Green Bonds Series: Part 3 - how green is your 'green' bond?

Green bonds have become increasingly popular of late, with more than 1500 bonds labelled as 'green' having been issued in 2018. In this article we take a closer look at the standards which underpin green finance, and consider how green is ‘green’.

The Climate Bonds Standard

The most prominent standard used to verify the status of bonds as ‘green’ is the Climate Bonds Standard published by the Climate Bonds Initiative (CBI). The Climate Bonds Standard is continually being developed to include better-defined concepts and assessment criteria. These are based on industry consultation and practical learnings experienced by issuers, verifiers and investors in green finance.

What does the Climate Bonds Standard do?

The Climate Bonds Standard aims to establish a platform for assessing the climate-friendly attributes of projects. It does not attempt to assess the credit worthiness of the financial instrument. Nor does it attempt to assess the issuer's compliance with local or international laws or any other environmental obligations. All of these aspects must either be self-monitored by the issuer or interrogated by the investor.

Pre-issue certification

The Climate Bonds Standard has pre-issue and post-issue requirements. Pre-issue certification requirements detail the necessary steps for the bond issues to go to market with the Climate Bonds Certification Mark on the information memorandum for investors. The debt instrument will not, however, receive full Climate Bonds Certification until the financial instrument is issued, allocation of proceeds is underway and there is an assurance report from an independent verifier. Pre-issue certification is advantageous from a marketing perspective but is not a pre-requisite to post-issue certification.

The issuer must identify the areas of the Climate Bond Taxonomy that the nominated projects and assets fall within. They must also engage an independent verifier to undertake a ‘readiness assessment’. This is a fact based report on the internal processes and procedures of the issuer relating to compliance with the Climate Bonds Standard.

An issuer must also disclose whether there will be ongoing assurance reports provided by independent verifiers during the life of the financing.

Post-issue certification

The post-issue certification requirements focus on the management and use of funds raised under the debt instrument. To achieve full certification an issuer must obtain verification from an independent verifier, including an opinion to the effect that the nominated project or asset complies with the nominated criteria under the Climate Bonds Standards.

The post-issue requirements also set out the annual reporting requirements that must be met if a bond or other finance instrument is to retain its certified status. The central factor of Climate Bonds Certification is compliance with the Climate Bond Taxonomy and proof that the nominated project or asset meets the requisite ‘greenness’ thresholds.

According to the CBI's 2018 Green Bond Market Summary (January 2019), Certified Climate Bonds comprised 14% by volume of the labelled green bonds issued in 2018.

The Green Bond Principles and Green Loan Principles

Other industry bodies and organisations have also published green finance standards. Voluntary Green Bond Principles (GBP) are published by the International Capital Markets Association. The CBI’s Climate Bonds Standard incorporates the GBP, and draft Version 3.0 of the Climate Bonds Standard has been developed with a particular focus on alignment with the GBP.

The Loan Market Association, Asia Pacific Loan Market Association, and Loan Syndication and Trading Association have together published Green Loan Principles (GLP), a high level framework to provide an assessment methodology for the green loan market.

The GLP focus on the Use of Proceeds, Process for Project Evaluation, Management of Proceeds and Reporting frameworks to guide market participants. The GLP include an indicative list of categories which may be classified as green, however the list defers to the GBP for detail and is not as detailed as the CBI’s Climate Bond Taxonomy. The GLP were updated in December 2018 with reference to the GBP of June 2018.

The GLP are being further developed and tailored for loan market considerations, with the December 2018 updated GLP expressly considering the monitoring and validation processes to be undertaken by lenders (either internally or by external review) in relation to GLP application to revolving credit facilities.

How green is ‘green’?

The CBI’s Climate Bond Taxonomy – a closer look

The Climate Bond Taxonomy and Sector-Specific Criteria have been developed by the CBI to assess the effective ‘greenness’ of a particular project or asset.

The CBI has certification criteria for:

• energy generation – including solar, wind and geothermal projects;
• energy efficient transport – including bus, rail, vehicle and mass transit transport; and
• low carbon building investment including – residential assets, commercial assets and retrofit projects.

The Taxonomy also sets out criteria for selected water infrastructure. There are a number of industries for which certification criteria are under development, but which are likely to be incorporated into the Taxonomy. These industries include:

• hydropower, bioenergy, wave and tidal energy, recycling and disposal in respect of waste and pollution control;
• the use of nature-based assets such as lands, forestry and coastal infrastructure; and
• green and hybrid water infrastructure.

The CBI has recognised the potential growth of a number of other areas. It is due to begin developing criteria for information technology and communications (including power management, broadband and teleconferencing), as well as industry and energy intensive commercial processes (including manufacturing, retail and wholesale, data centres, energy efficient appliances and combined heat and power).

The Taxonomy acknowledges that there are other assets which need further clarification and specification before they could be considered as ‘green’ or not. In particular, the use of bio-fuels across a number of industries is flagged as needing more work to address issues such as the appropriateness of the land use, the carbon footprint and the efficiency of using agricultural waste to power heavy goods vehicles.

The CBI is still developing specific criteria for these types of bio-fuel and other carbon capture projects (and has published draft Bio-Energy Criteria for industry comment), as well as for a number of other industries. The Taxonomy does not cover, and the Climate Bonds Initiative expressly excludes, fossil fuel projects and related assets from eligibility.

What's ‘green’ isn’t always black and white.

Take, for example, a bond issued to finance a freight rail transport project. The project falls within the Taxonomy as being eligible for green certification. The Sector Criteria applicable for freight rail transport state that all infrastructure, infrastructure upgrades and rolling stock for electrified freight rail lines pass the criterion as long as the primary purpose is not to transport ‘fossil fuel’.

This might seem like a satisfactory approach, but if you consider some of the inputs to a project such as dedicated freight rail it is less clear.

An electrified freight rail line is ‘green’ in theory, for example if the line is solar powered. However, if the electricity required to power the line is being generated by a coal-fired power station using high emissions coal burning processes then how ‘green’ is the project?

In an attempt to combat these issues criterion 7 of the Low Carbon Land Transport criteria states that a dedicated freight project only qualifies if an independent project appraisal demonstrates that the investment will reduce total transport-related emissions in the relevant corridor by at least 25%. While this qualification doesn’t necessarily solve the problem, it creates an additional safety net.

The CBI’s establishment of benchmarks with identifiable criteria for what classifies as ‘green’ does provide parameters. However, the practicalities associated with assessing the various projects and assets to which funds will be applied can make it difficult to ascertain the true 'greenness' of a bond.

Despite the difficulties associated with classifying projects or assets as green, it is encouraging that the market is actively engaging to create greater certainty and rigour around green projects and assets to prevent greenwashing.