Green Bonds 105: Can Brown and Green Mix?
This is part 5 of a 6-part series on Green Bonds. This series was inspired by numerous conversations which prompted me to create an online compendium on Green Bonds. With the Kenya Bankers Association and other key market stakeholders creating a pipeline for the first green bond in Kenya, it is important to be informed on what green bonds are and their potential role in Kenya’s sustainable development.
From the previous post, we learnt that there has an increasing call for divestiture from fossil fuels. Although financiers are embedding sustainability issues into their business models with initiatives like the Equator Principles, Sustainable Banking Network and Sustainable Stock Exchanges, activists and non-profits have increasing called them out for being “hypocritical” for supporting both alternative clean energy while still being heavily invested in fossil fuels such oil, gas and coal, the brown industries.
In the recent past, Deutsche Bank and HSBC London have made headlines for channelling US$ 7 billion and US$ 4 billion respectively from 2013–2015 to coal miners which works against the aims of the Green Climate Fund (GCF) as per the Paris Climate Deal.
Banks and energy giants have also issued green bonds despite having fossil fuel filled balance sheets. This was the case for Thailand based Bangchak Petroleum Public Company Limited which brought market their first USD 92 million green bonds in 2015 and thrust their underwriter Standard Chartered Bank (and Climate Bonds partner) into the limelight.
This raises the pertinent question:
Is it possible for fossil fuel companies can participate in green financing and whether financiers can co-fund green and brown organisations?
Let us analyse the pros and cons of the situation:
- Changes in policy, technology and physical risks, it will require re-assessment of various assets as the costs and opportunities¹. It has not been business as usual since the 2007/8 financial crisis for most industries, including the fossil fuels as investors have been increasingly vetting their investments with a sustainability lens. (See the figure below.) Moreover, international climate agreements and environmental activism have influenced regulatory frameworks that are encouraging fossil fuel phase out while increasing the potential volume of stranded assets. By investing in green finance, brown companies are attempting to attenuate transition risks as various stakeholders including fossil-based companies embrace a lower carbon economy.
- The urgency of climate change and environmental degradation requires all hands on deck; it would be unwise to procrastinate until all smaller pure-play green companies to scale up. Fossil-fuel companies offer scale and resources as some companies’ green units are bigger than even some smaller companies which contribute to reducing the investors’ renewable energy risk in the long-run e.g. Total’s investment in solar and bio fuel energy.
- Green bonds are all about the use of proceeds. According to Climate Bonds Initiative (CBI):
The use of proceeds concept means a fossil fuel company could issue a green bond with proceeds allocated to qualifying green projects — offshore wind farms, for example — and that bond will be just as green as a green bond issued by a pure-play offshore wind company allocating proceeds to the very same type of projects.
This implies that “use of proceeds” and structured green bonds allows investors to benefit from investing in green initiatives without taking on the additional risk of investing in exclusively and specific green projects. For investors willing to have exposure to green project risk, there are green project bonds and green securitised bonds issues.
- Brown companies are already investing in green finance and making are traction. For instance, gas energy company Engie issues its second green bond of €1.5 billion with two tranches in 2017: a 7-year tranche of €700 million with a 0.875% annual coupon, and a 11-year tranche of €800 million with a 1.5 % annual coupon. The average coupon amounts to 1.20 % for a 9.1 years average duration. The renewable energy projects to financed by this bond must check-off eight specific environment and social boxes as set out by Engie and reviewed by Vigeo Eris.
- It is also important to note that for brown companies to reduce their green credibility gap, they will need to invest in the truly green projects and not necessarily production efficiency projects and technology such as “clean coal” in order to be more acceptable in the green bond market.
See the contrast between Spanish refiner Repsol SA and U.S. power producer Southern Power, here
- Nonetheless, the danger of greenwashing will constantly hoovering over the deals and initiatives. This might also present liability risks in the event that the environmental catastrophes are linked to the fossil fuel companies and associated financiers. Hence it is important that brown companies and their financiers ensure transparent corporate governance practices in the use of proceeds are tied to green projects and receive third-party certification to increase credibility.
References
- Carney, M. (2016) Resolving the Climate Paradox. Speech. Arthur Burns Memorial Lecture, Berlin. 22 September. Available here.
Disclaimer: All views expressed here do not necessarily reflect the opinions of my employers or clients, past or present.
