[co-author: Ben Crosby]

INTRODUCTION

Although Environmental, Social and Governance-related (“ESG”) initiatives continue to face some political headwinds, and the ESG-linked debt market suffered a downturn in 2023, a nascent product type is piquing the interest of certain players in the sustainable debt space. Several debtors have entered the so-called blue financing space in an effort to contribute to the maintenance of the world’s waterways and demonstrate their commitment to ESG programs.

This Legal Update takes a look at the key trends and deal points in the emerging blue finance market, and highlights common themes that both debtors and creditors should consider.

SUSTAINABLE FINANCING: AN OVERVIEW

Generally, ESG-related financial products fall into one of two categories: linked products or use of proceeds products.

Linked products are those that incorporate sustainability performance targets (“SPTs”) and key performance indicators (“KPIs”) into the debt documentation. The debtor under such a structure is obliged to monitor its KPIs and calibrate its performance against a corresponding SPT benchmark. The debtor’s performance against the relevant SPT links —hence the nomenclature—to an interest rate margin ratchet in the debt documents: should the debtor exceed the KPI’s corresponding SPT, the debtor may receive a discount on the interest rate margin; should the debtor fall below the KPI’s corresponding SPT, the debtor may suffer an increase to the interest rate margin.

Use of proceeds products operate using simpler mechanics. Here the debtor selects an environmental and/or social project or projects that it needs funds for. The use of proceeds clause in the relevant debt document obliges the debtor to exclusively use the funds for such projects. Unlike with linked products, funds obtained via a use of proceeds product cannot be used for general corporate purposes and must only be used for the stated environmental or social project(s). Furthermore, the agreement with the creditors will likely oblige the debtor to monitor both the funds used for the project and the ongoing success of the project itself and to periodically report to the creditors on the same.¹

Linked and use of proceeds loans are most often drafted in accordance with voluntary recommended guidelines and standard drafting jointly produced by the Loan Market Association (“LMA”), the Asia Pacific Loan Market Association (“APLMA”) and the Loan Syndications and Trading Association (“LSTA”). Linked and use of proceeds bonds are most often issued in accordance with voluntary principles and guidelines published by the International Capital Markets Association (“ICMA”).

Debtors in the sustainable financing space often also choose to produce a green financing framework. These voluntary frameworks usually conform—as much as possible—to the principles and guidelines published by ICMA, the LMA, the APLMA and the LSTA, and set out the debtor’s green goals and ESG infrastructure. Key sections in such frameworks include:

• the identification of investment categories which are suitable uses of the green proceeds;
• a description of the internal mechanisms for ESG project selection;
• the processes for managing the retention and investment of the green proceeds; and
• the mechanisms for reporting to the debtor on the selected projects.

BLUE FINANCING: A NEW WAVE OF SUSTAINABLE FINANCING PRODUCTS?

I. AN OVERVIEW OF BLUE FINANCE PRODUCTS

Blue finance products are a sub-group of environmental use of proceeds products—so far exclusively of the bond variety—in which the funds, or at least a portion thereof, are earmarked specifically for water-based environmental projects.

This is not to say that a linked product could not necessarily include water-based KPIs. Rather, the nascent blue finance industry, its guidelines (discussed further below), and blue debt issuances have thus far focused almost exclusively on blue use of proceeds products.

II. GUIDELINES AND PRINCIPLES

THE UNITED NATIONS

The UN launched the Sustainability Blue Economy Finance Principles (the “UN Principles”) in March 2018. These principles, developed in collaboration with the European Commission, World Wildlife Fund, World Resources Institute, and European Investment Bank aim to promote the implementation of the UN’s Sustainable Development Goal 14 (Life Below Water) and provide 14 overarching philosophical principles that the UN seeks to support and develop in both public and private endeavors in the blue economy.

THE IFC

Based on the UN Principles, the ICMA Green Bond Principles and the LMA / APLMA / LSTA Green Loan Principles (each referenced herein above), the International Finance Corporation (the “IFC”)—a part of the World Bank Group—issued the Blue Finance Guidelines (the “Guidelines”) in January 2022. The stated aim of the Guidelines is “to provide a list of eligible use of proceeds to support private investments aligned with the Green Bond Principles and Green Loan Principles and contributing to Goals 6 and 14 of the United Nations Sustainable Development Goals…”. To that end, the Guidelines identify eight eligible blue finance areas for which the IFC could choose to earmark funds:

• Water supply;
• Water sanitation;
• Ocean-friendly and water-friendly products;
• Ocean-friendly chemicals and plastic-related sectors;
• Sustainable shipping and port logistic sectors;
• Fisheries, aquaculture, and seafood value chain;
• Marine ecosystem restoration;
• Sustainable tourism services; and
• Offshore renewable energy production.

For each of these blue finance areas, the Guidelines suggest specific projects or project types that might be selected in order to conform with the applicable green principles. Examples include investments in water treatment, storage and desalination technologies, investments in conserving, improving and restoring marine and coastal ecosystems, and increased use of recycled or reused plastics.

The Guidelines also recommend that an issuer of blue bonds or borrower of blue loans incorporate specific blue components into any green financing framework that the issuer or borrower has previously published or intends to draft for future publication. On blue-ing the four key components of a green finance framework, the IFC says:

• “To stay consistent with the Green Bond Principles and Green Loan Principles, an issuer of green bonds or borrower of green loans would elaborate, within its framework, on the governance to assess and select blue related activities and assets.”
• “An issuer of green bonds or borrower of green loans with a blue component would elaborate, within the framework, on how the proceeds will be managed in accordance with the Green Bond Principles and Green Loan Principles.”
• “The issuer or borrower would make all reasonable efforts to gather data for the use of proceeds in an allocation report and for impact reporting” in accordance with ICMA guidance.
• The IFC “strongly recommend[s]… hav[ing] a second opinion confirming that proposed blue loans and blue bonds are consistent with the Green Loan Principles and Green Bond Principles.”

The Guidelines are primarily intended to inform the IFC’s investments in the blue economy. However, the IFC does acknowledge the general lack of guidance currently available in the blue finance market. The Guidelines are therefore also intended to provide guidance beyond the IFC (on project eligibility in particular) and might also offer those looking to enter the blue financing space assistance in mapping their intended blue financings onto green financing principles. Ørsted’s inaugural blue bond issuance (discussed below) is explicitly stated to be in a format “in accordance with the IFC Blue Finance Guidelines,” demonstrating the potential that the Guidelines have to influence the market and become something of a standard-bearer. Parties looking to enter the blue financing space should consider how closely the terms of their blue debt documents track the Guidelines.

ICMA

In September 2023, the International Capital Markets Association issued voluntary blue bond guidance (the “ICMA Guidance”) with three stated aims:

• “to provide issuers with guidance on the key components involved in launching a credible ‘blue bond,’
• to aid investors by promoting availability of information to evaluate the environmental impact of their ‘blue bond’ investments, and
• to assist underwriters by offering vital steps that will facilitate transactions that preserve the integrity of the market.”

The ICMA Guidance builds upon the UN Principles and the Guidelines discussed above, as well as its own green use of proceeds guidance, while also drawing on blue frameworks produced by the Asian Development Bank (discussed below).

Much like the Guidelines, the ICMA Guidance provides issuers with guidance on mapping blue debt onto the existing green principles. This includes guidance on indicative eligible blue projects, creating a green framework and incorporating the requisite blue elements into the framework, managing all blue-related moneys, and reviewing and reporting on the issuer’s selected blue projects.

The ICMA Guidance also includes examples of “potential social co-benefits” of its indicative eligible blue projects, illustrating the possibility for blue financings to have crossover impact in conformity with the relevant social financing principles. For instance, the ICMA Guidance states:

“Blue projects can have social co-benefits including fair labor conditions, gender equity, social inclusion, health, poverty education, and economic empowerment. […] Issuers should further specify a target population(s) benefiting from the outcomes or impacts of the social projects. Examples of social projects that can be found in the blue economy are targeted at those living below the poverty line, excluded and/or marginalized populations and/or communities, people with disabilities, migrants and/or displaced persons, undereducated, and underserved, owing to a lack of quality access to essential goods and services.”

Interestingly, of all of the guidance discussed herein, the ICMA Guidance goes the farthest in expressly stating that it may be useful in the context of blue-linked—as opposed to purely blue use of proceeds—bonds, as well as blue loans, both linked and use of proceeds. In this regard, the ICMA Guidance cross-refers to ICMA’s Illustrative KPIs Registry. The Illustrative KPIs Registry includes 24 potential water-based KPIs that could be included in linked debt instruments across a wide variety of sectors. The ICMA Guidance also highlights the Thai Union’s 2021 THB 5bn seven year 2.47% sustainability-linked bond as the first sustainability-linked bond to include a blue KPI. This all signals potential for development of the blue debt market far beyond its current use of proceeds bond space, and the ICMA Guidance presents a useful framework from which this development can begin.

The ADB

The Asian Development Bank (the “ADB”) published a high-level green and blue bond framework in September 2021 and a longer form Ocean Finance Framework (the “ADB Framework”) in 2022.

Much like the Guidelines, the primary purpose of the ADB Framework is to guide the ADB’s investments in the blue economy, though it is also designed to provide industry guidance to other players (or potential players) in the blue economy. Unlike the other principles and guidelines discussed above, however, the ADB Framework limits its scope to projects located within ADB developing member countries bordering a major water source. Otherwise, the ADB Framework follows the same format as the Guidelines and ICMA Guidance: drawing from the UN Principles, the ADB Framework lists exemplar eligible blue projects, assists with the mapping of blue projects onto existing green principles and frameworks, and notes the ADB’s approach to accounting for blue proceeds and reporting on the selected blue projects.

SUMMARY

Debtors, creditors and other entities interested in entering the blue market may wish to consider the following:

1. if a green financing framework is already in place, whether the language and infrastructure described therein are sufficiently aligned with the UN Principles, Guidelines, ICMA Guidance and ADB Framework (as may be applicable), or whether specific blue-related amendments are necessary;
2. if a green financing framework is planned for the future, whether potential blue financings should be incorporated into the framework, or whether a separate blue sub-section should be included in the framework;
3. whether internal infrastructure and expertise is in place to select and monitor blue projects as distinct from green projects, and, if this is not currently the case, how such infrastructure can be built and expertise cultivated; and/or
4. if a third-party reviewer is currently engaged for the purposes of green financings, whether such reviewer has the capability to perform the same function for blue financings. If the reviewer does not have this capability (or no such reviewer is currently engaged) a suitable external reviewer will need to be sourced and engaged for the purpose of any planned blue financings.

III. HOW LIQUID IS THE MARKET?

The World Wildlife Fund estimates that the global ocean asset value is $24.2tn (Figure 1), with more value likely available but as yet unaccounted for “because many key ecosystem services are difficult to quantify” (Figure 3). The World Wildlife Fund further estimates that over one-third of this value—some $8.4tn—is at risk if a business-as-usual trajectory is pursued.

As of January this year, blue bond issuances have totaled just $6.8bn, according to Sustainable Fitch analysis cited by the Financial Times.

The vast majority of issuers in the blue bond space thus far have been issuers of sovereign debt. The Nature Conservancy—a global environmental non-profit organization —has helped to facilitate sovereign blue bond issuances for Gabon, Barbados, Seychelles, and Belize. These issuances take one of two formats:

• The simpler format, followed by the Seychelles, is a regular use of proceeds bond issuance with the funds ringfenced for marine conservation efforts.
• The second format, followed by Gabon, Belize and Barbados, utilizes an innovative “debt-for-nature swap” structure in conjunction with the Nature Conservancy, a national or supranational organization, and international financial institutions pursuant to which:
  1. blue debt is raised by the government-debtor;
  2. this newly raised debt is used to refinance and restructure the nation’s outstanding debt in the market with creditors going on to hold newly issued sovereign blue bonds in place of their previously held sovereign debt; and
  3. in return for the institutional assistance in putting this structure in place, the government-debtor agrees to ringfence a portion of the savings resulting from this debt restructuring for marine conservation efforts.

While initial blue bond issuances were sovereign issuances from smaller coastal economies, APAC nations and institutions have also begun to enter the space. The ADB launched its first blue bond in 2021, the Export-Import Bank of Korea issued $1bn worth of 10 year blue bonds in January of last year, and Indonesia launched a publicly traded blue bond in May of last year. In the private issuance space, BDO Unibank, in conjunction with the IFC, launched a $100mn blue bond in May 2022.

As mentioned above, in Q2 2023, Ørsted issued a €100mn, five-year 3.625% fixed-rate blue bond via a private placement. The proceeds of this bond will be used by Ørsted to invest in both offshore biodiversity and sustainable shipping. This is the highest profile private issuance of a blue bond to date.

There are no major reported instances of blue debt being taken in a loan format at time of writing.

CONCLUSIONS

Although the number and size of blue debt issuances has so far been small, history suggests that the market for this product type will only grow as more institutions learn of the product and guidance from various industry institutions continues to be produced, refined and updated. In the opinion of the United Nations Global Compact, “[b]lue bonds today are where green bonds were 10 years ago.” According to S&P data, some $443.72bn worth of green bonds were issued in calendar year 2022. The blue bond market, then, could be set to ride an incredible wave in the coming years. Given the dearth of activity in the blue loans space, this product area is likely also ripe for exploration.

Blue debt—like any other debt product—requires creditors, debtors, arrangers, agents, and a whole host of other actors. There are then seemingly innumerable opportunities to dive into the blue financing sector as the market continues to evolve and mature.

¹ These paragraphs describe the sustainable financing product structures in the loan market. Market practice in the bond market differs slightly, but the underlying principles are aligned between, and are applicable to, both the bond and loan markets.

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