A green bond is a type of debt instrument (loan) that is raised to finance a climate-related or environmental project. In essence, green bonds are like regular bonds but raised only for green purposes. Therefore, an investor buying a green bond assesses the specific environmental project it seeks to finance, in addition to the standard metrics (such as coupon rate, credit risk, and tenor) of a bond.
Green bonds have grown in popularity in recent years. Just $37 billion was issued globally in 2014; by 2018, total issues had risen to $150 billion, with the U.S., France and China accounting for 56% of this.
In examining some of the reasons why green bonds are thriving, let’s consider the $400 million green bond launched by the World Bank in 2008. First, the bond was issued in response to urgent demand from Scandinavian pension funds seeking to support climate-focused projects through a simple product. At the same time, the World Bank was looking for how to incorporate innovative climate financing into its strategy. The bond unveiled another way countries could act on climate change, and later issuances have driven acceptance of green bonds as a legitimate asset class and solution to climate change financing. For instance, the International Finance Corporation (IFC) has so far raised nearly $4 billion in nine currencies across 36 different green bond issues.
And green bonds are not only issued by multilateral banks, development agencies or state-owned entities. Toyota Financial Services issued an asset-backed $1.75 billion green bond in 2014 to fund consumer loans and leases for its electric, hybrid, and low-emission vehicles.
The Green Bond Play
To properly guide issuances of green bonds, a group of banks put out the Green Bond Principles (GBP) in 2014—a set of voluntary guidelines framing the issuance of green bonds.
The GBP recognise several broad categories of eligible projects which include renewable energy, energy efficiency, sustainable waste management, sustainable land use, clean transportation, and climate change adaptation.
In 2017, the Nigerian government began its $55 million green bond programme, issuing a five-year $29 million green bond (13.48% interest p.a.) influenced by our commitment to the Paris Agreement.
The bond proceeds will go to three projects; the Energising Education Project under the Rural Electrification Agency; Rural Electrification Municipal Project; Afforestation Project registered under the Federal Ministry of Environment.
The Environment Ministry also issued Green Bond Guidelines (GBG) to guide future domestic issuances, focusing on the use of proceeds, project eligibility, management of proceeds and reporting.
The Potential for Greenwashing
One issue that has dogged action on climate change is financing, and green bonds offer a tangible solution. Thus, green bonds have received accolades for their influence and innovation.
However, the link between green bond issuance and environmental impact is not clear-cut.
For example, France raised €7.5 billion in green bonds in 2017 to finance projects related to the Paris agreement. But many of the projects could have been financed through regular treasury debt, and it is unclear what difference the “green” tag had—apart from allowing France to boast of the largest sovereign green bond issue.
Generally, there has been a disconnect between the excitement over green bond issues and the impact of completed projects.
The main issue is what has been called greenwashing where green bonds have been raised for projects that are at best “grey areas” on the green scale. A green bond prospectus is often mainly filled with generalities sufficient to comply with the relevant guidelines, and like Nigeria’s, may just state the general types of projects or activities to be undertaken without specifying details.
As such, it is difficult to verify the green credentials of the project, and this often has to be done by a third-party. For example, Nigeria hired DNV GL to do so. Finally, there is the monitoring problem, i.e. figuring out if the procedures and promises set out in the framework or prospectus were followed.
From an investor’s perspective, the primary concern with green bonds is their unfamiliarity and illiquidity. For example, an investor that purchased some of Nigeria’s green bonds would be very lucky to find any willing buyer should she wish to offload the bond.
The Future of Green Bonds
The Climate Bonds Initiative’s official estimate is for $250-300 billion of new green bonds. Given the strong market interest, the green bond movement is inspiring a race on the African continent.
On July 2017, the City of Cape Town raised $76 million for a green bond which got a subscription of $304 million within just two hours. This is the same city that nearly ran out of water.
Kenya is now positioning to do the same, according to Geoffrey Mwau, Director-General of the Kenyan Treasury, who explained that the country is setting up a framework to issue a green bond for the 2018/19 fiscal year.
The excitement about the potential of green bonds is infectious. Earlier this year, FMDQ partnered with the Climate Bonds Initiative and Financial Sector Deepening Africa on a 3-year green bond market development program. The aim, presumably, would be to boost the number and size of green bond issuances. But the emphasis on the quantity of green bonds causes us to overlook the quality of these green bonds. The green finance community must move beyond financing activities with a “green” label on the cover and begin to demand accountability in green projects around the world.