This article was written by David Merry, Managing Associate
On 16 June 2016, the International Capital Markets Association (ICMA) announced the 2016 update to its Green Bond Principles. The Green Bond Principles are voluntary guidelines for companies wishing to issue Green Bonds – bonds whose proceeds will be applied towards projects with environmentally sustainable benefits. The Green Bond market is relatively young but rapidly expanding, growing from $0.4 billion of new issuances in 2008 to nearly $42 billion in 2015, with a total of $118 billion of Green Bonds currently outstanding. There is no separate legal framework under which Green Bonds are issued, and the Green Bond Principles are an effort to create a degree of standardisation in order to provide greater transparency within the market and comparability across bond issuances.
The Green Bond Principles were introduced in January 2015 and first updated in March of that year. The 2016 update represents another evolutionary advance in the Green Bond Principles, providing additional clarification and guidance without altering their essentially self-regulatory nature or the fundamentals of their four core components:
- Use of Proceeds –the proceeds from a Green Bond should be exclusively applied to finance (or re-finance) eligible Green Projects;
- Process for Project Evaluation and Selection –the issuer should outline the process it uses to determine how projects qualify as eligible Green Projects, the related eligibility criteria and the environmental sustainability objectives;
- Management of Proceeds – the net proceeds from an issue of Green Bonds should be segregated or otherwise tracked until fully invested; and
- Reporting –the issuer should report up to date on the use of proceeds at least annually until fully invested and thereafter following any new developments.
The 2016 update follows a period of consultation with the Members (currently 117 firms which are issuers, underwriters and investors in the Green Bond market) and Observers (currently 73 other interested entities, including law firms, auditors, NGOs and universities) of the ICMA Green Bond Principles and with other members of the wider Green Bond community. The changes implemented in the 2016 update include additional clarification as to the categories of eligible projects, guidance as to the recommended types of external reviews for project selection and strengthened recommendations as to ongoing reporting. In connection with the 2016 update, ICMA also published two templates to encourage standardised public disclosures about Green Bond issues: an Information Template for issuers, disclosing how a bond issue aligns with each of the four components listed above, and an External Review Form describing the external reviews undertaken in respect of an issue of Green Bonds.
In addition, the 2016 update addresses two types of bonds that do not qualify as Green Bonds within the Green Bond Principles but that fall within the wider universe of social, environmental and climate-themed bonds:
First are bonds issued by “pure play” climate themed companies, such as manufacturers of wind turbines. The proceeds of these bonds are used for general corporate purposes, rather than allocated to specific Green Projects, and accordingly they do not fit squarely within the Green Bond Principles. However, the business activities of a “pure play” bond issuer have environmental benefits and they have an obvious role in complementing the core Green Bond market. The 2016 update recognises the role of “pure play” bonds and encourages issuers to adopt the Green Bond Principles where possible, for example with respect to reporting the environmental impact of their activities. However, care should be taken to distinguish these bonds from those that follow the Green Bond Principles in full to avoid investor confusion.
In the second category are Social Bonds, whose proceeds are used for broader social or sustainability objectives (for example providing affordable basic infrastructure such as clean drinking water or sanitation). Here, ICMA and the Green Bond Principles have issued guidance defining Social Bonds and encouraging the application of the four core components and their recommendations on the use of external reviews to them. Further guidance regarding Social Bonds will follow.
Following is a brief discussion of the principal aspects of the 2016 update of the Green Bond Principles:
Definition of Green Bond
The definition of what constitutes a Green Bond remains essentially unchanged: a Green Bond is any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance in part or in full new and/or existing eligible Green Projects and which are aligned with the four core components of the Green Bond Principles.
1. Use of Proceeds
The list of eligible categories of Green Projects has expanded and a broader range of examples has been provided. As revised, the categories of eligible Green Projects within the Green Bond Principles include (but are not limited to):
- Renewable Energy (including production, transmission, appliances and products);
- Energy Efficiency(such as in new and refurbished buildings, energy storage, district heating, smart grids, appliances and products);
- Pollution Prevention and Control (including waste water treatment, greenhouse gas control, soil remediation, recycling and waste to energy, value added products from waste and remanufacturing, and associated environmental monitoring analysis);
- Sustainable Management of Living Natural Resources(including sustainable agriculture, fishery, aquaculture, forestry and climate smart farm inputs such as biological crop protection or drip-irrigation);
- Terrestrial and Aquatic Biodiversity Conservation(including the protection of coastal, marine and watershed environments);
- Clean Transportation
(such as electric, hybrid, public, rail, non-motorized, multi-modal transportation, infrastructure for clean energy vehicles and reduction of harmful emissions);
- Sustainable Water Management(including sustainable infrastructure for clean and/or drinking water, sustainable urban drainage systems and river training and other forms of flooding mitigation);
- Climate Change Adaptation(including information support systems, such as climate observation and early warning systems); and
- Eco-efficient Products, Production Technologies and Processes(such as development and introduction of environmentally friendlier, eco labelled or certified products, resource efficient packaging and distribution).
Five of the original eight categories (Renewable Energy, Energy Efficiency, Clean Transportation, Sustainable Water Management and Climate Change Adaptation) remain unchanged, although each contains a number of additional examples. The category of Sustainable Waste Management has expanded to Pollution Prevention and Control, and Sustainable Land Use has expanded to Sustainable Management of Living Natural Resources. Biodiversity Conservation has expanded to include marine biodiversity as well as terrestrial, and a new category of Eco-efficient Products, Production Technologies and Processes has been added. However, these changes are largely clarifications and don’t represent a fundamental expansion of the universe of eligible Green Projects.
The 2016 update reiterates that, in discussing the use of proceeds of a Green Bond, the issuer should not only describe and assess the environmental benefits to be derived from the funded Green Projects, but where feasible provide a quantification of those benefits (for example, in terms of tonnes of greenhouse gas emissions avoided) as well. In addition, where some of the proceeds may be used to refinance Green Projects, the respective shares of new financing and refinancing should be disclosed, as well as which investments or project portfolios may be refinanced.
The 2016 update states that the purpose of the Green Bond Principles is not to take a position on which green technologies, standards, claims and declarations are optimal for environmentally sustainable benefits. It refers market participants to examples through links on the Green Bond Principles webpage as well as to independent analyses, guidance and advice on the quality of different green solutions and environmental practices. It also states that “definitions of green and green projects may also very depending on sector and geography.” This is consistent with the general descriptive rather than prescriptive approach of the Green Bond Principles: issuers should be as transparent as possible about the projects being funded and their expected environmental benefits, and investors should decide for themselves whether they believe those projects merit funding.
2. Process for Project Evaluation and Selection
The second core component, the Process for Project Evaluation and Selection, remains largely unchanged from 2015. As before, the issuer of a Green Bond should outline:
- a process to determine how the projects to be funded fit within eligible Green Projects categories;
- the related eligibility criteria; and
- the environmental sustainability objectives.
The Green Bond Principles continue to encourage a high level of transparency and recommend the use of an external review (see below).
3. Management of Proceeds
The third core component, Management of Proceeds, is also largely unchanged. Issuers should credit the net proceeds of Green Bonds to a sub-account, move them to a sub-portfolio or otherwise track them in an appropriate manner which is attested to by a formal internal process. Again, a high level of transparency is encouraged and an external review is recommended.
The Reporting component received a number of clarifications, which is not surprising given the central role that transparency plays in the Green Bond Principles. While issuers should continue to report at least annually on the use of proceeds from a Green Bond issue, including a brief description of the projects, the amounts allocated and their expected impact, the 2016 update specifies that once all of the proceeds have been allocated to Green Projects, further reports are only required in the event of new developments. This is to minimise the reporting burden on Green Bond issuers in a situation where no further benefit would accrue to investors. The 2016 update continues to recognise that confidentiality restrictions or competitive concerns may limit the level of detail that can be given regarding individual projects, in which case information should be presented in generic terms or on an aggregated portfolio basis. This approach may also be appropriate where a large number of projects are being funded.
Particular attention is given to the use of quantitative performance measures where feasible. Examples of useful quantitative measures include energy capacity, electricity generation, greenhouse gas emissions reduced or avoided, the number of people provided with access to clean power and the reduction in number of cars required. The 2016 update clarifies that the key underlying methodology and/or assumptions used in quantifying environmental impact should be disclosed, and that issuers who can monitor achieved impacts are encouraged to include that in their ongoing reporting.
Four multilateral development banks active in the Green Bond market, the African Development Bank, the European Investment Bank, the International Finance Corporation and the World Bank, have developed a reference framework for Green Bond impact reporting. The Green Bond Principles had previously noted the absence of established standards for impact reporting and the 2016 update welcomes this initiative, which will permit greater comparability across Green Bond issues, but also encourages further initiatives to establish additional references for impact reporting.
The Green Bond Principles have always encouraged the use of independent experts to review and report on various aspects of Green Bonds, including the process for project evaluation and selection, the tracking and use of proceeds and conformity of an issuer’s Green Bonds with the Green Bond Principles. The 2016 update continues this, although with certain changes.
First, the title of the section, previously called “Assurance”, has changed to “External Review”. This change was requested by a number of reviewing entities, particularly auditors, who wished to avoid any implication that their reports constituted guarantees that certain results would be achieved, rather than an objective reporting of findings following an independent review.
In addition, the examples of the types of external review have changed somewhat. Formerly, they were Second Party Reviews and Consultation, Audits, and Third-Party Certifications. The new categories are:
- Consultant Review – advice from institutions with recognised expertise in environmental sustainability or other aspects of the issuance of a Green Bond, such as establishment of a Green Bond framework. This is the equivalent of the prior category of Second Party Reviews and Consultation. However, a statement to the effect that such reviews are private and made publicly available only at the discretion of the issuer has been deleted in favour of a general recommendation of public disclosure.
- Verification – independent verification of a Green Bond, Green Bond framework or underlying assets. In contrast to certification (the next category), verification may focus on alignment with internal standards or claims made by the issuer. This includes evaluation of the environmentally sustainable features of underlying assets. Again, this is similar to the prior category of Audits and presumably the name has changed to avoid any implication that the process is similar to that of a financial audit.
- Certification – an issuer may have its Green Bond, Green Bond framework or use of proceeds certified by a third party against an external green assessment standard.
- Rating - an issuer may have its Green Bond or Green Bond framework rated by a rating agency or research provider. The addition of this category of external review follows Moody’s publication of its methodology for Green Bond assessment in March 2016. This type of rating differs from a company’s broader Environmental, Social and Governance (ESG) rating in that it would be limited to individual Green Bonds or a company’s Green Bond framework.
The 2016 update clarifies that an external review may cover only certain aspects of a Green Bond or Green Bond framework, such as the use of proceeds, or may assess alignment with all four core principles of the Green Bond Principles. Publication of external reviews, or at least an executive summary, is recommended and an external review template has been published to encourage this. It is intended that completed review templates will be made available in the GBP Resource Centre on the Green Bond Principles webpage.
Types of Green Bonds
The four types of Green Bonds (set out in Appendix I to the Green Bond Principles) remain unchanged:
- Green Use of Proceeds Bonda standard recourse-to-the-issuer debt obligation, where the proceeds will be tracked and applied to Green Projects.
- Green Use of Proceeds Revenue Bond –a non-recourse-to-the-issuer debt obligation in which repayment of the bond is limited to the revenue streams of the funded Green Projects.
- Green Use of Proceeds Project Bond –a project bond for one or more Green Projects where the investor has direct exposure to project risk, with or without potential recourse to the issuer.
- Green Use of Proceeds Securitized Bond –a bond collateralized by one or more specific Green Projects, including covered bonds, asset-backed securities, mortgage-backed securities and other structures.
The largely self-regulatory and non-binding nature of the Green Bond Principles has caused controversy in a number of areas. For example, a hydroelectric project in Brazil funded by a Green Bond has been criticised for threatening wildlife in the zone behind the dam and displacing indigenous people. Its critics argue that as the environmental harm outweighs its benefits, the bond should not have been permitted to be labelled “green”. Others have criticised using the “green” label in the case of bonds which refinance existing projects, as no additional environmental benefits are delivered.
The Green Bond Principles take the position that decisions in these areas should not be made by a central body but are best left to investors, who can decide for themselves which projects are worth funding. On that basis, rather than attempting to arbitrate disputes about which bonds and projects are truly “green”, their efforts are best devoted to promoting transparency and a common framework in the market so that investors are able to make informed decisions. In that regard, is should be noted that the Members of the Green Bond Principles are comprised of Green Bond investors (currently 28%), issuers (23%) and underwriters (49%) and the 24 seat Executive Committee is comprised of eight members from each group. Accordingly, by involving all stakeholders in the Green Bond market, the Green Bond Principles do attempt to balance the desire to ensure that investments do in fact promote environmental benefits with the concern that over-regulation may discourage issuers from entering the Green Bond market.
In all, the 2016 update to the Green Bond Principles represents a welcome although incremental advance, providing useful clarification and guidance in a number of areas. However, additional standards and guidance will be no doubt be required as the Green Bond market develops.