Maximising the Potential of Environmental Bonds
by Thomas Gomersall
As discussed in previous blogs, to have any chance of adequately addressing the climate and ecological crises we face, one of the many things we must urgently do is to address the US$2.5 trillion deficit in annual funding for the UN Sustainable Development Goals (SDGs). Greater private investment in environmental projects is essential to close this funding gap by more than half, but another method with great potential to close it even faster is environmental bonds, also known as green bonds.
For the uninitiated, a bond is a financial instrument that companies or governments issue in order to borrow funds on international markets from the public or institutional investors. These funds are raised for specific or general purposes. In return, they pay back over an agreed period of time the initial principal plus interest.
Environmental bonds are capital meant to be used specifically for projects that benefit the environment. They meet four main criteria:
1. Proceeds are used to benefit the environment.
2. Projects that receive funds from a bond are first evaluated and selected based primarily on how well they deliver on the intended environmental outcomes. Fund use is restricted to fulfilling those outcomes.
3. Proceeds are managed to document how much bond money goes to a given project and what the balance is.
4. Before issuing an environmental bond, the issuer should provide a pre-issuance report* documenting their intention in issuing the bond, how their proceeds will be used, how they will evaluate and select projects for funding, and how much money will be exchanged. Once the bond is issued, a post-issuance report detailing its proceeds and environmental impacts should be provided at least once a year.
*Reporting is recommended, but currently not mandatory for all environmental bonds.
The first environmental bond was a Climate Awareness bond issued by the European Investment Bank in 2007. Since then, as various companies and governments have begun issuing their own — in order to better appeal to investors with an interest in green projects — the volumes and value of environmental bonds issued have grown exponentially, with a cumulative issuance of green bonds exceeding US$1 trillion to date. Today, many frameworks for environmental bonds and the standards that projects must meet to receive money from them exist, varying between regions.
Despite their explosive growth, there has been controversy surrounding environmental bonds. The latest report on green bonds by the Bank for International Settlements (BIS) found no clear evidence that issuers have reduced their carbon intensities, at the company level, more than other firms. Thus, while the use of environmental bond proceeds might be earmarked for environmentally beneficial projects, the overall environmental performance still falls short of what science dictates.
Greenwashing is another issue, as insufficiently stringent standards for project selection mean that projects may receive bond money even if their practices are just business as usual.
The differing frameworks for environmental bonds also create problems. Varying standards for bond issuance can confuse investors, who may not be able to tell at first glance if the projects are truly making a positive environmental impact, forcing them to do more research into them, potentially discouraging them from investing at all due to resource constraints.
Differing frameworks have also created differing regional standards on what types of projects are eligible for bond money and how much of it goes towards green projects. For instance, environmental bond guidelines in China used to classify ‘clean coal’ as eligible for bond money (though changes to this are being proposed) and also allow for up to 50 per cent of bond money to be used for non-green projects.
A common international framework for environmental bonds is needed to address the problems caused by differing regional frameworks. This will require common agreement among nations on what percentage of bond money goes to green projects, what types of projects are eligible for bond money, and the exact science-based standards that projects must meet to receive money. One means to help achieve this is the International Platform on Sustainable Finance, of which the EU, China and 12 other sovereign countries are members. Set up in 2019, it allows countries to communicate, share and compare practices, as well as to identify barriers to and opportunities for aligning them with each other.
Another step is to make post-issuance reporting mandatory and more detailed for all environmental bonds to ensure that they are actually being used to deliver verifiable, tangible environmental benefits. Doing this will help to reassure investors that their investments will actually be used for maximum environmental protection.
“The Green Bond Principles has successfully demonstrated that tracking of and reporting on the use of proceeds of green bonds are technically feasible and beneficial […],” says Jochen Krimphoff, Deputy Director of Environmental Finance for WWF-France. “WWF believes that the time is now ripe to apply the concept of ‘use of proceeds’ to all types of bonds”.