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Derivatives

Build it green and they will come

The arrival of the first benchmark-sized green bond in February — a $1bn three year offering from the International Finance Corporation — was a landmark event in the development of the growing market for themed SRI bonds. But plenty of obstacles to growth remain. For green and SRI issuance to really take off, new issuers must be encouraged to bring deals. Another issue that needs to be tackled in this growing market is how a green or SRI bond should be defined, whether issuance should be regulated or rated, and if so, how. EuroWeek met key issuers, bankers and some investors in New York in mid-September to discuss whether 2013 is a turning point, and what new borrowers can learn from the market’s pioneers.

EUROWEEK: Does the fact that we’re finally holding this panel and publishing a special report on SRI mean that the green bond market and socially responsible capital markets have finally found real traction and depth?

Heike Reichelt, The World Bank: Green bonds have certainly helped the profile of the SRI market. They are a product that is quite tangible for investors because of the specified use of funds, so it has helped people focus their mind on SRI investing in fixed income. 

The World Bank has been in this market for a long time. The first product that we launched specifically targeted at SRI investors was in 2005.The overall mandate of development banks is to fight poverty — it’s what we do —  but the green bonds, because they address the issue of climate change that everybody is affected by, have really helped focus people’s minds on SRI.

EUROWEEK: Evelyn, as another issuer of this type of product, do you think that 2013 is the beginning of the end, or the end of the beginning, of the development of this product? 

Evelyn Hartwick, IFC: I hope not the beginning of the end! We’re here and it’s great to see we have generated enough interest to hold a panel on the SRI/ESG market. Like the World Bank, the IFC has issued green bonds in various markets for quite a few years. 

The work of all these years led to the $1bn public deal launched earlier this year. It was very important to get investors focused on this type of product. Private sector investment is the catalyst that will help economies transition into green economies; this is a great development.

EUROWEEK: There seems to be definite momentum at the moment. Why now? Why not five years ago?

Hartwick, IFC: Environmental, social and governance considerations have always been embedded in developmental institutions’ culture but over the last couple of years we have seen a real change in the investment strategies of a lot of investors. That adoption of ESG criteria among investors helped us make the decision to launch large size public deals.

EUROWEEK: Ashley, Evelyn mentioned this change in investors. Is that accurate?

Ashley Schulten, BlackRock: Yes. Deals are begetting deals and what we notice is that when we participate in a large transaction and there’s a press release about it which we’re mentioned in, we get calls from pockets of asset owners that are just finding out about the sector and are curious. The momentum is picking up and it’s bringing in new buyers.

EUROWEEK: What is behind, for example, BlackRock taking this space more seriously?

Schulten, BlackRock: We respond to asset owners and we’ve seen a pick-up in curiosity and demand for their money to have a positive environmental or social impact in addition to a financial return. There’s a whole wave of interest in impact or sustainability investing, outside green bonds. You see Obama’s recent climate change action plan encouraging green infrastructure in the US. You see companies signing up to complete the PRI questionnaires. So the green bond development is going alongside other global interest in impact/sustainability reporting and investing.

Stuart Kinnersley, Nikko Asset Management: There’s a realisation within the ESG community that fixed income has been overlooked.

EUROWEEK: Because is SRI is an equity product?

Kinnersley, Nikko: It has been traditionally and one of the reasons for that is that there has been no scalable, liquid ESG fixed income product to invest in. When the World Bank started issuing these bonds, because of its size and standing in the marketplace it was the catalyst to get this started. 

Other supranationals have come in and now we’re seeing the market broaden. For the first time there’s a real choice to fixed income investors since the initial creation of green bonds.

Reichelt, The World Bank: It’s also awareness. People nowadays are much more focused on the problems of climate change than they were many years ago and there’s a growing awareness that these products are out there. There’s still a long way to go — it’s a new market. It’s been five years since we issued the first green bond, but things start slowly and then at some point they pick up momentum. 

Big investors are in the market now, which helps. When people know that big investors are in there, it helps again and creates more momentum. And at some point you reach a tipping point. 

Suzanne Buchta, BAML: Like the deals beget deals, awareness also begets awareness.

Michael Eckhart, Citi: What we’re seeing is SRI entering the mainstream. Because of the very low interest rates in the US, we have institutional investors looking for yield, which means they’re looking for new products and they are open to new ideas, whereas before they might have been repeating what they had been doing. They must look at new things now and that opens the door to SRI offerings more than before. 

Secondly, matching that, the clean energy industries have reached scale. We have $1bn wind farms. We have $1bn solar projects. We have assets that are low risk and at-scale matching the low risk and at-scale interests of the institutional investor, so there’s a matching of sources and uses. It’s a good coincidence and helps to reinforce a tipping point situation. 

Schulten, BlackRock: There’s also been a realisation on a very macro level by insurance companies when they look at the catastrophic losses that they’re taking due to climate change — on a very long term basis it’s economically beneficial for them to invest in abating climate change.

Hartwick, IFC: Climate change is an integral part of sound corporate risk management strategy nowadays because it’s so expensive to cope with the changes of climate. Now the private sector is engaged and asking what needs to be done.

Andrew Salvoni, Morgan Stanley: On the insurance company side there are some large potential asset management mandates that are up for grabs over the next few months that should hopefully start to filter into the fixed income SRI space, so that will help as well.

EUROWEEK: Søren, the phrase ‘tipping point’ has just been mentioned. Is it enough for someone like your institution to issue this type of security or are you going to hold your fire for a little bit longer?

Søren Elbech, IADB: We’ve been following the development of the green/SRI bond market for quite some time. We fully recognise the awareness creation that this has, and the World Bank’s and IFC’s results. We also issued two themed bonds, the themes being poverty reduction, to better understand how this works as well as our own operational capacity and internal reporting on the ‘best efforts’ channelling of the bond proceeds.

We have not yet issued a green bond, mainly due to considerations about cost efficiency. A very important part of IADB’s mission is to bring about development in a sustainable, climate friendly way, as well as at the same time use our strong financial position and triple-A rating to borrow at competitive rates and transfer that benefit to development finance projects in our region.

In the last three fiscal years, we have approved between $3.5bn and $5bn loans, annually, under the ‘sustainability’ header, so there should be no doubt about the Bank’s commitment to green. Yet, as IADB’s business model requires that our borrowers fund the Bank’s admin costs through a loan spread on top of the Bank’s own cost of borrowing, we pay very close attention to any additional costs associated with bond issuance.

Fundamentally — and it is important to have this conversation not only with issuers but also with investors — do green bonds meet these dual objectives, i.e. raising sufficient financing for green projects without increasing the Bank’s admin costs? When we can be assured of that, it would make sense for the IADB to issue a green bond as well.

One of the things that, in my perception, has happened this year is the size of the green investor base seems to having reached a tipping point. I’m thinking of IFC’s green bond in the spring, which reportedly had more than $1bn of orders from dedicated green buyers. Such opportunity for investor diversification is certainly something we are paying very close attention to. 

EUROWEEK: Yes, the IFC’s $1bn bond was launched on the day of Chinese New Year. That was a deliberate ploy, wasn’t it, to launch it on that particular day?

Hartwick, IFC: We did take a number of things into account because it was the first benchmark-sized green bond in the market, and it was also the first three year benchmark issued by IFC. An important consideration was the investor base— we were going to issue a $1bn green bond and if the majority of investors had been central banks— a very faithful group of investors who are IFC’s biggest followers for our public deals — that could have become difficult to manage. So we discussed it with the lead managers and decided to intentionally not target central banks for this deal and focus on SRI investors. Although some central banks still came in, we managed to place the bond among mostly SRI investors.

EUROWEEK: Those central banks turned out not to be on holiday…

Andrew Salvoni, Morgan Stanley: We worked with the IFC on that transaction and it was challenging because you can’t just exclude a whole subset of investors. It was down to the communication ahead of the transaction and being very upfront with investors, telling them that allocations will be preferentially given to investors with a track record in the SRI space, that have had previous discussions with the issuer bilaterally, that have been on a roadshow and proved their credentials in that space. We managed that the best way that we could.

Jose Padilla, Daiwa CM: Yes, a lot of it is in the marketing effort. When we did the IFFIm [International Finance Facility for Immunisation] vaccine bonds we made a real effort to really get people involved in what GAVI’s purpose is and really understand who are the sponsors behind it. 

We had a slightly different approach from the climate control world, but the deal was well received, as was the fact that we could bring a themed bond away from climate change. Climate change is paramount for everyone in this room and the entire market. But it’s good to see that when we talk about the tipping point that there are other themes that we are able to introduce into the market.

Reichelt, The World Bank: Another part of it is that green bonds do require more activity with investors, and we enjoy it. We enjoy the direct dialogue with investors and hearing from them what they want to see.

When we issued the first bond, SEB came to the World Bank with a group of Scandinavian pension funds that were looking for that product.

EUROWEEK: That was the genesis, wasn’t it, of the World Bank green bond?

Reichelt, The World Bank: That’s when it started. We developed the green bond product in an iterative process and went back and forth with SEB — the lead manager — and with the investors, finding out what is it that they wanted and how we could meet their requests.

The investors wanted to have a liquid product that fit the other fixed income products that they had. They wanted to choose the currency, the maturity and structure, and they wanted it to be a liquid instrument. But they wanted the funds to support projects that helped mitigate climate change and help countries adapt to the effects of it. 

So that’s how we developed the criteria we defined for the green bond that others have followed. And in dialogue with investors that also Nikko has brought to us, we’ve developed the reporting that we do. 

The standards or the criteria are relatively straightforward, but there’s a lot of work behind the scenes where climate experts of the World Bank work with our member countries on the projects. Based on the defined criteria, we have experts who carefully select projects as eligible support from green bond proceeds if they meet the criteria and have a primary climate focus. And then working with investors, we’ve developed factors they’ve asked for that go beyond bonds, such as information, communication, and reporting on the impact. There’s more active engagement with investors with green bonds but it’s something that we enjoy and learn from.

Samantha Sutcliffe, SEB: Transparency is key to ensure that investors are informed of what they are buying, they are then given the opportunity to decide themselves if a green bond fits in their portfolio. Transparency also gives investors awareness and education on climate related issues and their financial relevance which is what ultimately is bringing the green bond market forward.

Mahesh Jayakumar, State Street Global Advisors: You had asked why didn’t green bonds happen five years ago. I believe that the investing world was just waiting for financial markets to heal and was not sure of how things were going to move ahead. The biggest asset owners and asset gatherers would not have had time to talk to about SRI five years ago. 

Now the world has finally started to heal, and as painful as rate hikes are on bond portfolios — and I can personally testify to that — we need this, we need rates and the financial conditions to come back to more realistic levels, and that is finally happening.

So now investors are sitting back, looking at their asset allocation and they’re prudently looking at what bonds they need to buy and what fixed income investments they might make. 

Buchta, BAML: The underperformance that hit the entire market really hurt investor interest in SRI portfolios because people had the perception that if you invest in SRI you underperform. The markets were already overwhelmingly underperforming, so investors shied away from anything that they thought might underperform any further. 

With the markets recovering and the realisation that SRI does not necessarily underperform (and can even outperform), we’ve really been able to observe more asset allocation into this sector.

EUROWEEK: We mentioned momentum and that five years ago perhaps markets needed to heal and now markets are ready to start looking properly at this sector. Does that have a lot to do with why the New York Green Bank is at the stage it is at? 

Jessica Aldridge, New York Green Bank: It does, but there are also a lot of pieces that need to align for establishing a new government or quasi-governmental organization. The political, regulatory and financial market forces have come together at a really critical time. 

I absolutely agree that the markets on both the equity and debt side needed the last five years to recover.

Now, there’s not just a recognition that we need to be paying more attention to the downside but that there’s a lot of opportunity on the upside for really good governance and for growth in clean energy. On the New York Green Bank front, we think that there is a really big need to add financing capability to the market so that we can bring in more private capital to finance a transition to a cleaner, more long-term focussed, stable economy.

EUROWEEK: This is a perhaps a good opportunity for you to tell us a little bit more about the Green Bank and what it plans to do and how it plans to work?

Aldridge, New York Green Bank: As of September 10, we are official. We are going through a regulatory process here in the State of New York — it is capitalising this entity that will help the private sector more appropriately price risk in clean energy by assuming certain categories of risk that we think the private sector has temporarily mispriced. 

The idea is that by providing a bridging product, we eventually want to get crowded out by the private sector. We’re going to be a wholesale outfit: working with intermediaries to develop partnership opportunities — primarily via credit enhancements and aggregating functions — to help bring multiples of private capital into clean energy markets for every dollar that we put in on the public side. 

We expect to open the doors officially in the first quarter of 2014, and in the meantime we are organising and working with the broader powers in the State of New York to do that effectively.

EUROWEEK: Stuart, we talked about momentum — does that tie in with what you’re seeing and what you’ve been doing on the project finance side? Are you finding that there are more investors looking at these types of trades than ever before, or is it like pushing water uphill?

Stuart Murray, Citi: Most project finance transactions in the power, energy and renewables sector are triple-B rated, which is different from many of the other types of securities that we’re talking about that are more in the double-A or triple-A category. 

The investors in these non-recourse triple-B projects are primarily, and historically have been primarily, insurance companies, and what these investors are looking for are project finance or structured project finance paper. 

Whether it’s wind or solar or gas or coal or gas pipeline, they don’t really care. For better or for worse, they’re just looking for attractively-priced long-tenor structured project finance assets. Finding capital to fund the construction of largely wind or solar projects of those types over the past few years — in the US and I think globally — hasn’t been a problem at all. 

There’s not a shortage of capital to fund these projects, and the fact that it’s wind or solar is sort of immaterial. 

EUROWEEK: So you’re perhaps not benefiting from this uplift that people have been describing.

Murray, Citi: No, for better or for worse. On the one hand investors don’t care if it’s a wind or a solar project versus a gas fired power plant as long as it’s good technology and the deal is well structured. That’s a good thing in that it’s not pushing water uphill. But on the other hand, the fact that it’s wind or solar is not drawing additional interest, from the triple-B focused investor base that buys these deals. 

We’re not having difficulty placing it but we’re also not seeing incremental demand from new buyers that are looking for SRI type investments. We’d love to see more investors coming into this. More appetite means better pricing for issuers, but we’re just not seeing that. 

EUROWEEK: Stuart Kinnersley —are you surprised about that?

Kinnersley, Nikko: No, because what Heike said is right — it’s part of an evolution in terms of making investors more aware. 

It may be coincidental that the first issue was after the global financial crisis, so when we looked at these bonds there were two key elements that attracted me to create our fund concept. 

One was transparency, that was something clearly resonating from the financial crisis that people had bought into a lot of bonds and weren’t necessarily sure where their risk was. With the World Bank green bonds, because of the issuer, their projects and where the money is being channelled to, that transparency was something that was lacking in most other bonds on offer at the time. Secondly, it offered the positive externality — combating climate change. 

We as a house wanted to make sure that it was a mainstream product. We didn’t go out into the market saying because we were investing in these green bonds, investors were going to generate superior investment return. My objective was that we were going to generate a mainstream investment return, but the investor was going to get the added positive externality and the transparency that was offered there. So we could argue that the total return was going to be much greater, and the financial return is only part of that.

Setting up a green bond fund was about giving investors a choice when they didn’t have that choice before. It takes time for investors to be aware of it. 

EUROWEEK: I just wanted to pick up on the pricing issue that you’ve mentioned there and ask whether investors, if they are buying SRI bonds, should be getting the same pricing as they would on a normal bond, or whether they will not get the same return because they are getting the added transparency and the ESG criteria.

Schulten, BlackRock: What we’re witnessing now is the beginning of, hopefully, a different market, and we all in this room have an obligation to make sure that we give it a strong base to start from. We’re seeing momentum because we haven’t asked investors to pay up for greenness yet. 

Should the market develop like we hope, and should there be growing interest in investing in green bonds, you may see an environment where green bonds trade through other non-green bonds. And that turns into cheaper funding for green projects, which is ultimately our goal. But we need to be very delicate with that process. 

At BlackRock we’re going to be very strict about asking about transparency and guidelines and what we define as a green bond. When we use the term green bond that needs to be a label that means something. 

From there we can develop a market that’s robust and that has broad interest for the types of investors that invest in SSA paper. Then, on top of that, we can build a corporate market that is green or an asset backed market that is green. But right now we need to focus on this particular sector.

Elbech, IADB: I think it is very encouraging that we have this conversation. I mentioned earlier my thoughts on cost efficiency, and I have had the privilege of meeting investors to talk about that — in order to create the desired ring-fencing, bond-to-loans mapping transparency etc — there will be costs associated with that. Let’s say these costs would amount to 2bp a year, so one of my questions has been if investors were willing to substitute some of the financial return for a green return. Up until now, I have not yet seen a critical mass willing to, so it’s very encouraging to have this discussion now.

EUROWEEK: Ashley brought up an interesting point about transparency and what is a green bond, and the possibility of putting a boundary around it. Bank of America Merrill Lynch and Citi have put together a white paper on what is a green bond or what is an SRI bond.

Eckhart, Citi: What we need is a framework of integrity and transparency leading the debate on what’s a green bond or not. We’ve drafted something and have released it to JP Morgan and Morgan Stanley. They embraced it immediately for internal review. 

It’s a framework for green bonds and it goes through seven points that says that to call it a green bond you have to follow these rules. 

We’re intending that the market will self-police this, or give it to an institution to promulgate so that there will be a standard of performance where an issuer must declare what taxonomy they are using, must declare that they will ring-fence the funds or state that they will commit to use the funds against a certain screen or taxonomy or definition. 

Reichelt, The World Bank: We have to be careful. As Ashley said, it’s about development of the market and it’s evolving. When we did the first green bond we had benefited from a lot of feedback from investors already on how to set up the criteria, but even for us things continue to evolve. Investors told us they wanted to see reporting on impact — that’s what we’re doing. 

But it might be hard to set up something for issuers where the barriers are too high because they are still growing into it. We’ve been approached by several issuers that are looking at this. Some of them are still working on it. And it does take a lot of work, depending on where you start. Development banks have standards and safeguards and a lot of things already set up, and an entity like the World Bank has detailed so-called ‘Access to Information Policies’, so everything is up on our website. But other issuers might have to work to get there. If their goal is to issue green bonds, they know that investors are going to ask them for more details on use of funds and they can work towards that. I agree that it’s good for each issuer to clearly define what their green bond is by publishing their eligibility criteria. But this might be different for different types of issuers. So it needs to be flexible. 

The key thing is transparency — then the investors can decide. Investors still have to do their homework even if there’s third party verification. It needs to be a step-by-step approach in the development of the market. 

Even on size, issuers should be careful not to define a size saying that’s what they’re going to issue in green bonds, because it has to be organic — issuers need to develop their programmes based on demand from investors that actually care. 

Eckhart, Citi: I wanted to be sure to say early on that we studied the World Bank, we talked with you and the IFC and SEB as the basis for drafting the framework. I want to recognise your leadership in this arena. 

What we’re doing is trying to set an evolutionary framework for the corporate and municipal markets, and this is not intended to apply to the supranationals, this is not going to apply to most of the project bonds such as solar project bonds but for the broad corporate and municipal markets where there’s nothing defined as yet. 

So we’re looking for your comments on how to make this as workable as possible.

Sutcliffe, SEB: I’d like to pick up on what Heike said and agree that the framework has to be dynamic in order for different issuer types to enter the green market without fragmenting the concept.

To ensure accountability and prudence both banks and issuers must take responsibility and do their homework on the green aspect. SEB has chosen to work with Cicero to make sure that we have a vetting on the green. At the same time we recognize that for the market to grow we need to share the accessibility and ownership of this framework with investors, issuers and banks to avoid dilution of the concept. We are currently discussing such framework with various stakeholders. 

Buchta, BAML: One thing that we have done in visiting with investors such as those around this table was to really listen to what is it that the investor wants. The thing we heard more than anything is that investors want transparency. 

They want to know what the end projects are that are receiving this funding. They want metrics on what is achieved by those projects to the extent that that is possible. They would like annual — if not semi-annual — updates on those projects. And then they would like some sort of assurance that the monies are actually going to those projects. 

The investors want this ‘evidence’ in part to be able to help them with their own constituents whose money they’re managing — to be able to show them what the end projects are. 

That’s why if you look through the paper it says issuers should define their use of proceeds. We don’t yet know who the authority will be on what the correct possibilities are for use of proceeds. But investors also want to see if issuers can prove that their cashflows actually go to where they say they’re going to go. 

All of us who are seated at this table want more than anything to avoid the ‘greenwashing’ concept, we want to establish a market that has integrity. 

The important thing that the World Bank and IFC have done as leaders in this space is to be able to create a green capital market. 

We have trillions of dollars of capital that needs to be mobilised, but the question is how do we mobilise it? 

Now that the supranationals have come to the market with green bonds we want to broaden out the market to other issuers so that we are mobilising more of those needed dollars to be invested. In bringing green bonds, we allow the project investment decision to be taken by entities which understand project finance and loans, but still providing the full faith and credit of the issuer; this allows end investors, even mom and pop investors, to support the green finance revolution without having to take project finance risk. 

EUROWEEK: I’d like to hear from Trillium — what did you think about the recent Massachusetts bond, for example?

Cheryl Smith, Trillium Asset Management: As investors, we are doing everything we can to encourage investments that address a host of green concerns, such as climate change, ecological restoration, toxic emissions reduction, and energy efficiency. Reporting transparency and ring-fencing a very important concepts, but we acknowledge a difference in the political and operating constraints on an entity such as the Commonwealth of Massachusetts versus a supra-national issuer such as the World Bank.

By construction, municipal bonds channel funds to a strictly limited geographical area, and appeal to a different set of investors. When we have an opportunity as an investor in a state — and the Commonwealth of Massachusetts is my home state — to buy a green bond, and the Treasurer identifies the type and range of projects that will be funded, the home investor base is likely to be familiar with those projects. With the Massachusetts bond, I reviewed the list of proposed projects and could easily identify both the need for and the probable benefit from them. For example, one of the projects is a waterway restoration — the same river that regularly floods basements in my neighbourhood. My point is that more local investors can bring a knowledge of the geography and needs from a geographically limited area; our ability as investors to have that knowledge for supranational or corporate issued bonds is considerably more limited. From our perspective, the goal is to provide investors with the information we need to evaluate the use of the proceeds, and to have reasonable assurance that the proceeds will improve the environment. 

We certainly want to do everything possible to encourage the Commonwealth of Massachusetts to make infrastructure investments that address environmental issues and energy efficiency. As investors with environmental, social, and governance concerns, we recognise that green bonds are a developing field, and we want to encourage transparency and reporting.

We don’t want to say to issuers that they’re not good enough to get into the room. We want to say that they’ve made a good effort, now let’s see how that effort can be improved.

Reichelt, The World Bank: I’m glad you said that. It’s amazing what the State of Massachusetts did. A bond like that defined as green where they list examples of the types of things they want to support is the kind of transparency investors are asking for. If issuers are transparent then it’s up to the investors to decide what transaction they want to support. Their green bond went really well and was oversubscribed.

Smith, Trillium: I’d like to say one more thing about the ring-fencing. In our conversation with the deputy treasurer of Massachusetts we asked why they weren’t ring-fencing, and they said, as they interpret the law governing issuance in Massachusetts, they can’t earmark specific projects until they have the money raised. 

Therefore, we asked for a commitment to after-the-fact transparency. They have committed to list what they spend the proceeds on, so we can review at a later date how they spent those proceeds, and then decide whether we would participate in a future Commonwealth of Massachusetts green bond.

EUROWEEK: Just for the record, Massachusetts were invited to this. They
were very keen to come but unfortunately couldn’t. 

Elbech, IADB: It’s important that we don’t forget that over the last many years there have already been billions of dollars of loans going to finance green projects and sustainable energy technologies. It’s not that this financing doesn’t take place, even though the green bond market is nascent. 

The emergence of the white paper mentioned could be a very important step in maturing the market. We are moving into a new space where investors will be getting much more transparency on use of proceeds, much more certainty and more certification — but I will argue that the IADB bonds they bought before were also green bonds, because of the Bank’s overarching mission.

Schulten, BlackRock: A side effect of this is a highlight on what projects SSA issuers fund. Now investors are really digging down and asking where the money is going and what the projects look like. The story of the different SSAs is really illuminating for investors.

Elbech, IADB: As it is for issuers. I perceive IADB to already be very transparent and detailed about our loan operations, but we must listen to investors’ requests for even more transparency, so there can be no doubt that we already finance billions of green projects.

Schulten, BlackRock: A green investor is going to ask for a higher level of transparency and a higher level of greeness because they may be already buying your paper as it is and they want to set aside certain percentages specifically for very strict green projects.

The work there is to maybe push projects to be more green, even if they are already green. Perhaps the market will develop into something where there are potential tax breaks for specific green issuers or other kinds of benefits.

Elbech, IADB: That’s why the publication of the white paper is going to be very important.

Jayakumar, State Street: This is a very interesting and prickly topic between issuers and investors. Some issuers say that everything they do is green, so why do they need to create something separate and call it green?

The labelling of a green bond brings with it a certain sense of responsibility and a commitment by the issuer to the investor base. 

It broadens the market because an issuer is going above and beyond by saying that they’re putting the ring-fencing in place, they’re putting in accountability on where the use of proceeds is going, saying they will be able to report back to investors on what they’re doing. They may not need to do that on an ordinary bond.

While I understand that at development banks absolutely the mission has always been towards sustainable poverty alleviation and global development, the green bond gives an issuer extra work in the responsibility that it brings. 

Elbech, IADB: Exactly — but that need to be ‘above and beyond’ comes with a cost, and, as mentioned, that cost in our current business model is passed through to the Bank’s borrowers of the bank, i.e. the green requirements would make it more expensive to borrow from the Bank. I’m convinced that is not what anyone wants to achieve. And that’s why I find it very encouraging that we are having this dialogue with investors about the costs associated with green bonds. 

Aldridge, New York Green Bank: I’m not sure that I am fully on board with how productive it is to label a lot of these activities that we all want and that we’re all striving for as ‘responsible’. While there obviously has been a lot of capital available for development activities that fall into broader governance categories, particularly on the energy side, there are just as many pockets of the market where it’s not that capital is available at a really expensive price, it’s that capital is simply not available. 

For example, there are pockets of the market where there is demand for residential solar loans and there are entrepreneurs who are providers of a model that want to facilitate that but they can’t get the scale needed to make that paper interesting to the big banks. That’s an area where, by providing an aggregation or forming a structure that will help make a product more broadly available will drive the markets to work in a more functioning way. In this situation, it is not necessarily any need to say you’re doing something good.

It would be our responsibility as issuers or partners in that process to make sure that if our end goal is scale and deploying clean energy, we would make sure that energy characteristics and governance standards are incorporated into that type of underwriting. Responsibility is absolutely something that we need to think about but I would push back on heavy reliance on ‘responsibility’ as the only driver in this space. 

Eckhart, Citi: This raises a lot of reasons why Suzanne and I and others participating in this paper wanted to go after it. We learnt a lot from doing the IFC benchmark because non-SRI investors bought it based on IFC’s credibility. 

The IFC and the World Bank and SEB have really built this market on a stage of integrity, credibility, transparency and trust, and we want to build on that. 

We want to establish credibility for the whole market, so instead of having the 3% or whatever of all investment money that’s deemed SRI, we hope that this will get SRI investments sold to non-SRI buyers — the 97% of investors.

Sutcliffe, SEB: Yes, that is also our aim and when you look at the 170 investors who invested in green bonds through SEB the bulk represent what we call the committed mainstream, namely the 97%. Our experience from corporations with investors is that the market needs a clear owner who provides transparency, directions (standards), diversity in form of issuers, markets and providers to eventually replicate the ‘normal’ market. 

We think the right owner is a joint venture between the stakeholders building on the existing platform.

Salvoni, Morgan Stanley: The next challenge is how to scale the market up, how to create efficiencies for smaller issuers. There’s already a raft of issuers that have green projects that they’re funding from their general pool of investments, and they don’t have the same economies of scale that the World Bank enjoys, they don’t have the same capabilities with regards to disclosure of the projects that they’re funding, they don’t have the same marketing teams. That’s where the next step of growth is going to be from the issuers’ standpoint.

Schulten, BlackRock: This is an issue from the buyer standpoint as well. We don’t have 20 environmentalists on staff to look at individual projects. When we invest in something we say to our clients that this is a green fund and that we are doing some due diligence that the bonds that we are investing in are actually green. 

There’s no one out there rubber stamping green bonds. We have to get comfortable internally that an investment is green enough. For smaller investors that don’t have the staff for that there needs to be some sort of help there. 

EUROWEEK: Do you think that will be the responsibility eventually of a rating agency?

Schulten, BlackRock: It would be fantastic if they did that. 

EUROWEEK: Or would it be a consultancy? Are we all agreed that there needs to be a kitemark like a rating or not?

Schulten, BlackRock: It would be great if we could have a green rating on something. 

Reichelt, The World Bank: There are firms that give ESG ratings. It could be an expansion of that. But climate is not an exact science. There will be different opinions — also for investors. Green might be one thing for one and something else for the other. That’s why we keep coming back to transparency — we just need to say what’s included and what’s not included.

Salvoni, Morgan Stanley: It will be a spectrum. Because you have some institutions that are so small or don’t have the capability of assessing these types of factors themselves and then you have on the other end of the spectrum a company like an Amundi in France which has an ESG rating for each issuer on every single investment that they make.

Along that spectrum they can add specific instruments to SRI related funds providing they receive a certain rating.

An Amundi model is probably not possible for the entire SRI universe. At some point, to have the involvement of the smaller issuers and the smaller investors that aren’t able to police this on their own, there needs to be some sort of middle ground — we need to strike that balance but it’s a young market and we’re not quite there yet. 

EUROWEEK: I wonder if in 10 years’ time every issuer in EuroWeek’s bond comments section will have an ESG rating along with a credit rating because if it doesn’t it will get penalised by the investor base?

Jayakumar, State Street: You already have the parent company issuer ESG rating but you also need a little bit of time and effort to look at what the use of proceeds are for that bond and that’s where investors and issuers have to meet halfway. 

We trust IFC and the World Bank because of who they are. They have that intangible benefit that a smaller issuer doesn’t. Yes, as investors we need to do our homework but we walk into that exercise knowing the background of who the issuer is and that’s a disadvantage for smaller issuers.

A rating agency would have to be able to bridge that credibility, that intangible benefit that the issuers around this table have, but then also provide a realistic service where they take a certain fee, and we need to explore what that fee should be.

Padilla, Daiwa CM: This is beginning to sound like a covered bond roundtable. We’re going to get to a point where the buyers have their criteria in terms of what they need, in terms of being able to classify this as a good instrument, as a green instrument, and then you have issuers that are saying: ‘Listen, if I provide you with this disclosure it’s going to cost me $2m more a year.’ That’s what’s killed the covered bond market in the US. I’m afraid that the niche market that we were trying to create with covered bonds is going to happen to the SRI market. The white paper is a great place to start but is it enough? 

Buchta, BAML: But what is interesting is that you see companies providing more and more disclosure now around what they’re doing in carbon. Companies are starting to see value in disclosing — even counting the carbon they are emitting and looking at ways to mitigate that carbon as well as opportunities that help us transition to a low carbon economy. So if companies are willing to do that, there is some willingness for companies to also work on things like green bonds and disclose on the projects that they’re investing in. 

EUROWEEK: The SSAs are doing the pioneering work but is the future of the market a corporate market? 

Eckhart, Citi: Our idea with this paper, and we hope it gets traction, is that lacking a set of rules of integrity, the market won’t develop. The risk is that, lacking any guidelines, some bad behaviour will ruin the market’s credibility early on. 

Our guidelines don’t call for third party verification but it opens that door in that should the issuer feel they should, then they can get verification or certification.

Padilla, Daiwa: Have you had the SEC review or will they review this white paper?

Eckhart, Citi: We’ve had internal lawyers say we should when we’re ready. 

Padilla, Daiwa: That’s a tipping point, in my opinion. 

Eckhart, Citi: Before it gets promulgated. One of the issues we’re talking about at the moment is what is the right platform to house this. Is it the International Capital Market Association? Or some accepted standards organisation that can convene us all and keep us working on it?

Buchta, BAML: In addition to broadening the use of proceeds of green bonds, we would also like to see more project bonds come to market. As green banks provide better pricing information around those types of project finance opportunities, it will encourage more private capital to come in. We also hope that at some point there will be standards around asset backed bonds, for instance bonds backed by power purchase agreements for solar panels as these panels are rolled out on every residential home (in a state that has sunshine) in the US and abroad. 

We want to see all three types of those green bonds go to market. There’s a lot of discussion around what proceeds count and what don’t for use of proceeds. There is also discussion around how to prove what projects got the money. But discussion aside, green bonds build awareness and, as we said, awareness begets awareness, so investors increase their focus on the sector. 

That allows for pillars of green investing to be erected, pillars that represent different credit classes across the credit and spectrum. The more investment options available, the more capital can be mobilised to these areas. 

Aldridge, New York Green Bank: Why would we want to or why we would ask the framework or guidance on this burgeoning sector to go to the SEC versus getting run by the rating agencies? 

While it’s very respectable and important that the ratings agencies are being more thoughtful about taking on or promoting new sectors or risks post-financial crisis, it makes it challenging for a lot of new activities, especially in clean energy, to move forward.

The CFO of the New York State Energy Research and Development Authority, of which the New York Green Bank will be a part, recently got a $25m portfolio of efficiency financing bonds issued into the market, but part of his challenge in doing that was that the ABS markets and the muni markets don’t understand each other and the rating agencies don’t have a framework to deal with this. So then the Nyserda CFO had to go and get the Environmental Facilities Corp to wrap those bonds with a guarantee, and in the end the issuance was fairly over-capitalised. That was great for us to get done regardless but it was one step in a multiple step process in pushing forward the markets. 

Padilla, Daiwa CM: Now I want the high grade market to latch on. The supranationals are the pioneers, but we need scale. Yesterday we witnessed the largest corporate bond ever with Verizon’s $49bn offering. I want to be alive for the $49bn green bond. To get that is through a combination of making sure that investors get what they want in terms of disclosure. Standardised disclosure by the SEC is going to help tremendously. That’s why I think the SEC has to approve your white paper. 

Salvoni, Morgan Stanley: From the Morgan Stanley perspective, corporate borrowers have seen the work that the World Bank and IFC have done — and I’m sure that they’re coming to our colleagues at other institutions as well — asking how they can replicate some of that success. Having a standardisation there is something that’s really going to be key.

Reichelt, The World Bank: We’ve had some corporates in some of our emerging market countries approach us and say they have some clean energy projects which haven’t been financed because there hasn’t been enough focus on them and how to finance them. Having seen the growing green bond market, they now think maybe they have a chance to get the financing done. Søren was talking about the cost, but for issuers like us the additional cost is marginal. There is some extra work for the individuals involved in the process but it’s worth it beyond the overall goal that we’re striving for, to mobilise private sector finance for low carbon development.

Corporates might have to change many things internally before they can issue a green bond because they may not have the “S” and the “G” from ESG taken care of and green bond investors don’t want to run reputational risks. They don’t want to buy deals from issuers that haven’t already focused on getting the rest of their house in order before they issue green bonds. 

What many equity SRI investors engage with corporates to work with them on ESG factors that are important to them. But if corporates want to issue a green bond and are willing to work towards fulfilling ESG criteria and more transparency, that would be great. 

One reason why we, as an issuer, value green bonds is investor diversification. For that reason alone — setting aside the main goal of mobilizing capital for climate finance — green bonds are more than worth it. For the investors that came to us through SEB in 2007 — our other bonds weren’t yet on their radar screen. As the market expanded, new investors joined.  Maybe some investors had bought our bonds for other portfolios before, but having this green product for them where use of proceeds is tangible, fit their more dedicated SRI/green portfolios, which is great.

Hartwick, IFC: Having this framework will be so helpful. Corporations are now at a stage where they’re trying to understand how the supranationals got to where we are in this space. Since IFC launched the $1bn green bond benchmark, we are being approached by corporates in a number of industries who’d like to know how to go about it. 

They’re asking if we can put together education programmes on how to set up an appropriate ring-fenced portfolio of projects so that they can set up successful green programmes. And we will have a series of these training sessions for different industries over the next few months — it’s very exciting!

EUROWEEK: Would it help as part of this paper to be thinking of the ultimate catch-all name for this sector? Is there one already? Are we happy with the green title? 

Eckhart, Citi: Green is a subset of SRI and ESG. It’s the “E” part of the ESG and we’re defining this particular category not by who issued it but by the use of funds. A coal company anywhere in the world could float a green bond if it truly did invest in green purposes like wind farms and solar projects. The framework says that it’s about the use of funds, not the issuer.

Reichelt, The World Bank: But would people buy that?

Eckhart, Citi: Well, we even have to look at how we’re defining the category. We’ve had ESG investors, SRI investors, now we have a category that’s a use of funds category. So it’s quite a mosaic. 

My sense is that impact investing is becoming a larger broader category, does everyone agree?

Kinnersley, Nikko: I see it as a democratisation of the bond market. It’s giving investors a choice. If they have a specific cause, why can’t they support that through the bond market?

Aldridge, New York Green Bank: Why does it need to be a special capital market? Why can’t it be that we’re putting a framework around systematically incorporating broader considerations into the existing capital markets? 

We need to be diligent because we have goals that are broader and we want to have an impact but the more that we call things responsible that are also just good business the more we’re putting time in between when it’s just a facilities manager that cares about energy efficiency versus getting it up to the C-suite. I’m just not sure that we necessarily need to come up with an all-encompassing new market category for capturing attractive growth opportunities. 

Schulten, BlackRock: I would disagree with that. What we’ve seen is that when you define something and you make clear strict guidelines for it, it helps illuminate a sector and we’ve seen asset owners come in, that really have not been involved in the space before, all of a sudden take a look at it. That’s why we have momentum now — because we’ve defined the sector and we’ve had strictly defined issuance there. The results are coming because of this. We talked about corporations and other SRI issuers coming in, and that will come, but I’d love to see us focus now on what is working. It’s working out in the green bond space for SSA issuers and that’s really where we should focus on making this project successful and being very clear about it and transparent about it and then those other markets can develop over time. Then that brings a larger universe of other environmental funding over time. But right now you’re seeing a big pick-up in SSA green bonds. If you build it they will come. We’re building these large deals that are getting press, that are awakening people about the opportunities in fixed income. 

Aldridge, New York Green Bank: I would support that whole-heartedly. It’s a balance we need to be transparent, like everyone said, but also leave ourselves open to flexibility in the future when defining these guidelines — but making them bankable by at least starting to define them now. 

Padilla, Daiwa CM: I disagree a little with you there as well. I think branding is essential. We need more branding out there and bankers, issuers, investors in this room should not be taking the role of branding. We need a full scale attack by Madison Avenue to really get this thing going. 

Aldridge, New York Green Bank: Absolutely, but we need to be realistic about the stage of the market and careful about how we brand because we’re in a nascent state. That’s why discussions like these are so important — the leaders in this room are taking a collaborative approach to management across parties with shared end-goals of catalyzing capital into impact investments.

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