Landscape Green Bonds: An emerging new asset class?
GCP Founder Director Andrew W. Mitchell is speaking today at the World Bank’s AgriFin 2017 Forum. In this blog post, he reflects on the green bond market and the six ingredients for successful, large-scale sustainable finance.
The green bond market is growing fast but remains a small component of the bonds universe. According to the Climate Bonds Initiative 2016 Report, ‘labelled’ green bonds accounted for US$118 Bn of the market, in turn a subset of the ‘climate — aligned’ green bond market of US$694 Bn. Most issuances are linked to energy, but an emerging new opportunity is in ‘Landscape Green Bonds’. Today these are rare and make up just 3% of green bonds issued. In the next decade, this market could expand, offering exposure to a US$200bn a year business opportunity in climate-smart tropical agriculture, which is essential for meeting targets on emission reductions; two thirds of tropical deforestation is driven by the production of agricultural commodities.
A huge emerging opportunity exists in transforming tropical landscapes, where most of the world’s food will come from in the future, to become climate smart and deforestation free. Some scientists believe that up to 50% of what is needed to keep earth’s atmosphere below a 2 degree rise in temperature could come from action to halt deforestation and reform agricultural production. That’s where capital markets come in, because that job is far too big for governments to finance on their own. However, at present there are no products which are at the right scale and level of return to attract the significant capital investment required for the billion-dollar opportunity represented by the transition to sustainability.
Over the last four years GCP has been involved in building a portfolio of investable projects for future landscape finance mechanisms. In all cases what has emerged is a pioneering but broadly similar scalable financial mechanism. The first transactions are about to get underway in a pilot project in San Martin.
Here are the six ingredients which are needed for large scale finance mechanisms that deliver more productive landscapes, reduce deforestation and deliver sustainable livelihoods:
- Banks need to be incentivised to invest for the long term as payback periods are often longer than 4 years. The lack of long dated, low interest capital is a major barrier for smallholder farmers. Replacing old palm oil trees with new ones, leaves smallholder farmers facing a 5 year “Valley of Death” without an income stream, so decade long loans need to be available to them at a price they can afford.
- Donors need to be willing to use Climate Finance to de-risk deals and increase the scale of investment. There is a significant amount of climate-linked finance potentially coming on stream, such as through the Green Climate Fund. By offering floor prices, insurance and guarantees, public sector funding can be leveraged within blended public-private finance mechanisms.
- Finance has to adapt to requirements on the ground, as ‘bundling’ sectors brings its own challenges. An initial lending mechanism needs to finance not just one supply chain but possibly 5 or 6 commodities together, coupled with say weather insurance and other de-risking incentives.
- Technical Assistance is essential to build capacity, not only among farmers, but also provincial governments that may not be familiar with novel finance mechanisms, such as bonds. Private sector investors rarely finance such activities, so their funds need matching grants or concessional finance from donors to oil these wheels.
- Aggregating portfolios can help to reach the scale capital markets need. That means finance mechanisms themselves and their pipelines, may need to be aggregated, possibly across a country, region or even globally. Projects and larger portfolios can be ‘warehoused’ as they come on-stream, until the required scale is achieved. Then a bond ‘wrapper’ can be put around them and taken to market, increasing liquidity.
- Mixing and matching with more mature sectors, can reduce the perception of risk for investors. So for example, including off-grid renewable energy for smallholders, alongside sustainable agriculture, helps to diversify the portfolio and can make a landscape green bond more attractive to investors and also to governments, keen to meet their Sustainable Development Goals and Paris climate targets.
The World Bank’s ‘AgriFin’ Conference taking place 12th-13th September in London will provide a fertile testing ground for such ideas to take root.
This is a slightly shorter version of a blog written by Andrew Mitchell, originally appearing here. Edited for this publication by Alex Morrice.