INTRODUCTION TO GREEN BONDS AND WHY INVEST IN THEM? – PART 2

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This edition of FMDQ Spotlight focuses on the second of a two (2)-part series on an ‘Introduction to Green Bonds’. The first part, published in the June 2018 edition of FMDQ Spotlight, focused on green bond principles, use of green bond proceeds, management of green bond proceeds, benefits of green bond to issuers and investors, amongst others.

This edition concludes the 2-part series on the ‘Introduction to Green Bonds’ and will focus on parties involved in a green bond issuance, green bond taxonomy and the importance of green bonds to the Nigerian debt capital markets.

By way of a reminder, 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.

READ: INTRODUCTION TO GREEN BONDS AND WHY INVEST IN THEM? – PART 1

Parties involved in a Green Bond Issuance

Issuer: Any company, government agency or financial institution that develops, registers and sell bonds to finance green projects that generate climate or other environmental benefits. The issuer usually selects a financial institution as an underwriter to administer the issuance of the bond.

Investors: Are individuals, companies, institutional investors (e.g. hedge fund managers, insurance companies, asset managers, investment companies, investment trust companies, mutual fund managers, pension fund managers, the sovereign wealth fund managers, endowment fund managers, etc.) who buy green bonds with the expectation of a financial return.

Credit Rating Agencies and Auditors: Are institutions responsible for verifying compliance with the standards for green bonds or established credit standards.

Regulators: Financial authorities responsible for regulating capital markets; they examine the qualifications of underwriters as well as the securitisation of credit assets and bonds’ custodial arrangements; and regulate the issuance, clearing and settlement provisions. Regulators include securities commissions and other regulatory bodies, including exchanges and central banks.

Credit Guarantors and other Intermediaries: Creditor guarantors are institutions that provide credit guarantees and credit enhancement products in secondary markets, thus modifying the risk profile of the underlying bond. A wide range of financial intermediaries offers a variety of intermediation and credit enhancement services, including raising investor capital, establishing special purpose vehicles etc.

Green Bond Taxonomy

The aim of the green bond taxonomy is to provide broad guidance to prospective green bonds issuers and investors. The green bond taxonomy helps to break down green bonds projects into categories which relate to what is being financed rather than the industrial sector classification of the issuer.

The table below gives a breakdown of the classification of green bond projects:

ClassificationDescriptionExamples
Transport▪ Highly efficient vehicles that meet mandatory emission standards
▪ Improved technology for aviation fuels –e.g. bio-kerosene production (subject to feedstock standards)
▪ Fully dedicated rail lines, or related infrastructure for transportation
▪   Rail
▪  Vehicles
▪  Mass Transit
▪  Bus Rapid Transport
▪  Water-borne Transport
▪  Alternative Fuel Infrastructure
Energy▪  Development, construction and operation of generation facilities, where 100% of electricity is derived from solar energy resources
▪ Small hydro facilities that require little or no reservoirs
▪  Development, construction and operation of generating geothermal energy facilities
▪  Solar
▪  Wind
▪  Geothermal
▪  Hydropower
▪  Bioenergy
▪   Marine Renewable Energy
▪   Energy Distribution and Management
Water▪ Land management to reduce possible erosion and siltation which would include increased dam heights, enlarged floodgates, de-silting gates and expanded installation capacity to accommodate increased river flows at hydroelectric power plants▪    Built (grey) Infrastructure
▪   Green and Hybrid Infrastructure
Low-Carbon Buildings▪ The use of energy efficient technology/products for buildings that meet industry metrics▪ Residential
▪ Commercial
▪ Products for Building Carbon Efficiency
Information Technology and Communication▪ The use of conferencing software and centres directly designed to reduce private vehicle and air-travel
▪ Investing in fibre-optic cables, renewable energy-powered mobile base stations and other low carbon sources
▪   Power Management
▪   Broadband
▪   Resource Efficiency
▪  Teleconferencing
Waste Pollution and Control▪   Products/technologies  that  reduce  and capture carbon emissions
▪ Composting
▪   Recycling facilities
▪   Recycled Products and Circular Economy
▪    Circular  economy  activities  that  lead  to lower lifecycle energy and carbon usage▪   Waste to Energy
▪   Methane Management
Nature-Based Assets▪ Include forestry activities that substantially avoid or reduce carbons sequestration. Examples include afforestation and re-vegetation
▪ Agricultural activities that increase soil-based carbon sequestration, reduce carbon emissions and improve climate resilience
▪   Agricultural Land
▪   Forests  (managed and unmanaged)
▪   Wetlands
▪   Degraded Lands
▪   Other Land Uses (managed and unmanaged)
▪   Fisheries and Aqua Culture
Industry and Energy Intensive Commercial▪   Improved  industrial  processes  through cleaner  production/manufacturing  e.g.
and cement manufactured with lower clinker content
▪   Highly efficient consumer/industrial equipment
▪    Manufacturing
▪    Energy Efficiency Processes
▪    Energy Efficiency Projects
▪    Data Center
▪    Process and Fugitive Emissions
▪    Energy Efficient Appliances
▪   Combined Heat and Power

Importance of Green Bonds

Green bonds have grown rapidly in recent years and emerged as an effective investment tool to finance critical infrastructure needs such as railways, roads, airports, buildings, energy and water, and at the same time, achieve positive returns for the environment and society. Investors in the green bond markets have become increasingly interested in holding green bonds within their own portfolios. The appeal of green bonds to investors includes: making investments with an environmental impact; being at the forefront of climate finance; sending a signal to stakeholders of their commitment to responsible investment; and aligning their investing activities with their own principles.

However, the developing green market must deal with several challenges such as the clear definition of what is considered “green”, procedures on how the green bond proceeds should be used, tracked, managed and reported, and the lack of verification requirements over the information reported. Given that green bonds are long-term financing vehicles, the reputational risk to issuers extends for many years across the life of the bond and beyond. However, being an investment instrument for sustainable projects, green bonds present an opportunity for sustained and better returns in future. The introduction of the first green bond into the Nigerian DCM, by the FGN, provides an alternative means of financing capital-intensive green infrastructure projects in Nigeria and presents opportunities to fund solutions to environmental and climate challenges, invariably contributing to Nigeria’s development.