Green Bonds 106: What Can We do to Make Green Bonds Work?
This is the final instalment 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.
Let us do a quick rundown of what we have learnt so far about green bonds.
We started off by understanding that green bonds are debt-instruments whose proceeds are used to fund low-carbon emitting assets, projects or business activities. Though the jury is still out on what qualifies as “green” or not. Then we took a short trip down memory lane and got to know that since the first green bond was issued by European Investment Bank and listed on the Luxembourg Stock Exchange in 2007, the market has been growing in leaps and bounds due to the increased awareness and commitments by various stakeholders. Thereafter we delineated reasons why green bonds are suitable instruments for climate finance.
So who exactly issues and buys these green bonds? We found that the green bond market blossomed in 2016 as seen in the increased number of market participants, issuer types, ratings and use of proceeds as well as market innovations. The majority of the issuers were corporates. In addition, China led the Asian region in bond issuance as noted through the various policy frameworks and market infrastructure that has been putting in place. The buy side is dominated by institutional investors such as insurance companies and pensions mainly in Europe and followed by Asia.
Then we tackled a controversial issue: whether brown companies can (financially) support green initiatives. It was noted that it was already happening and the “big oil” companies like Total can assist in attenuating transition risks. In addition, what matters is the use of proceeds are ring-fenced. It is the responsibility of the brown companies and third party verifiers to monitor and report on the progress of these projects.
This then begs the question, what can stakeholders do to cultivate a conducive green bond market?
Central Banks and the Financial Sector at Large
Mark Carney, the current Governor of Bank of England and Chair of G20’s Financial Stability Board has been actively championing the need for the central banks to factor in climate change as part of their operations. In his seminal speech, Governor Carney recognised three climate-related risks: (physical, transitional and physical) risks that threaten financial stability. Currently, the Bank of England co-founded and co-chairs the G20 Green Finance Study Group (GFSG) with People’s Bank of China while the UN Environment (UNEP) Inquiry hosts the secretariat. This has led the Bank to indulge in climate related bank research and disclosing associated risks.
See: Breaking the Tragedy of Horizon-Climate Change and Financial Stability
Central Banks could possibly borrow a leaf (pun-intended) from the Moroccan Bank Al Maghrib (Central Bank) who purchased USD 100 million worth of green bonds which will be used for the bank’s reserve management.
Green Sukuk also hold the potential of deepening and broadening bond markets in regions that favour Shari’ah compliant instruments or ethical investors in general.
The good news for emerging and developing countries with nascent bond markets is that they are more able to have an easier time in growing their green bonds markets. Novel green instruments can be easily integrated into the bond market development process. Climate change will not pause for the maturity of all bond markets for green instruments to be incorporated. This would ensure early adaptation and adoption by having market structures that are supportive of green instruments.
National and Sub-National Governments
Governments, in particular, can be instrumental in strengthening their local bond markets to ease the process of green bonds. A number of governments are considering green bonds as tools for accessing capital that is required to implement country climate plans (NDCs) as agreed upon in the Paris COP 21 deal. Some quarters have suggested that 2017 could be the year of the sovereign green bond. France set the pace by coming to market with an impressive USD 7.5bn bond in January and Nigeria is expected to follow suit. The Climate Change Act 2016 created a provision for a fund which could be used to finance the first public green infrastructure in the country.
That said, national and sub-national frameworks should be put in place to ease the process of the bonds coming to markets such as developing green standards like in the case of China and India. They should also establish agencies that translate national green strategies that support climate-smart infrastructures into investable project pipelines.
Bespoke tax incentives can be instrumental in supporting certain segments of the green bond market. In a 2015 consultation paper by the Climate Bonds Initiative, it was noted that:
- The US has offered tax incentives for bonds financing green buildings as well as renewable energy from 2009, in addition to providing tax incentives to more than 80% of the USD 3.7 trillion municipal bond market.
- Brazil allows tax-free bonds to be issued for wind developers, as well as other infrastructure investments and construction.
- In 2015, China proposed tax incentives specific for labelled green bonds, as part of their broader package for green bond support.
Private Sector
There is the challenge of diseconomies of scale that is associated with multiple small projects especially in the renewable energy space such as the wind and solar installations. This renders them uncompetitive not because of technical inadequacies but funding that is limited to conservative sources.
Green securities present an issuance opportunity for small scale companies to access funds through the capital markets at lower rates.To recap, the securitisation process involves pooling a large number of illiquid assets and transforming them into tradable financial instruments. In this case, the underlying assets and proceeds are required to possess green attributes.
Though the 2007–8 mortgage backed securities crisis cast a dark shadow on these instruments, regulators are keen on their transparency. Further, a number of companies have already successfully issued green asset backed securities (ABS) like Toyota and Obvion. In Kenya, market frameworks have been put in place to allow trading of ABS but they are yet to gain traction.
Bringing It Home
In the last few years, the Kenyan government has been actively taking steps to deal with the effects of climate change notably, the passing of the Climate Change Act 2016 and the banning of plastic bags in 2017 and pledging its NDC under the earlier referenced climate agreement. The Central Bank of Kenya has also provided some forward guidance on the sustainable finance issues due to a central role of banks in the Kenyan economy.
The Capital Markets Authority and Nairobi Securities Exchange have also facilitated investor awareness and are supporting the financial ecosystem through their regulatory frameworks. However, a lot more can be done proactively to deal with climate change issues while still pursuing triple bottom line.
One of those steps is through their collaborative efforts with Kenya Bankers Association (KBA) to bring to market Kenya’s inaugural green bond, which we are all waiting for with bated breath. Also, issuing the bond through crowdfund investing platforms such M-Akiba may provide green opportunities to retail investors.
To conclude, the green bonds has presented itself a great opportunity for addressing climate change from a financial perspective. It is imperative for Kenya to glean lessons from other countries and to charter its own course within the green finance space. Since even Elon Musk has not yet discovered a green magic bullet to curb climate change, combined commitments and efforts are required from supranational to individual levels for us to meet the 2 degree target by 2030.
Disclaimer: All views expressed here do not necessarily reflect the opinions of my employers or clients, past or present.
Just in case you missed the previous articles in Green Bond Series:
Green Bonds 101: What are Green Bonds?
Green Bonds 102: A Brief History of Green Bonds
Green Bonds 103: Why Green Bonds as Financing Instruments?
Green Bonds 104: Who Buys and Issues Green Bonds?
Green Bonds 105: Can Green and Brown Mix?
