[co-author: Nick Quarrie]
In November 2007, the European Investment Bank set the blueprint for sustainable investment with the issuance of the world’s first green bond. Since then, interest in green finance, and in particular, green bonds, has surpassed analyst projections.
According to the International Capital Markets Association (“ICMA”), in the first six months of 2019, green bonds raised almost U.S.$100 billion and were on track for a year-end total of U.S.$230 billion; an increase of 56% in one year. While credit-rating agency Moody’s had predicted a record-setting year for green bonds, its projection was revised to U.S.$250 billion from U.S.$200 billion after growth exceeded expectations (with the average offering more than three times oversubscribed according to a recent report from BNP Paribas).
High profile issuances in 2019, such as French electrical power company Engie SA’s U.S.$2.8 billion issuance and Germany’s KfW Bankengruppes U.S.$3.4 billion issuance helped Europe remain the fastest growing regional market in 2019 for offerings of green bonds with an estimated U.S.$95 billion worth of issuances, an increase of 41.4% on 2018. In November 2019, Apple launched a €2 billion offering (its first euro-denominated green bond offering).
Europe is not the only region seeing an uptake in the issuance of green bonds. Following the U.S.$1.1 billion green sukuk issued by the Islamic Development Bank towards the end of 2019, the Department of Energy in Abu Dhabi recently announced its intention to become the sustainable finance and green bond hub for the region through the creation of a Green Bond Accelerator. With Middle Eastern analysts claiming that the green sector in the region is largely untapped, 2020 could be the year that green sukuk become a key investment vehicle, assisting the region’s aspirations to transition to a more sustainable future.
The green bond market in Africa also continues to develop at pace. Since the success of Nigeria’s inaugural green bond issuance in 2017 and its most recent listing in June 2019, African sovereigns and corporates are making inroads into this largely untapped sector. In October 2019, the Nigerian Stock Exchange and the Luxembourg Stock Exchange signed a memorandum of understanding aimed at cooperating in promoting cross listing and trading of green bonds in Nigeria and Luxembourg. In January 2020, East Africa’s first green bond was listed on the London Stock Exchange. Although the African Development Bank remains the largest green bond issuer in the region, analysts have commented that it is only a matter of time before the volume of issuances from African issuers increases.
Green Bond Principles
The recent growth in popularity of sustainable finance has been managed and promoted by capital market authorities and regulators. As investor interest increases, issuers must look for ways to distinguish their issuances and to publically commit to providing a genuinely “green” product. One way in which issuers can do this is by complying with the voluntary guidelines and principles that have been steadily refined by the market regulators, commentators and authorities in different jurisdictions.
At the outset of a transaction, consideration should be given as to which set of green bond principles should be followed. The principal considerations for choosing one set of principles over another include: (i) listing venue; (ii) geographical connection of the issuer to a region; (iii) investor requirements and (iv) market considerations. Set out below is a description of certain of the most widely used sets of principles:
ICMA Green Bond Principles
ICMA published its first voluntary Green Bond Principles (the “GBP”) in 2014, in response to the interest of 55 institutions, which at that time represented all the participants in the green bond market. The GBP are intended for use by market participants, to develop the role that debt markets play in funding projects that contribute to environmental sustainability. Their purpose is to enable issuers to transition their business model towards greater environmental sustainability through specific projects, by promoting a change in transparency that facilitates the tracking of funds into environmental projects. The GBP are internationally accepted and widely used for the development of national green bond guidelines or standards issued globally.
The GBP’s core components include:
1. Use of Proceeds
ICMA recognises that the “cornerstone of a Green Bond is the utilisation of the proceeds of the bond for Green Projects”, and that the projects should provide clear, assessed and quantified green benefits, falling under one of several broad categories of “Green Project”, which aim to mitigate climate change, adapt to climate change, conserve natural resources and biodiversity and prevent pollution.
2. Process for Project Evaluation and Selection
ICMA has stated that the issuer of a green bond should clearly communicate to investors the environmental objective pursued, the process of environmental assessment, and the assessment criteria, within the context of the issuer’s overarching objectives for environmental sustainability. Levels of transparency should be high, and the process of project evaluation and selection should be subject to external review.
3. Management of Proceeds
The net proceeds of the bond should be tracked in a formal internal process, such as being moved to a sub-account or sub-portfolio, and the methods of allocation to eligible Green Projects disclosed to investors. The GBP specify that this process should be verified by an auditor or other third party.
Issuers should keep up to date ‘use of proceeds’ information available to investors. Such information should be renewed annually until the funds raised have been fully allocated, with a list explaining each project funded with a brief description and their aims/expected impact specified in the annual report. Investors should be made aware of the qualitative and quantitative performance indicators, such as energy capacity or greenhouse gas emissions, and the key underlying methodology and assumptions used.
ASEAN Green Bonds Standards
The ASEAN Capital Markets Forum (the “ACMF”) is comprised of capital market regulators from all ten “ASEAN” jurisdictions (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar (Burma), Philippines, Singapore, Thailand and Vietnam). One of the key initiatives by the ACMF is the development of a green asset class in line with the importance of green finance in supporting sustainable growth in ASEAN, particularly in meeting ASEAN’s infrastructure needs.
Following the publication of the GBP in 2014, the ACMF developed the ASEAN Green Bonds Standards (the “AGBS”) (which are based on the GBP) in collaboration with ICMA.
While the GBP set out broad principles, the AGBS aim to provide more specific guidance on how the GBP are to be applied across ASEAN jurisdictions. Issuers who wish to issue and label green bonds as ASEAN green bonds must demonstrate compliance with the AGBS. Key additional features of the AGBS include:
- Eligible Issuers - the issuer or issuance of the green bond must have a geographical or economic connection to the ASEAN region.
- Ineligible Projects - fossil fuel power generation projects are excluded from the AGBS.
- Continuous Access to Information - the AGBS require issuers to disclose information on use of proceeds, the process for project evaluation and selection and management of proceeds to investor in the issuance documentation, as well as to ensure that such information is publicly accessible from a website designated by the issuer.
- Encourage More Frequent Reporting - issuers are encouraged to provide more frequent periodic reporting in order to increase transparency on the allocation of proceeds.
- External Review – while the appointment of an external reviewer is voluntary under the AGBS, the AGBS require that any external reviewers must have the relevant expertise and experience in the area which they are reviewing. The external reviewers’ credentials and scope of review conducted must be made publicly accessible from a website designated by the issuer.
EU Green Bond Standard
The EU is also working to develop an EU green bond standard. In June 2018, the European Commission (“EC”) set up a Technical Expert Group (“TEG”) with the aim of developing: (i) a unified classification system (or taxonomy) for sustainable economic activities (the “EU taxonomy”); (ii) a standard for EU green bonds; (iii) bench-marks for low-carbon investment strategies; and; (iv) guidance on improving the disclosure of climate-related information.
In June 2019, the TEG published its ‘Report on EU Green Bond Standards’, compiled using feedback from over 100 organisations; it proposed that the EC create a voluntary, non-legislative EU Green Bond Standard (the “EUGBS”) to enhance the effectiveness, transparency, comparability and credibility of the green bond market and to encourage market participants to issue and invest in EU green bonds. The TEG recommended that the core components of the EUGBS should comprise:
- Alignment with EU Taxonomy - the EUGBS should provide guidance on the interpretation of the EU taxonomy (which is expected to be finalised through a series of delegated acts scheduled for publication during the period until 31 December 2022). In particular, the EUGBS should specify that green projects can include green assets and green expenditures that contribute to improving and maintaining the value of such green assets. The EUGBS will also require that the proceeds from green bonds should go towards projects that: (i) substantially contribute to one of the environmental objectives; (ii) do not significantly harm the other objectives; (iii) comply with minimum social safeguards; and (iv) meet any technical screening criteria.
- Green Bond Framework - the Green Bond Framework is intended to be a document that will cover issuer alignment with the EU taxonomy, project selection and future reporting. The draft standard foresees the inclusion of the use of proceeds to be specified in the legal documentation and is expected to include (among other items): (i) the environmental objectives of the green bond and how the issuer’s strategy aligns with such objectives; (ii) the process by which the issuer has determined that the green bonds are in line with the EU taxonomy, and, if applicable, the qualitative and quantitative Technical Screening Criteria; (iii) information on the methodology and assumptions to be used for the calculation of key impact metrics; and (iv) a description of the reporting (e.g., envisaged frequency, content and metrics).
- Mandatory Reporting - mandatory allocation and impact reporting should be carried out on a project by project or portfolio basis. Allocation reporting and impact reporting will be published on the issuer’s website and/or other communication channel. This will be particularly important for long-term bonds with a maturity of 10 years or more.
- Mandatory Verification - verification should be mandatory and accreditation of external verifiers is necessary. Verification will only be provided by external verifiers that have been formally accredited and supervised by the European Securities and Markets Authority.
The June 2019 report was accompanied by a call for feedback. The TEG has analysed the feedback received and is expected to provide its final recommendations to the EC in March 2020. It is not yet clear when the EUGBS will be finalised.
Looking to the future
Although issuances of green bonds currently account for only 2.5-3% of the total bond market, the market continues to grow unabated. The challenge is now building on this momentum. Investor interest in the social and environmental purpose of their investments reflects a fundamental shift in the bond market, gone are the days where investors knew and cared little about what their investments were supporting - this purpose now matters more than ever. The Climate Bonds Initiative estimates that green bond issuance needs to reach around U.S.$1 trillion per year if we are to reach the goal of successfully financing a low-carbon economy. Accordingly, while green bonds will likely play a vital role in the transition towards a sustainable global economy, we have a long way to go and the legal and regulatory framework surrounding green bonds will continue to change and develop as the market continues to evolve.