Green bonds: the way of the future?


26 November 2014


As investors seek securities that are socially responsible and sustainable, the debt-capital-markets industry has reacted by developing a new type of bond that’s proceeds have to be used by the issuer on projects to promote the green agenda. Christian Doherty hears from Nicholas Pfaff, ICMA’s secretary of the Green Bond Principles, and Steve Weiner, SVP finance, tax, treasury and pensions at Unilever, on the green-bond-issuing process and the product’s underlying principles.


Companies embracing sustainability is nothing new as the past ten years have seen a wholesale shift in the ways in which businesses interact with the environment and their impact on it. From reducing energy use, using sustainable materials and mandating suppliers follow suit, the 'sustainability agenda' has become firmly embedded in the corporate landscape.

In the past, when companies sought capital to construct environmentally friendly factories or infrastructure, they used project finance or bank loans, issued traditional securities, or were supported by NGOs or government development agencies. All this changed in November 2013 when EDF, the French power group, raised $1.9 billion in the first euro-denominated green bond issued by a large corporate.

Pioneered by the World Bank in 2007, green bonds were initially marketed as a means of financing infrastructure projects in developing countries. According to the Green Bond Principles of the International Capital Market Association (ICMA), "green bonds enable capital-raising and investment for new and existing projects with environmental benefits".

The projects involved are often government sponsored (and triple-A-rated), reducing risk. On their launch, green bonds were not widely considered a product with broad commercial application, given the health of the corporate bond market, but a development-centred niche instrument.

"According to the International Capital Market Association (ICMA), “Green bonds enable capital-raising and investment for new and existing projects with environmental benefits."

Now, though, that is changing. In 2012, $3 billion of green bonds were sold. In the first six months of 2014, the amount reached $20 billion, a sum that amounts to nearly double those issued in 2013.

That figure includes bond issues from the likes of Unilever and Toyota. Indeed, earlier in 2014, the world's biggest car manufacturer announced the issue of a $1.75-billion asset-backed bond, the net proceeds of which "will be used to acquire retail instalment sale contracts and lease contracts to finance new Toyota and Lexus gas-electric hybrid or alternative fuel powertrain vehicles".

Green agenda

Other recent issues have included Swedish property group Vaskronan, which in 2013 issued a bond valued at Skr1.3 billion ($180 million) to finance a range of projects. But why choose a green bond and not a regular issue?

"We've noticed an increased demand for green investments from the capital market and we want to respond to that. Vasakronan's current energy use is already nearly 50% lower than the industry average and, since 2008, the company has had climate-neutral operations," Christer Nerlich, Vasakronan chief executive said at the time. "In addition to that, we are pursuing the very ambitious goal of obtaining environmental certification for our entire property portfolio."

Meanwhile, municipalities across the world have embraced green bonds with marked enthusiasm. The state of California recently announced a $200-million bond, following the lead of Massachusetts, which recently increased the size of its green bond from $250 million to $350 million. Local authorities in Europe have similarly embraced green bonds to fund their own sustainable projects.

But it's not just unsexy government-underwritten finance. From the buy side, the market is clearly taking green bonds seriously. For instance, in November 2013, Zurich Insurance announced the purchase of $1 billion of green bonds, with the portfolio run by asset manager BlackRock.

But, of course, issuers of green bonds have to put clear blue water between the instruments and regular issues. Differentiation is key. With the Green Bond Principles, ICMA has taken what it believes is a significant step on the way towards the wholesale acceptance of 'green finance' as a bona fide form of financing projects large and small.

"The whole reason for the Principles is to try to channel the broadening of the green-bond issuer base and to make sure that there's a proper dialogue between the issuers and the investors," says Nicholas Pfaff, secretary of the Green Bond Principles at ICMA, explaining why developing the principles is such a critical part of boosting green bonds' profile and currency.

"Investors have a key role in this since they are the ones who have the mandate to invest in green issues. Issues include, however, making real commitments that can be challenging and costly to implement. The Principles represents an intelligent compromise that also takes into account the input from the banks."

Central to the emergence and continued credibility of green bonds, Pfaff acknowledges, is the issue of reporting and assurance. How can investors be sure that the bonds they are buying are funding the right type of project, and how will issuers maintain clarity and transparency? "Transparency on the use of proceeds and reporting requirements are key parts of the green bond," Pfaff explains. "I think that there certainly are going to be best standards of reporting, and that they will become apparent to market participants."

Up to standard

Pfaff explains that, following a recent consultation, there are new recommendations focusing on how companies should approach green-bond reporting as well as looking at how third-party assurance mechanisms will work. "Because these are voluntary standards, all this is based on recommendations, but there are more and more third parties out there who are ready to provide that independent view."

Those third parties will no doubt perform a critical role in certifying green bonds as financing credible and sustainable projects. To many observers, simply saying a bond is 'green' isn't enough to establish credible difference.

This is acknowledged in the principles, which say: "The management process to be followed by the issuer for tracking the proceeds should be clearly and publicly disclosed. The environmental integrity of green-bond instruments will be enhanced if an external auditor, or other third party, verifies the internal tracking method for the flow of funds from the green-bond proceeds. Depending on issuers' and investors' expectations, outside review of the internal tracking method may or may not be necessary."

For its part, Unilever, for example, hired an external firm in order to act as an intermediary with the company's banks to help translate the rules into a list the company was comfortable aspiring to. This external firm set the guidelines that allowed Unilever management to evaluate the selected projects, and then, in a year, the external company return to judge progress.

Third-party process

Other third-party evaluators have also emerged. In Norway, a group of academics launched the Centre for International Climate and Environmental Research in Oslo (CICERO) in order to offer "second opinions" on green bonds. Simply put, CICERO offers "[a] second opinion based on documentation of rules and frameworks provided by the institutions themselves (the client) and information gathered during meetings, teleconferences and e-mail correspondence with the client."

Such has been the demand for credible evaluation of green bonds that CICER PO has recently partnered with four other academic bodies to form a syndicate of evaluators able to assess and work with companies issuing green bonds. It should be said, however, that not all issuers believe this approach is necessary. That Toyota bond mentioned previously was designated green purely on the company's say-so, without any external oversight or accreditation.

Future progress

For now, though, Pfaff is encouraged not only by the progress made on the principles, but also from the buy-in ICMA has had from the executive committee of the Principles membership. Given that the list includes investors Blackrock, Zurich and Standish Mellon; issuers including Unilever, the European Investment Bank and World Bank as well as underwriters that currently include 25 banking giants such as Citi, HSBC, JP Morgan Chase, Barclays and Bank of America Merrill Lynch.

"Pfaff is encouraged not only by the progress made on the principles, but also from the buy-in ICMA has had from the executive committee of the principles membership."

With the increasing participation of banks, investors and issuers, it seems that the growth of the green-bond market is something of a perfect storm; whether the weather conditions will remain favourable remains to be seen.


Green Bond Principles

The Green Bond Principles (GBP) is an ICMA committee with approximately 100 members and observers who are active in the green-bond market. The GBP is governed by an executive committee with 18 members representing issuers, investors and banks.

Case study: how Unilever got on board with green bonds

Steve Weiner, SVP finance, tax, treasury and pensions, explains Unilever's reasons for issuing its recent £250-million green bond:

"When we started talking to the banks about the green market, we were seeing things like wind farms being capitalised, which are good things, sure, but very specialised. So we started talking to the banks about how we can play a role.

"One of the things we were very anxious about was having the banks write down the rules to ensure that we're playing by them. So when the consortium of the banks came up with the rules around how to work green bonds, we saw it as an opportunity to lend them credibility and tap into an investor base that we hadn't tapped into previously.

"Sustainability is at the heart of Unilever's ambition to double the size of our business while reducing our environmental impact and increasing our positive social impact. So we recognised that issuing a green bond was another important front in that regard. But ensuring there was the right perception around it was key. This wasn't a case of us saying 'give me £250 million and "wink wink" I'll do the right thing'. This was, 'If you give us £250 million, we're going to invest it in these six projects that are directly linked to our sustainability ambitions'. It was all about transparency.

"We did a road show, which we don't generally do for bonds; in fact, we haven't done a bond road show in more than ten years. We went out to the investors and shared with them where the funds would be invested and what our commitments against them were.

"There is more complexity in a green bond than in a base bond, but that's because in the latter there's essentially none. But we made the judgement that it was complexity we could manage, and in any case, most of the complexity centres on things that we're measuring anyway as whenever we build a factory, we have to think about its impact on things like greenhouse gases, water, waste and so on. The only other complexity is that we track these funds separately by keeping separate bank accounts; but that's not a big deal."

Nicholas Pfaff is secretary of the Green Bond Principles and a director in market practice and regulatory policy at ICMA. He worked as an investment banker at BNP Paribas and Goldman Sachs, and was a senior banker at EBRD.
Steve Weiner is the SVP finance, tax, treasury and pensions at Unilever. He joined Unilever in 1994 and spent the first seven years with the company in Unilever’s US operations. He later became national finance director for Unilever Mexico before being appointed SVP in 2010.