Trends: Sovereign green bond issuances to pick up pace

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 30, 2018 - August 05, 2018.
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Governments are ramping up sovereign green bond issuances to promote sustainable policy agendas and encourage private capital investment in low-carbon and climate-resilient infrastructure, says Moody’s Investors Service.

In its recent report, “Sovereign green bond market on course for critical mass, but challenges remain”, the rating agency says seven sovereign issuers have issued green bonds, worth some US$25.5 billion, chiefly for climate mitigation efforts.

Poland was the first to issue sovereign green bonds in December 2016, followed by France, Fiji, Nigeria, Belgium and Lithuania. Indonesia is the latest to follow suit with the issuance of the first sovereign green sukuk this year.

“Green bond issuance provides a strong signal of a government’s commitment to its climate and environmental policy agenda and, in particular, how it intends to raise capital to implement its Paris Agreement commitments,” says Moody’s senior vice-president Rahul Ghosh.

For example, the eligible project categories stated under the green bond programmes of

Nigeria and Lithuania are explicitly linked to their respective nationally determined contributions (NDCs) submitted under the Paris Agreement — a collective initiative to cut carbon emissions to limit the increase of global warming to less than 2°C.

Sovereign green bond issuance, together with green tax incentives and formal market guidelines, is an important tool for governments to facilitate greater private sector capital flows into green and sustainable investments, says Moody’s report. “France’s inaugural green bond came after the government implemented Article 173 of the law on energy transition and green growth, which requires investors to disclose how they factor sustainability criteria and carbon-related aspects into their investment policies.

“As a result of such measures, issuance from entities domiciled in France was the third largest globally last year, behind only the US and China.  Looking ahead, the government of Hong Kong announced a planned

HK$100 billion green bond programme in its most recent budget as part of its broader strategy to position the economy as a regional hub for green finance.”

Public financing will be critical in enhancing an economy’s climate resilience, given that governments are typically the first line of defence when dealing with the aftermath of natural catastrophes.

“We recently stated that the credit profiles of small agriculture-reliant sovereigns are most susceptible to the physical effects of climate change and highlighted Fiji as one of the most vulnerable islands across our rated sovereign universe. Other sovereigns, particularly in emerging markets, may also look to green bonds as an attractive means to finance large-scale climate adaptation and resilience investments,” says the report.

The use of proceeds from the sale of sovereign green bonds will support investor demand for the securities, says Moody’s. “By providing a high-quality benchmark, sovereigns can enhance market liquidity and encourage other prospective green bond issuers to come to market.”

Increasingly, green bond issuance attracts a broader and more diverse investor base. This can be seen in the case of Poland, where dedicated green investors accounted for 61% of the final allocation of the December 2016 issuance.

“In France, meanwhile, foreign investors made up the lion’s share of investors, at 63%. This compares with a 55% share for non-resident holders of France’s total government debt,” says the report.


Deployment of proceeds

Governments are exposed to environmental risks and opportunities, either directly in dealing with the aftermath of natural disasters or indirectly through policies and incentives for renewable energy investments.

“They also have a duty of stewardship towards citizens to safeguard against environmental hazards, such as air pollution and water shortages. Additionally, the investment gap to transition to a lower-carbon economy will require large-scale public financing in sustainable infrastructure. Indeed, global infrastructure investment needs are projected to be as high as US$90 trillion by 2030, much of which will need to be channelled to investments aligned with the UN Sustainable Development Goals,” says Moody’s.

Thus, governments tend to spend a higher proportion of proceeds on projects such as clean transport, waste management and land use, as opposed to the broader green bond market, which is predominantly used to fund energy-related projects. For example, Fiji has placed climate resilience expenditure at the core of its green bond programme, with projects including flood mitigation, drought management and disaster reconstruction.

This, in turn, allows sovereign green bond investors to diversify their exposure. “We see this as positive in terms of supporting market growth and maturity as it allows green investors to diversify their exposure away from largely renewable energy and energy efficiency projects, and provides a road map for other issuers to consider financing a broader suite of environmental projects,” says the rating agency.

Although the diverse deployment of green bond proceeds will attract investors, governments face challenges in terms of the granular impact reporting and effective proceeds management, says Moody’s. “The challenge of impact reporting on a more diverse set of project types is reflected in the wide variety of impact metrics cited in sovereign green bond frameworks, limiting the ability to compare or aggregate the environmental benefits derived from green bonds.”

The report points out that renewable energy and energy efficiency — which account for the largest share of projects financed by green bonds — have core indicators for measuring environmental impact that are widely accepted and employed. The indicators include the annual greenhouse gas emissions reduced or avoided in tonnes of CO² equivalent, annual renewable generation in megawatt or gigawatt hours (renewable energy) and annual energy savings in megawatt hours or gigajoules (energy efficiency).

However, there is less consensus on what to report for other projects. An example of this is the lack of impact reporting guidelines for land use and climate adaption, says Moody’s.

Other difficulties governments face is effectively segregating and tracking green bond proceeds. “The intricacies of central government financing, such as intergovernmental fiscal transfers, make it difficult to ensure effective segregation and tracking of green bond proceeds and raise potential double counting issues. This is particularly the case where concerns over transparency and accountability of public finances are typically more acute,” says the report.

“Nevertheless, sovereign issuers are addressing these challenges in a variety of ways, including enacting legislation to ringfence funds, on-lending proceeds to public investment companies and committing to independent audits by external parties. Ultimately, the scaling up of sovereign green finance will require sustained political support.”