Green bonds are fixed income securities issued to raise capital specifically to support climate-related or environmental projects. Ideally, bonds categorised as ‘green’ imply that proceeds raised from their issuance will be tagged for projects intended to benefit the environment. Green bonds could be issued by financial, non-financial and/or public entities.
Green bonds are similar to regular bonds in that they are coupon-paying instruments, bearing a promise by the issuer to repay interest and principal at maturity but with a particular ‘green’ purpose given to the use of the proceeds of the bond. The specific use of the funds raised — to support the financing of specific projects— distinguishes green bonds from regular bonds. This edition of FMDQ Spotlight is the first of a two-part series on green bonds, including among others, topics on green bond principles, parties involved in a green bond issuance and benefits of green bonds.
Green Bond Principles
There is no single global framework which must be followed to label a bond as ‘green’. However, the known primary global guidance comes from the International Capital Markets Association (“ICMA”) which produced the Green Bond Principles (GBP). GBP is a set of voluntary guidelines framing the issuance of green bonds in the capital market. These Principles encourage transparency, disclosure, and integrity in the development of the green bond market. The GBP set the foundation for the various elements that need to be incorporated within a Green Bond Policy Framework — a critical document developed prior to the issuance of a green bond depicting the sustainability-based qualities and the environmental value-add of a given green project and which gives credibility to a green bond.
The core elements typically covered in a Green Bond Policy Framework are as follows:
- Use of Proceeds
- Process for Project Evaluation and Selection
- Management of Proceeds
- Reporting
Use of Proceeds
The use of proceeds is a fundamental element of green bonds issuance. Proceeds realised from the issuance of green bonds must be directed towards projects that deliver clear environmental benefits.
Some areas of eligible projects include:
▪ Renewable energy and energy efficiency
▪ Pollution prevention and control
▪ Sustainable land use (including sustainable forestry and agriculture)
▪ Sustainable water management (including clean and/or drinking water)
▪ Clean transportation
Routines and systems are set up to ensure the proceeds are allocated to the intended projects.
Process for Project Evaluation and Selection
Within the Framework, the below should typically be outlined:
▪ a process to identify eligible green projects
▪ a process to determine how a selected project(s) fits within the eligible green projects categories identified in (1) above
▪ the environmental sustainability objectives of a selected project(s)
Management of Proceeds
The process for managing and tracking the proceeds of issued green bonds should be clearly and publicly disclosed.
Typically, the net proceeds from an issuance is moved to a sub-portfolio account or tracked and attested to in an appropriate manner by a formal internal process linked to the issuer’s lending and investment operations for green projects. Where the green bonds are outstanding, the balance of the tracked proceeds are periodically adjusted to match allocations to eligible green projects made during a given period. Full disclosures must exist with respect to the intended types of temporary placement for the balance of unallocated proceeds.
Reporting
Another key element of the Green Bond Policy Framework is the reporting of the funded project(s). Detailed reporting promotes credibility and transparency of the entire process. For instance, it not only provides periodic information which assures the investors but also highlights the issuers’ effort in the promotion of sustainability and related practices. On an annual basis, or as is required/agreed, periodic reports on the use of green bond proceeds and expected climate and/or environmental impacts of eligible projects must be reported.
Benefits of Green Bonds
i) Benefits to the Issuers
For issuers, the benefits of issuing green bonds include but are not limited to the following:
1) Acquisition of public acceptance by demonstrating a willingness to promote green projects: When issuers, such as companies or governments, issue green bonds, the proceeds are allocated to green projects, and in promoting these projects, the issuers are in turn being promoted.
2) Diversification of funding base: Through the issuance of green bonds, issuers have availed the opportunity to diversify their funding base by building relationships with new investors, who value investment destinations that help to solve environmental problems such as global warming.
3) The possibility of raising funds on favourable terms: Emerging renewable energy companies, for example, who wish to access long-term funding may find it difficult to obtain loans with advantageous terms. In such cases, by issuing a green project bond, these companies may be able to raise funds on relatively favourable terms from investors who are well versed in evaluating the feasibility of the renewable energy projects.
ii) Benefits to the Investors
Some of the benefits for investors investing in green bonds are as follows:
1) Return on investments and environmental benefits: Investors can gain both the environmental benefits that contribute to creating a sustainable society as well as returns on their bond investments.
2) Diversification of investment portfolio: Green bonds serve as an alternative investment asset class, allowing investors to hedge their investment risks through diversification of their portfolio.
The growing need for energy efficient and clean technologies globally, especially in emerging market countries, has generally helped to drive forward the importance of and the issuance of green bonds. These securities form a sub-set of the fixed-income market and they present issuers an opportunity to widen their investor base as they appeal to environmental, social and governance (ESG) investors. To launch the Nigerian economy into the world of opportunities inherent in the green bond market, the Nigerian Green Bond Market Development Programme was launched by FMDQ, FSD Africa and CBI in June 2018 and will run over a 3-year period with a focus on, among others, the promotion of market education about green finance and sustainable investing.
FMDQ Spotlight
