Green Bonds and COP 21

IIEA22nd January 20166min
By now, the dust has settled on the Paris Agreement on climate change. At the COP21 summit in December 2015, governments agreed on a goal of keeping globaltemperatures ‘well below 2 degrees’ above pre-industrial levels and promised topursue efforts to limit the temperature increase to 1.5 degrees.

By now, the dust has settled on the Paris Agreement on climate change. At the COP21 summit in December 2015, governments agreed on a goal of keeping globaltemperatures ‘well below 2 degrees’ above pre-industrial levels and promised topursue efforts to limit the temperature increase to 1.5 degrees. As manycommentators have already noted, the bigger challenge of implementing theseambitious objectives now begins.]]>

]]> By now, the dust has settled on the Paris Agreement on climate change. At the COP 21 summit in December 2015, governments agreed on a goal of keeping global temperatures ‘well below 2 degrees’ above pre-industrial levels and promised to pursue efforts to limit the temperature increase to 1.5 degrees. As many commentators have already noted, the bigger challenge of implementing these ambitious objectives now begins.

 

In order to avoid dangerous climate change, investment patterns will have to change. Currently investment in fossil fuels continues with an assumption that all reserves may be burnt long into the future. In a 2 degree world this is not the case. So, how can the world begin to shift private investment from brown to green? At a keynote address hosted by the IIEA and the ISI Centre in January 2016, Sean Kidney, CEO of the Climate Bonds Initiative, focused on green bonds as an effective instrument for financing the transition to a low-carbon economy.

 

What are green bonds?

Green bonds are a method of raising capital for environmentally-friendly investments. The issuer of a bond promises to spend the money raised on projects such as wind farms, low carbon transport or forestry. Labelling a bond as green creates an extra incentive for investors and makes environmentally-friendly projects easier to discover. The market for green bonds has grown rapidly in recent years, from $3 billion issued in 2012 to approximately $41.8 billion in 2015. Moreover, a significant portion are now issued by companies, a shift from the early years of green bonds, when the vast majority were sold by institutions and development banks. The demand for green bonds is high among investors and many are reported to be three or four times oversubscribed.

 

Where is the market coming from?

Sean Kidney believes investors are primarily motivated by a growing awareness of the long-term risks that climate change poses to their portfolios. This financial risk was highlighted by Mark Campanale, founder of the Carbon Tracker Initiative, at a previous IIEA event in October 2014. Mr. Campanale explained that if the world is to stay below 2 degrees of warming, only 20 per cent of proven fossil fuel reserves can be burnt. Therefore, if governments follow through on the promises made at Paris, many of the carbon reserves currently held by listed fossil fuel companies will become ‘stranded assets’. More recently, a November 2015 report by the Carbon Tracker Initiative estimated that fossil fuel companies risk wasting up to $2.2 trillion in the next decade by investing in projects which make neither financial nor climate sense in a 2 degree world. This creates serious financial risks for investors, pensions funds and ordinary citizens with money in fossil fuel companies. Moreover, if action is not taken on climate change and these fossil fuel reserves are burnt, the physical impacts of climate change will only increase the risks to investments and the world economy in the long-term.

 

There are signs that this reality may be starting to hit home. The World Economic Forum, which meets this week in Davos, for the first time listed climate change as the risk with the greatest potential impact in its annual Global Risks Report. The divestment movement has already seen $2.6 trillion in investments moved away from the fossil fuel industry. Green bonds represent an opportunity to channel investment away from this risk into the infrastructure sorely needed for a low-carbon transition.

 

Where is the money going?

The bulk of green bonds in 2015 (45.8%) were spent on renewable energy projects. However, a substantial amount also went toward energy efficiency (19.6%) and low-carbon transport (13.4%), including rail and electric vehicles. Smaller amounts went toward projects in sustainable water, waste and pollution, agriculture and forestry and climate adaptation. Clearly, green bonds can be useful for raising capital for a wide range of infrastructure projects. Yet, this flexibility could also be a hindrance, as concerns have been raised about the environmental credibility of certain green bonds.

 

What makes a bond green?

As the green bond market grows, so do calls for standardisation. Currently, there is no mandatory framework to decide if a bond is green, it is simply the issuer of the bond who decides. The potential for misuse was highlighted in 2015, when it emerged that the Massachusetts State College Building Authority in the US used part of the proceeds of a green bond to fund a multi-storey car park. Unsurprisingly, this led to accusations of ‘greenwashing’ which could discredit the market. It seems that at the very least a minimum set of benchmarks by which to assess the environmental credibility of a green bond is necessary. This void has been filled to some extent by independent groups of experts, like the Centre for International Climate and Environmental Research in Oslo (CICERO), which offer independent review of green bonds. For a bond to be listed on the London Stock Exchange, it now needs to be independently reviewed.

 

Yet troublesome issues remain to be resolved. While a green multi-story car park may seem like an obvious contradiction, assessing the green credentials of other projects is less clear-cut. Can nuclear power or biomass be considered green? These are hotly debated questions. Finding a set of standards, which is robust but not exclusionary will be a challenge for those involved in the emerging market. However, it will be essential to maintain the reputation of green bonds, something which is a major concern for investors. For its part, the European Commission’s Action Plan for Capital Markets Union expresses support for the development of the green bond market and notes that it will ‘continue to monitor the need for EU green bond standards’.

 

Potential for growth

If these hurdles can be overcome there is significant potential for growth in the green bond market, according to Sean Kidney. The EU remains the region with the most green bonds but there has been significant interest in emerging markets, such as India and China. China recently became the first country in the world to develop official rules on issuing green bonds. Mr. Kidney highlighted that the labelled green bond market is currently worth approximately $85 billion, only a fraction of the total size of the bond market. However, there is an as yet unlabelled but climate-related bond market of $600 billion, which Mr. Kidney hopes could soon become official green bonds.

 

Green Bonds and COP 21

The Paris Agreement provided a clear signal to investors that the world intends to move away from fossil fuels. While this has rightly been lauded as a major diplomatic success, as Michael Levi, Senior Fellow at the Council on Foreign Relations notes, ‘it is national politics and policies, not international agreements, that are the prime driver of emissions-reducing actions.’ If, over the next few years, national governments act as if they mean what they said at Paris, private investors will follow suit. The national plans governments submitted at Paris (so-called INDCs) require major investment in new renewable energy projects and the rebuilding of infrastructure. If they can fulfil their promise in redirecting financial flows from fossil fuels to sustainable infrastructure projects, green bonds will form an important part of the toolkit needed to deliver on Paris.