How can technical assistance help cities float Green Bonds?

The world’s fastest-expanding cities are now in the global South. Rural to urban migration, combined with the effects of urban population growth, could add another 2.5 billion to the world’s urban population by 2050. According to the UN, close to 90 percent of this increase will be in Asia and Africa. At the same time, least developed countries are most affected by climate change and rarely have the means to finance resilience and adaption efforts. The cost of climate change adaptation in Africa has been estimated by the African Development Bank in the range of US$20–30 billion per annum over the next 10 to 20 years. Financial options available to cities in most emerging markets have not kept pace with the growth and looming threats.

Lagos 2017 (Photo by Katharina Neureiter)

Green Finance on the rise…

Many are looking towards ‘green finance’ as a potential solution to help governments plug the climate change and infrastructure financing gap. Green finance covers the funding of investments that generate environmental benefits as part of a broader strategy to achieve inclusive, resilient and sustainable development. Financiers are often willing to take slightly lower returns in return for better environmental outcomes, which can reduce the cost of financing from the perspective of borrowers. Green finance can cover any financial instrument for example insurance products or tax credits in exchange for the delivery of positive environmental externalities that are real, verified and additional to business as usual. Within the available instruments, Green Bonds are becoming increasingly popular. According to the City of London’s Green Finance Initiative global green bond issuances have increased from USD 2 billion to almost USD 55 billion over the past 10 years.

Yet … the Global South is left out

However, cities in the Global South are mostly left out. A 2013 World Bank report demonstrated that less than 20% of cities in developing countries have access to local capital markets, through for example issuing bonds to investors, and only 4% are deemed creditworthy enough to access international capital markets. The ability to access markets obviously a precondition for issuing a green bond. Hence, cities in the South have a steep road ahead towards launching the first Green Bond.

To be clear, even in the North, cities make up only a small portion of the overall issuers of green bonds. The majority is issued by energy and utility companies, banks or in the case of developing countries DFI’s such as the World Bank and the African Development Bank. Within the sub Saharan Africa only Johannesburg and Cape Town have successfully issued a municipal green bond.

Key barriers to raising green finance

We’ve identified three key barriers that prevent cities in the South to take advantage of these new avenues of financing:

Below are three key barriers that prevent cities in the South from issuing green bonds:

1. Weak enabling environment and unsuitable regulatory frameworks

Many low and middle income countries lack a transparent and sound regulatory framework for investment. This trickles down to the inability of the city to raise finance, as investors lack confidence that contracts will be upheld, that local governments will be protected from expropriation, and that commercial disputes will be arbitrated. Additionally, the municipal policy and legal framework must make it legal and feasible for local governments to borrow and to mobilize the resources to repay credit. In many developing countries, the municipal law either does not allow for borrowing, or limits it to a very short term of a year or two.

2. Financial market rules prevent deployment of capital

The policy and legal framework of global capital markets limit most investors in municipalities in the global South. Large institutional investors such as pension funds and commercial banks in the global North are guided by strict fiduciary rules that govern the handling of funds. Most can only invest in assets that are rated ‘Investment Grade’ by the big three credit rating agencies (Standard & Poor, Moodys, Fitch). Kenya’s B+ rating by Standard & Poor’s for example, puts the country into the ‘highly speculative’ bracket. This by default precludes most institutional investors from deploying capital there. There is little Nairobi or any other municipality can do.

3. Lack of bankable projects and skills

Cities must identify sustainable bankable projects as part of their capital investment plans. To demonstrate creditworthiness, local governments must: (i) provide accurate information about the operational and financial activities of the local government; (ii) identify and prepare sustainable bankable projects; (iii) provide a strong repayment stream and demonstrate or mobilize local willingness to pay; and (iv) manage the financed projects during the life of the bond issue or other financing to ensure continued operation and maintenance of the investments, and collection of associated revenues, where relevant. This requires specialised technical and financial skills as well as strong management, evaluation and reporting processes which are often in short supply in local municipalities in the global South.

Overcoming these constraints will need concerted efforts and collaboration between cities, Governments and the financial markets. DFID can play an important role in brokering these contacts and help municipalities in preparing for a green bond.

There are a number of cities that are in the process or have already accessed the financial markets through regular municipal bonds. Since 1999, 12 municipalities in India for example have issued tax-free bonds to finance road constructions and upgrade water supply systems. Most recently, the Pune Municipal Corporation launched a bond in late June 2017. Over the coming five years, the city plans to borrow a total of 350 billion USD to help fund a major infrastructure program for universal residential access to water. Other cities in India are similarly planning issuances, including Ahmedabad, New Delhi and Greater Hyderabad.

Nairobi Skyline 2017. (Photo by Katharina Neureiter)

We have identified three immediate steps that DFID could take to help cities in the South that have not previously tapped the capital markets.

1. Supporting the enabling environment

DFID has an excellent track record in helping countries put the right policy frameworks in place. As part of their Business Enabling Environment Programmes or wider Public Financial Management programmes, DFID could assist countries to develop long-term urban master plans including green urban development goals, support reviews of existing legislation and required reforms to create a more permissive environment that allows municipalities to responsibly borrow from the debt capital markets and supporting city creditworthiness improvements through increasing transparency uses of finance through reporting requirements and internal administrative coordination between city departments.

2. Support advocacy and evidence

Many municipalities might lack the knowledge about benefits and trade-offs of launching a green bond. Many might not have considered this option as part of their climate resilience and infrastructure needs. DFID is well placed on working directly with municipalities to produce evidence and advocate for incorporating these instruments into the wider financing portfolio of a cash-strapped municipalities.

3. Support Compliance efforts

DFID can support with aligning city-based projects with the green bond frameworks of issuers can ensure urban infrastructure follows national or international green performance requirements. Often, local governments have only a laundry list of investment projects. What is required is to assist local governments to prepare a list of projects that supports a medium- to long-term development plan for the city, has been consulted with key stakeholders to ensure their support and willingness to pay for these investments, and to seek formal approval of the plan with the city council or corresponding legislative body. Providing this support may mean providing training to develop local skills in areas such as municipal accounting, local government strategic and financial planning, investment/project preparation, and cost recovery strategies.

4. Support strategic partnerships to improve risk-return ratios

Investors assess all investments based on risk and return. However, few global investors are familiar with municipal projects or with investments in low-income countries, which makes the evaluation of return and risk often too difficult. Cities can overcome this barrier by working with partners who can increase investor confidence: for example, USAID offered to guarantee municipal bonds issued by Dakar, Senegal. Municipalities can also interact with alternative investors such as faith-based organisations or impact investors, which are able to deploy capital to more risky locations and have longer time horizons for their investments.

Although the green bond market has had relatively little impact on cities in developing countries to date in terms of financial flows, it is growing rapidly, with more investors engaging and more domestic market actors participating. Cities should therefore consider how the issuance of green bonds may expand their access to regular, low-cost capital over the long-term. Even where cities may not be able to launch green bonds in the near future, there are immediate benefits to improving their revenue generation and financial management processes. These early steps towards creditworthiness can increase trust in city planning and management, and therefore unlock larger investment flows for urban infrastructure.

Climate Policy Institute shows that USD 2.3 billion in value is linked with city-based projects in developing countries, including urban mass transit systems, district heating and water distribution networks.
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