costs associated with a bond issue also have to be taken into account,
i. e. the costs of drafting a securities prospectus and the rating process, possibly also for
environmental certification and ongoing reporting.
Project bonds tend only to achieve a BBB rating, meaning that they just make it into the
investment grade segment. Due to internal or regulatory requirements, many investors prefer an
A rating to ensure that a sufficient distance separates them from the speculative level, which
starts at BB+. It also remains to be seen how regulatory changes (e. g. Solvency II) will impact
bond portfolios.
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Climate Bonds
The development of suitable insurance and hedging products can reduce specific risks associated
with renewable energy projects46 and in turn have a positive effect on ratings.
3.5 Barriers on the investor side
Climate bonds are a fairly new phenomenon and many players are still relatively unfamiliar with
the type of projects and assets to be financed. Although investors, especially institutional
investors, are on the lookout for attractive alternative investment opportunities in this phase of
low interest rates, assessing the underlying risks and returns compared with other interestbearing securities still poses a challenge for investors, at least in the case of project bonds:
1.
On a young market like the climate bond market, there are relatively few sources of
information and opportunities for orientation such as those provided by (replicable)
transactions of particular interest value. This increases the transaction costs and the risk
premiums.
2.
The lack of market transparency and standardization increases the reputational risks for all
players regarding an inadequate object selection of the funds generated by the bond.
3.
What is important is that the expected return can compete with "regular" bonds. One aspect
that is significant here is whether a "green return" can be taken into account and whether
this is even permissible. This dividing line, which is often not made known, gives rise to
problems: an investor's sustainability department and its investor team, for example, can
differ in their opinion.
4 Possible approaches for the development of the
climate bond market
Many of the experts interviewed believed that there were ways of overcoming or circumventing
the market barriers for climate bonds described in section three. Targeted measures could have a
favorable impact on the market environment and individual bond issues, even if particularly
adverse developments in the bond environment, e. g. the credit crunch or lack of trust in
securitization, are considered to be temporary.
The securitization and structuring of corresponding bank loan portfolios could also help to
expand the climate bond offering. This gives banks new scope for project financing. The overall
financial framework, however, has to be attractive from the banks' perspective. The
securitization market came to a virtual standstill when the financial crisis hit, but appears to be
slowly but surely recovering. The expected developments on the asset-backed climate bond
market may be excessive, because banks will tend to securitize more "straightforward" asset
classes (credit cards, real estate).47 At the same time, the overhaul of the regulations that apply to
alternative investment funds in Germany could drive the costs of closed-end funds up and make
12
Climate Bonds
access for retail clients more difficult, making bonds more attractive as an alternative investment
vehicle as a result.48
One way of achieving a risk-return profile that is attractive to institutional investors while
ensuring a sufficient credit rating is to structure bonds in tranches with different credit ratings.
This tool, which was used extensively prior to the financial crisis, has largely been abandoned
due, not least, to the lack of bond insurers, which is hindering the growth of project-related
climate bonds, in particular. Signs of a recovery on the bond insurance market are only gradually
starting to emerge.
A series of public-sector measures could also improve the risk-return profile of climate bonds
and leverage state funds:
1. Feed-in remuneration: The underlying projects could be supported by subsidy mechanisms,
such as guaranteed feed-in remuneration for renewable energy projects; this would facilitate
the market penetration of new technology and provide long-term investment security thanks
to cash flows that are easy to plan.
2. Regulation: Targeted regulation could also be effective in order to create scope for the
development of corresponding bond classes. One possible approach would be, as with
"Pfandbriefe" covered bonds, to allow bonds based on renewable energy to use facilities as
cover assets.49
3. Guarantees: Another measure to foster trust comes in the form of export loan guarantees to
secure projects abroad. The public sector could set up guarantee facilities for certain projects
or project pools to reduce, in particular, uncontrollable risks against which the private sector
finds it hard to obtain protection, e. g. regulatory changes.
4. Tax measures provide effective incentives, as can be seen, for example, from the municipal
bonds in the US: gains from the corresponding bonds are tax-incentivized or incentivized
from an interest rate perspective, which has turned climate-related US municipal bonds into a
significant market segment.
5. Structuring support: The public sector, IFIs or export loan banks could support bond
securitization and structuring by subscribing to junior tranches. Structured bonds could also
be used to attract investors to climate project bonds without exposing them to the full project
risk. The Europe 2020 Project Bond Initiative launched by the European Commission and the
EIB is a good example of how projects can be supported by public-sector players assuming
some of the risk.50
In Europe, the not-for-profit Green Deal Finance Company in the UK is pursuing a novel, largescale approach to finance publicly subsidized but privately structured energy efficiency
programs: the concept provides for future income from "pay-as-you-save" structures to be
financed using short-time bank loans, for the loans to then be aggregated and bonds issued using
this as a basis.51 The first set of bonds could have a volume of GBP 400 to 500 million, in order
13
Climate Bonds
to make the market interesting for institutional investors.52 Overall, the plan is to issue a bond
volume of GBP 5 billion over the first five years of the program. This figure could rise to as
much as GBP 20 billion.53
New investor groups and a gradual increase in liquidity could also be attracted via the systematic
inclusion of climate bonds in (existing) widely used bond indices. Institutional portfolios are
often managed based on a recognized index.
As part of an international standardization and certification project, the CBI developed a climate
bond standard, initially for wind energy investments. The first question that always has to be
asked is: "Is it really green?".54 The CBI believes that a recognized certification system for the
environmental integrity of a climate bond will support the investment decision-making process
and could also help the market to achieve the necessary depth.55 Approaches to ease the
securitization of solar projects exist in the USA. By standardizing electricity offtake and lease
agreements, as well as other collateralization-relevant aspects, clarity concerning risks
connected with the asset class is established (Solar Access to Public Capital).
5 Summary and outlook
Climate bonds present an opportunity for mobilizing institutional investors to finance climaterelated projects. The financing gap in this segment is a huge one. The global framework will be
focusing more and more on encouraging climate-friendly investment and avoiding investments
that harm the environment.
The market is still young, with only just over five years under its belt. There is still a lack of
liquidity and diversification. IFIs and municipalities with good to very good credit ratings
constitute the lion's share of the issuers to date. The projects to be financed by these players,
however, are limited, even though new approaches are emerging that could promote market
growth in the future. Various IFIs are looking at new ways of leveraging more private capital,
e. g. using first loss structures.
Project bonds issued by the private sector have the potential to account for a larger share of the
climate bond market in the future, provided that the structuring opportunities and risk appetite
start to increase again. Examples show that sustainable bonds with low investment grade ratings
are generally received well. There are also signs that renewable energy is moving away from its
niche image and is also becoming more interesting for (and better known among) mainstream
investors, as the Topaz project bond has shown. Particularly in the US, mega projects for
renewable energy that meet the volume requirements of institutional investors are already more
widespread.
Climate bonds are also a possible tool for portfolio diversification, which is in the natural
interest of investors as climate regulation becomes more demanding, e. g. due to higher emission
trading prices or tougher standards for industrial facilities that emit greenhouse gases. The fact
14
Climate Bonds
that environmental factors are now being included as standard in the research processes of major
investors could also result in new materiality considerations, which will make climate bonds
more of a focal point for investors with long-term investment horizons.
Acknowledgement
We would like to thank our interview partners: Christof Aha (Beiten Burkhardt), Imtiaz Ahmad
(Morgan Stanley), Tanguy Claquin (Crédit Agricole CIB), Frank Damerow (LBBW), David
Diamond, Bozena Jankowska and Steffen Hörter (Allianz Global Investors), Søren Elbech
(Inter-American Development Bank), Christopher Flensborg (Skandinaviska Enskilda Banken),
Wolfram Haller (Siemens), Jochen Harnisch (Kreditanstalt für Wiederaufbau), Sean Kidney
(Climate Bond Initiative), Matthias Kopp (WWF Deutschland), Bryan A. Kornswiet and
Kimberley Stafford (PIMCO), Peter Munro and Dominika Rosolowska (European Investment
Bank), Heike Reichelt (World Bank Group), Nick Robins (HSBC), Jens Rosebrock (Berater),
Joseph Salvatore (Bloomberg New Energy Finance), Michael Schneider (Deutsche Bank),
Vikram Widge (International Finance Corporation). Also Tobias Stalder for his excellent
assistance.
Comments
1
At the annual UN Climate Change Conference, the 194 signatory states to the UN Framework
Convention on Climate Change, which was adopted in 1992, develop specific climate protection
measures.
2
This climate stabilization requires the concentration of greenhouse gases to be limited to a
maximum of 450 ppm CO2e (ppm = parts per million; CO2e = CO2 equivalent, measure of CO2
concentration in the atmosphere). Since the dawn of the industrial age, the concentration has
risen from around 280 ppm to approx. 400 ppm CO 2e today. If no additional measures are taken,
this figure will have risen to 685 ppm by 2050. Cf. OECD (2012B).
3
Cf. IPCC (2007). The next IPCC Report will be published this year and is likely to deem more
drastic cuts to be necessary if the 2°C target is to be reached.
4
Global CO2 emissions account for around 75 % of the total greenhouse gas emissions.
5
Cf. OECD (2012B).
6
Cf. UNFCCC (2009).
7
Cf. IEA (2011).
Cf. UN (2010).
9
Cf. Climate Bonds Initiative. CBI is a non-profit organization that is committed to developing
this market and market standards.
10
Cf. CBI (2013), Bonds are mainly from the transport (USD 263 billion), energy (USD 41
billion) and financing (USD 32 billion) sectors. Other areas are buildings and industry,
agriculture and forestry, waste and pollution control. The calculation is based on bonds issued
since 2005 and that remain outstanding on 1 March 2013.
11
Cf. CBI (2013).
8
15
Climate Bonds
12
Cf. OECD (2013, forthcoming).
Please refer to the acknowledgement for a full list of the interview partners.
14
This includes, by way of example, the solvency ratio.
15
Cf. World Bank (A), World Bank (B), World Bank (2013).
16
Cf. EIB (2010), EIB (2013).
17
Cf. IFC (2012), IFC (2013).
18
Cf. ADB (2010), ADB (2012A), ADB (2012B).
19
Cf. EBRD (2010), EBRD (2012).
20
Cf. World Bank (2013), EIB (2012A).
21
Cf. EIB (2012B).
22
Cf. World Bank (2013), ADB (2012C).
23
Cf. EIB (2012A).
24
Cf. World Bank (A).
25
Cf. Nikko Asset Management (2010).
26
Cf. State Street Global Advisors (2011).
27
Cf. CBI Blog (2013A).
28
"Muni" is an abbreviation for "municipality".
13
29
In Norway, bonds are already more widespread: in the period from 2010 to 2011,
Kommunalbanken Norway issued climate bonds for Norwegian municipalities to the tune
of USD 245 million. Cf. OECD (2011).
30
Cf. OECD (2011), DSIRE (2012).
31
The energy cost savings have to be greater than the measure implementation costs.
32
Cf. CBI Blog (2010), Sustainable Industries Blog (2010).
33
Figtree Energy Resource bond, January 2011. Finances seven projects in four Californian
cities via a USD 750,000 bond; cf. Gerdes, J. (2012).
34
Cf. Energi Insurance Services, Inc., Aston, Adam (2011). The companies involved are
Lockheed Martin (technology & assessment), Energi (insurance for the savings), Hanover
Re (reinsurance for Energi), Barclays Capital (bond structuring and placement) and Ygrene
Energy Fund (fund management).
35
California has filed a claim against the decision, the case has been postponed until the fall of
2013. Cf. United States District Court (2013).
36
Cf. CBI (2012).
37
Cf. Brinda, B./Fislage, B. (2011).
38
Cf. OECD (2011).
39
Cf. OECD (2011), Brinda, B./Fislage, B. (2011).
40
Cf. CBI Blog (2013B). Bond achieved Baa3 rating by Moody’s.
41
Cf. BNEF (2012). Also placement as "Rule 144A" bond, with less stringent regulatory
provisions in the event of distribution to institutional investors. Nevertheless, two rating
agencies have to assess the bond in this respect.
42
Cf. OECD (2013), based on Bloomberg New Energy Finance (BNEF) ‘Green Bonds Market
Outlook 2013 – Ripe pickings at the green bond market’.
43
Cf. NREL (2009). Attempts at increased project bundling, as in the PACE program, have not
proven very successful to date. One example is Massachusetts, which bundled 12 renewable
energy projects accounting for a total volume of 1 MWp.
44
Cf. BNEF (2011).
16
Climate Bonds
45
Cf. CBI (2012).
Cf. OECD (2013).
47
Cf. Accenture (2011). Between 2011 and 2020, up to EUR 1.4 trillion could be securitized as
"green bonds".
48
The German transposition of the EU Directive on Alternative Investment Fund Managers
(AIFM) will come into force on July 22, 2013. This is associated with far-reaching obligations,
also for smaller funds and citizen's participation models. New regulations will also apply to
closed-end single object retail funds, as will a maximum borrowing rate of 60 %.
49
Cf. Kidney, Sean (2013).
50
Cf. EIB (A).
51
Allows private households and companies to pay back energy efficiency investments via
savings in their electricity bills.
52
Cf. Nicholls, Mark (2012).
53
Cf. Nicholls, Mark (2012).
54
Further standards for solar energy, bioenergy and energy efficiency projects, as well as for
forestation measures and measures to adjust to climate change are currently being developed.
55
The certification costs are put at around USD 60,000 per bond. These costs are reduced for
repeated issues. The standard cannot be deemed equivalent to a buy recommendation; it merely
stands for the environmental integrity of the bond and is no substitute for a financial evaluation.
46
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Climate Bonds
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Climate Bonds
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20