5.6.3 Future developments for the sustainability ratings market: Green Bonds and the Climate Bond Initiative Standard and Certification

In 2007 the European Investment Bank issued a €600 million “climate awareness bond” that helped fund renewable energy and energy-efficient projects.3 The World Bank and the Skandinaviska Enskilda Banken (SEB) developed the Green Bond concept in 2007/2008 as a response to increased investor demand for engagement in climate-related opportunities.4 They created the first labeled green bond, a fixed income product to respond to demand from investors who wanted to support projects that address climate change. As the World Bank and the SEB define it, it is an investment vehicle that integrates the fiduciary element of fixed income products with climate mitigation and adaptation awareness, giving mainstream investors access to climate-related investment opportunities. The main objective of a green bond is to invest in projects that are designed to achieve a specific climate or environmental purpose.5 Although there is no standardized approach of labeling a project as “green”, the World Bank and the SEB have developed the Green Bond Principles, last updated in June 2018. 678 In a publication in March 2019, the Climate Bonds Initiative has reffered to a number of efforts under way that may contribute to the development of taxonomies to identify green assets. For example, the Technical Expert Group (TEG) on Sustainable Finance has been working on the development of proposals for the EU taxonomy for sustainable economic activities, including an EU green bond label, low-carbon indices and climate-related disclosure.9

The Green Bond Principles are voluntary guidelines promoting transparency, disclosure and integrity in the development of the green bond market by clarifying the approach for issuance of a green bond.10 The Green Bond Principles are coordinated by the International Capital Markets Association, which provides administrative support and guidance for the governance of the principles.11 According to the World Bank and the SEB, the principles provide guidance to their issuers on the key components involved in launching a credible green bond; help investors evaluating the environmental impact of their green bond investments by ensuring the necessary information is available; and assistance to the underwriters by moving the market towards standard disclosures that will facilitate transactions.12 For the World Bank eligible green projects may include projects that target among others, mitigation of climate change including investments in low-carbon and clean technology programs, such as energy efficiency and renewable energy programs and projects (“Mitigation Projects”), and adaptation to climate change, including investments in climate-resilient growth (“Adaptation Projects”).13 Since 2008, the World Bank raised more than US$13 billion through almost 150 green bonds in 20 currencies for institutional and retail investors worldwide.14 The Worldbank reported that by the end of the fiscal year 2018, there were 91 eligible projects and a total of US$15.4 billion in commitments.15

Green bonds offer the same financial risk and return as a regular bond, with the added assurance that the investment will finance the development of sustainable business. By 2010, almost $4 billion of green bonds were being issued by a variety of institutions such as the World Bank and the European Investment Bank. The initial market for Green Bonds was with socially responsible investors, who seeked to earn a return and to generate a positive social impact. The market’s growth has encouraged mainstream investors to participate and has encouraged a wide array of corporate and governmental entities to initiate Green Bond-fundable projects. With more than $36 billion of green bonds issued in 2014, they have become a distinct “asset class.”16 As for the unlabeled climate bond universe there were $532 billion USD issued in 2015 (Climate Bonds Initiative, 2015).17 According to the yearly report “Green Bonds: The state of the market” of the Climate Bonds Initiative, in 2018 the issuance of labelled green bonds reached $167.6 billion USD.18 The 3 top countries issueing green bonds were in 2018, the US with $ 118.6 billion USD, followed by China ($77.5 billion USD) and France ($56.7 billion USD).19 Regarding a future outlook, in 2017, in the report “Mobilizing bond markets for a low-carbon transition”, the OECD estimated that in a 2 degree scenario, the green bond market could be between $4.7 a 5.6 trillion USD in outstanding bonds by 2035, with annual issuance reaching between $620 and $720 billion UDS.20 Another important takeaway from the OECD report is that to “move from billions to trillions”, “convergence towards commonly accepted definitions will be essential to maximize the effectiveness, efficiency and integrity of the market.”21 As we have seen, green bonds were initially issued by banks and Governments, now they are also issued by a number of different companies in different sectors and it has expanded to fast growing economies.22 An illustration of the Green Bonds’ market growth from 2007 until 2018, by the International Finance Corporation (IFC), is provided below, in figure 11.23

Figure 11 – Growth of the Green Bond market from 2007 until 2018, by the International Finance Corporation (IFC), World Bank Group24

Source: International Finance Corporation (IFC), World Bank Group25

The green bonds were introduced in 2014 on a stock exchange. The S&P Green Bond Index, was launched on the 31st of July of 2014, it was the first green bond index from a global index provider. It is a market innovation that enables the labeling of a bond as “green” based on relatively transparent and independently verifiable qualifying criteria.26 It is an important step towards meeting the global green bond market’s new needs. These bonds need to be qualified as green by Thomson Reuters and CBI. A bond only qualifies as green if its proceeds are used to finance environmental friendly projects. The issuer must publicly and clearly state that is issuing a green bond and its purposes. By applying a rigorous set of disclosure criteria to the labeled part of the green market, it promotes issuer discipline and accountability. The S&P Green Project Bond Index has a public methodology and it is designed to measure and provide transparency in the project finance segment within the green bond market and independently track and report its performance.

As the green bonds’ market develops, questions are raised about how green a bond can be, being already referred to as how to “capture the varying shades of green” of green bonds, depending on how environmentally friendly the results are.27 Currently, there is no specification about the quality and quantity of the environmental benefits. Also the cost-benefit relation remains unanswered. To tackle some of these pressing challenges the EU has developed an Action Plan on sustainable finance, the EU Action Plan in 2018 (further explained below in chapter 6). This Action Plan sets-up a road map to achieve the EU’s commitments to tackle climate change and to foster sustainable finance. Part of the action Plan is a key action to develop a voluntary EU Green Bond Standard, as recommended by the EU’s Technical Expert Group. The EU Green Bond Standard would be linked to the EU taxonomy for guidance on qualifying a bond as green. Developing an EU taxonomy is also part of the key actions recommended by the EU’s Technical Expert Group. The EU Green Bond Standard is expected to minimize the risks of “greenwashing” and maximize transparency and the credibility of the green bond market.28

The challenge of developing a global ESG stock exchange standard, and whether it is desirable and feasible, is also part of the market’s agenda. It is seen as an opportunity to collaborate, share best practice and act in concert. As a participant in this process NASDAQ is aware of the challenges: “It’s going to be very difficult to come up with a universal standard. Every stock exchange had localised rules, localised customs, localised regulatory bodies in some cases. Whatever standard wecome up with that manages to span the globe is going to have to be extremely adaptable to each exchange’s particular needs.”29

China has been referred to as a possible be a game changer30 in the green bonds arena. As reported by the Belfer Center for Science and International Affairs at Harvard University, China’s carbon emissions equal the US and EU’s combined.31 Therefore, China has committed to reform its financial markets towards a greener economy. China has set ambitious targets for reducing environmental impact (e.g. pollution and carbon emissions). Among the measures to achieve its economic development objectives, in August 2013 the State Council (Government’s cabinet) of China has directed the banking sector to develop green financial products and planned to grow a corporate green bonds market in China.323334The 13th Five- Year Plan has a strong focus on tackeling environmental challenges, including climate change and issuance of more green bonds, to be used mainly for green and circular development’ projects, and also for low carbon growth. It can be a key moment both for the national Chinese development as internationally.3536

Below in figure 12 we can see some of the most important developments and milestones of Green Bonds since 2008, according to the 2018 Green Bond Impact report from the World Bank.37

Figure 12 – Main Green Bond developments and milestones, according to the 2018 Green Bond Impact report from the World Bank38

Source: World Bank, 2018

In response to the growing concern with the credibility of labeling Green bonds, the Climate Bonds Initiative, a not-for-profit international organization developed the Climate Bonds Standard and Certification Scheme. The Climate Bonds Standard and Certification Scheme is meant to improve confidence, transparency and foster the growth of climate bonds. It is a public good labeling scheme for bonds to assess whether an asset is green, prior to its issuing. The standard is a screening tool for helping investors and Governments to identify the environmental integrity of bonds claiming to address climate change mitigation and adaptation. It is a multi-sector standard that is certified by a third party verifier. The Climate Bonds Standards Board (comprised of members representing $34 trillion of assets under management) provides the final confirmation.

A first version of the Climate Bonds Standard, the prototype Standard (V1.0), was released at the end of 2011 and was used for five certifications until August 2015. In October 2015, a second version of the standard was released. It was called Version 2.0 and included a certification process,40 pre-issuance requirements, post-issuance requirements and a set of sector-specific eligibility and guidance documents.4142The latest version of the Climate Bonds Standard was released in Jnauary 2017, which included improvements on the range of debt instruments that can be certified under the standard and also a programmatic certification directed to regular issuers with large portfolios of eligible assets.43 The version 3.0 is under develelopment, and is expected to be in line with the Green Bond Principles (2018), to be harmonized other regional and international approaches, such as the Green Loan Principles, the EU Green Bond Standard (draft) and the ASEAN Green Bond Standard. Moreover, more clarity on reporting requirements and clarity on definitions is expected.44

Certification according to the Climate Bond Standard does not provide credit risks nor returns’ assurance, however, it simplifies decision-making. It saves time and money to investors when analyzing low-carbon credentials of investments across sectors and asset classes. Besides, some of the benefits of certification of climate bonds, as pointed out by the Climate Bonds Initiative, are: i) certifying the integrity of the bond contributes appeals to a more diverse range of investors interested in these bonds; ii) it allows potential investors to quickly find a credible climate bond on e.g. Bloomberg; iii) enhances reputation of the issuer of green bonds; and iv) certification is cheaper than asking for a second opinion, so issuers will have a lower cost and investors avoid the cost of environmental due diligence. Having a uniform and globally accepted set of standards for verifying the credentials of green bonds creates more security for investors.45 It would also increase the speed of execution, reduce investment risk and lead to a progressive increase in green bond issuance.46 Ultimately, it would also enhance liquidity.47

The certification process according to the Climate Bonds Initiative has two phases:i) the pre-issuance certification, which takes place before issuing the bond, where the internal processes of the issuance of the bond are assessed and certified. It includes its selection process for projects and assets, internal tracking of proceeds, and the allocation system for funds. The certification “Climate Bond Certified” stamp of approval is only provided when an approved third-party verifier gives a verification statement that the bond meets the Climate Bond Standards.48 Fist-time issuers are required with a reasonable assurance from the verifier;49 and ii) the post-issuance certification where the assessment and certification of the bond must be undertaken after the allocation process is initiated. It includes reasonable assurance from the verifier that the issuer and the bond conform to all of the Post-Issuance Requirements in the Climate Bond Standard.50

After the second phase of the certification process, when the post-issuance is completed and confirmed, the issuer will have to provide annual reports (no external verification required but it is an option) to the Climate Bonds Initiative secretariat during the term of the bond.51

Back in 2016, according to Sean Kidney, the CEO and co-founder of the Climate Bonds Initiative, the Big 4 accountancy firms were not yet involved as there was no clear standard to guide the third party review. However, the Big Four accounting firms had formed a working group to support the Climate Bonds Standard and in conformation with their internal governance and ethics recommendations, were already auditing against this independent standard.52 Sean Kidney clarified that in a meeting with the world’s biggest law firms, the Climate Bonds Initiative was informed that “companies have a risk of being sued if they assert their own green bond credentials. For example, if investors buy something on a green claim and find out from an environmental group it wasn’t very green, they’re going to sue them. Furthermore, the current model of getting an independent review, as proposed in the Green Bond Principles, getting an assurance against vague concepts is indefensible legally. They will not advise their clients to accept that as a risk mitigation tool. If there are credible standards in the market and a company gets certified against those standards, that is a reasonable risk mitigation measure.”53