Earlier this month, the World Bank announced the launch of US$ 550 million dollars of Green Bonds—its largest U.S. issuance to date. Are Green Bonds a way forward for climate finance, or will the World Bank’s Green Bond issuances remain a niche opportunity in the realm of adaptation finance?
The Green Climate Fund, as per the agreements of the COP 16 is to receive $100 billion dollars per year in climate financing. Since its inception, the question of where that financing will come from has hovered over the climate finance community. Even in an era less financially troubled than the present one, donors have been hard pressed to produce so much money so constantly and quickly. Since Cancun, the words ‘private sector’ have been murmured around the back halls of conferences in order to hand wave away the obvious question. But the band-aid only gives rise to another, obvious question—how can the private sector be made to invest in the high-risk low-return investments that characterizes much of the adaptation and mitigation needs of developing countries?
Though often uttered in the same breath, adaptation and mitigation have radically different profiles as investments categories. Mitigation projects include energy efficiency, renewable energy projects, and land use change projects. Adaptation projects include infrastructure projects such as the building of sea walls, water collection facilities, irrigation, strategies for deal with coastal erosion, and even the outlandish development of floating districts for inexorably inundated regions.
The point is that there is a clear path to profits from the power projects that characterize mitigation. In the case of land use there is, at least, environmental pricing work underway to create upside for investors. Whether or not this work will ever be realized is another question. But the benefits from the infrastructure projects for adaptation are not so easily monetized and therefore do not lend themselves to private sector taking risk on the transition. Which is not to say that there is not room for private sector investment. Adaptation comes at a cost, and the cost must be borne by the government. Governments lack the cash to pay for adaptation up front; therefore, there is room for a fixed income revenue stream for the private sector through debt instruments. But it is still the government that will pay. Green Bonds as a vehicle for climate finance will not satisfy those who want to see transfer payments from wealthier countries as a form of climate reparations. But they are an enabling form of financing for projects that might not otherwise be built. And without the innovation of the World Bank’s Green Bonds, even a transfer in the form of debt would be difficult.
Investors in the latest issuance of the World Bank’s Aaa/AAA rated Green Bonds include pension funds, foundations, private asset managers, and the State Treasury of California. Through the World Bank’s vehicle, these investors’ money has gone, among other things, to a community based natural resource management and development project in Tunisia. Without the World Bank’s repackaging, restrictive covenants would have prevented money from these predominately European and American investors from entering into Baa1/BB- rated Tunisia. The same is true of debt for renewable energy projects, which because of the immaturity of developers and uncertain policy, seldom are able to achieve an AAA credit rating on their own.
The World Bank is able to provide a de-risked portfolio through two means. First, its longstanding relationships with sovereigns allow preferential access both to projects and to repayment, which substantially lowers default risk. Second, the Bank covers its investments in riskier, lower-yield projects by bundling them with more secure projects such as small hydro or gas switching projects. The inclusion of these projects is necessary ballast for the final product, but it has caused some environmental groups to question their overall green credentials.
The recent $US 550 million Green Bond issuance has a yield of 0.375%. The low yield is partly a reflection of the fact that these are short term bonds, coming due within two years of the issuance, but also reflects the historic lows of U.S. Treasury yields, over which Green Bonds were pegged to have a spread of +8.3 basis points. Both of these facts, combined with question of the Bank’s method of packaging bonds, begs the question of how well this approach can scale. The historic lows of U.S. Treasuries and $US Libor make this investment attractive to US dollar investors, but when these benchmark rates inevitably rise, will the Green Bonds be able to keep up? Assuming that the World Bank can, then the question becomes—at a greater volume of projects, will the World Bank still be able to source and manage attractive offerings while staying true to the environmental principals? The jury is out.
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