CAPITAL MARKETS GREEN BOND CHALLENGES CAPITAL MARKETS GREEN BOND CHALLENGES Critical challenges facing the Green bonds’ growing pains green bond market Green bonds are now in the mainstream. But the lack of contractual Green bonds are now in the mainstream. But the lack of contractual protections, as well as issues with reporting metrics and transparency, risk protections, as well as issues with reporting metrics and transparency, risk undermining the market and the broader sustainable finance project undermining the market and the broader sustainable finance project n the space of barely a decade, green bonds have gone from the periphery of the capital markets to being one of its fastest-growing n the space of barely a decade, green bonds have gone from the MINUTE segments. Green bonds are now used globally as a financing periphery of the capital markets to being one of its fastest-growing sIource for a wide range of issuers including green renewable energy MINUTE segments. Green bonds are now used globally as a financing READ sIource for a wide range of issuers including green renewable energy companies, sovereigns and supranationals, and brown corporate issuers READ In 10 years green bonds have seeking to transition some or all of their business operations. companies, sovereigns and supranationals, and brown corporate issuers 1gone from being an esoteric In 10 years green bonds have seeking to transition some or all of their business operations. Global green bond issuance in 2019 is projected to hit $200 billion 1gone from being an esoteric fringe product to being (against $167.3 billion in 2018). Green features have also expanded Global green bond issuance in 2019 is projected to hit $200 billion accepted and used in the across the asset class from vanilla corporate bonds to project bonds, fringe product to being (against $167.3 billion in 2018). Green features have also expanded mainstream of the international asset-backed bonds and covered bonds, with 2018 witnessing the first accepted and used in the across the asset class from vanilla corporate bonds to project bonds, capital markets. These green commercial paper programme. With the Paris Agreement and mainstream of the international asset-backed bonds and covered bonds, with 2018 witnessing the first instruments are critical in UN Sustainable Development Goals as the compelling double catalyst, capital markets. These green commercial paper programme. With the Paris Agreement and helping to bridge the massive and the UN stating that the world needs $90 trillion in climate instruments are critical in UN Sustainable Development Goals as the compelling double catalyst, investment gap required to investment by 2030 to achieve these, there should be no limit on the helping to bridge the massive and the UN stating that the world needs $90 trillion in climate meet the targets set out in the rise and use of green bonds. investment gap required to investment by 2030 to achieve these, there should be no limit on the 2016 Paris Agreement on However, there remain significant challenges and risks to the meet the targets set out in the rise and use of green bonds. Climate Change and the 2015 continued use and growth of the green bond market. These include 2016 Paris Agreement on However, there remain significant challenges and risks to the UN Sustainable Development inadequate green contractual protection for investors, the quality of Climate Change and the 2015 continued use and growth of the green bond market. These include Goals (see figure 1). However, reporting metrics and transparency, issuer confusion and fatigue, UN Sustainable Development inadequate green contractual protection for investors, the quality of there are several concerns greenwashing, and pricing. We describe these challenges below, and Goals (see figure 1). However, reporting metrics and transparency, issuer confusion and fatigue, which could undermine the suggest ways in which the green bond market can evolve to safeguard there are several concerns greenwashing, and pricing. We describe these challenges below, and credibility and evolution of the integrity of the asset class, make the instrument more robust from which could undermine the suggest ways in which the green bond market can evolve to safeguard green bonds as a much- an investor perspective, and enhance product transparency and credibility and evolution of the integrity of the asset class, make the instrument more robust from needed market product. These discipline for all market participants. green bonds as a much- an investor perspective, and enhance product transparency and include a surprising lack of needed market product. These discipline for all market participants. green contractual protection for include a surprising lack of investors, so-called Common terms and actionable rights green contractual protection for greenwashing, the quality of investors, so-called Common terms and actionable rights reporting metrics and There is no universally accepted legal and commercial definition of a greenwashing, the quality of transparency, issuer confusion green bond. Imitating the International Capital Market Association's reporting metrics and There is no universally accepted legal and commercial definition of a and fatigue, and a perceived (ICMA) Green Bond Principles, elements common across many transparency, issuer confusion green bond. Imitating the International Capital Market Association's lack of pricing incentives for standards include: (i) use of proceeds disclosure stating the cash raised and fatigue, and a perceived (ICMA) Green Bond Principles, elements common across many issuers. This article by Baker will finance new or existing projects that have positive environmental lack of pricing incentives for standards include: (i) use of proceeds disclosure stating the cash raised McKenzie lawyers discusses or climate benefits; (ii) ongoing reporting on the foregoing green use issuers. This article by Baker will finance new or existing projects that have positive environmental these concerns and presents of proceeds and (iii) the provision of a second opinion by an McKenzie lawyers discusses or climate benefits; (ii) ongoing reporting on the foregoing green use potential solutions. independent third party reviewer certifying the green aspects of the these concerns and presents of proceeds and (iii) the provision of a second opinion by an bond (see figure 2). potential solutions. independent third party reviewer certifying the green aspects of the bond (see figure 2). 2 2 | I F L R . C O M | O C TO B E R / N O V E M B E R 2 01 9 2 2 | I F L R . C O M | O C TO B E R / N O V E M B E R 2 01 9 CAPITAL MARKETS GREEN BOND CHALLENGES Figure 1 specifically highlight that no event of default Figure 2 Timeline of major developments or put event will be caused if the use of ICMA Green Bond Principles in the green bond market proceeds or reporting referred to elsewhere in the disclosure document are not complied • Published in 2014 and last updated in • 2007 EIB and World Bank issue first with. See figure 3 for an example of such June 2018 green / climate awareness bonds language. • Aim of the GBP was to strengthen the • 2010 The Climate Bond Initiative This provokes a dilemma. Bondholders integrity of the Green Bond market launches the Climate Bond Standard who are still being paid interest and principal • Voluntary market guidelines: not law or and Certification Scheme on time per the terms of the green bonds may regulation • 2014 ICMA publishes the ICMA Green be unable to show loss, and so may be unable • The GBP have four components: Bond Principles to have effective redress. A bondholder who is 1. Use of proceeds Typically similar to • 2015 UN Sustainable Development placed in breach of its own investment criteria “to finance and/or refinance, in whole Goals and 2030 Agenda for may be obliged to promptly sell in the or in part, eligible green projects” Sustainable Development secondary market and in so doing may incur 2. Process for project evaluation • 2016 Paris Agreement on Climate a loss. In the absence of express contractual and selection Varies based on Change – ratified by 170 countries provisions, sustaining a claim for that loss may individual nature of projects and • 2018 Green bond issuance hits $167.3 prove difficult. While clearly there are selection criteria billion reputational motivations to dissuade against 3. Management of proceeds In • 2018 EU Commission publishes action deliberate mis-selling by issuers, the fact some cases ringfenced into separate plan on financing sustainable growth remains that there is no contractual stick to accounts • 2019 Green bond issuance estimated to ensure that bonds sold as green remain green 4. Reporting Using external third-party be over $200 billion for their lifetime. This risks potential abuse, verifier, or can be self-reporting. • 2019 As part of EU action plan critical which could severely undermine the Generally reports published at least papers are published: credibility of the green bond market. An annually (e.g. on website of issuer). • guidelines on corporate climate- example of things going badly wrong for related information reporting investors is the high-profile case of the Mexico • classification system –taxonomy – Airport green bonds (see figure 4). for environmentally-sustainable Figure 3 economic activities Sample risk factor from a green • a voluntary EU green bond standard Reporting standards, metrics and bond prospectus for a bank • EU climate benchmarks and transparency issuer benchmarks' ESG disclosures Green bond reporting is built on two simple “Although the Issuer may agree at the pillars: (i) the pre-issuance use of proceeds Issue Date to allocate the net proceeds disclosure (which sits alongside and aligns of the issue of the Green Bonds However, the green bond market has with the second opinion report) used to sell towards the financing and/or developed in such a way that none of the the green bonds, and (ii) the also disclosed refinancing of Eligible Green Assets in above product-critical elements confer post-issuance ongoing reporting on the actual accordance with certain prescribed actionable rights on bondholders.