Innovation lends power to the arms of green investors

Green bonds that make a difference: the IFC Cornerstone Fund

A few do, but most want, safe, liquid, investment grade bonds. Such debt issues are out of reach for many companies and banks in emerging markets — hence the low output of green bonds from EM.

Into this gap has stepped the International Finance Corp. In April it announced plans for a $2bn Green Cornerstone Bond Fund that will invest only in green bonds issued by emerging market banks. Amundi will manage it.

The plan cleverly combines several innovations. The fund is structured in three tiers, like a securitization. The IFC takes the first $125m of risk; other investors a $75m mezzanine layer. Senior investors’ money is therefore all the safer.

Concentrating on bank bonds is another neat idea. Banks know their local markets, what kind of green projects are needed and bankable. They can make small loans, much too granular for the capital markets. And the banks’ own capital will bear the risk of the projects. The Fund is actually exposed only to the senior debt of some EM banks, with which IFC has been working for years.

Moreover, the Fund will not be a passive investor. The IFC will work with banks to encourage them to issue green bonds, and help them with the extra work and cost involved.

The Fund has a real chance of unlocking a passage, through which those cautious Western investors’ money can actually get to where it is most needed.      

A new way to crack this conundrum appeared in March, from an unlikely source: synthetic securitization. Mariner Investment Group, a New York hedge fund, devised with Crédit Agricole CIB a securitization that frees up about 75% of the capital on a $3bn portfolio of the bank’s project and infrastructure loans. A Mariner fund took the first loss tranche. 

Some of the loans were green, but that was not the point. CA agreed to recycle the freed up capital to support $2bn of new green loans. Granted, it might have been going to make those loans anyway — and it could have achieved the same with a securitization not branded green. 

But this is a remarkably powerful technique. The sophisticated investors that buy first loss securitization tranches, if they have green leanings, can prioritise such deals — enabling green assets to leap to the front of a bank’s queue for securitizing, and hence gain a lower cost of capital. That saving could be passed on to the projects.

Or if a bank has reached its capacity limit for lending to, say, the wind power sector, it could securitise its loans, free up capital and make a stack of new loans. 

Since the Agricole deal, Mariner has done another with US affordable housing loans, and it is working on a securitization with a multilateral development bank. A trove of synthetic equity for the MDBs has got to be a good thing.

No longer. Activity bubbled privately in 2016, but burst into the public eye in April this year, when Unibail-Rodamco, the French property company, and Dutch electronics group Philips signed similar deals simultaneously. 

Lloyds and Rabobank, which had led the Sainsbury’s deal, are stirring this pot, along with ING, arranger of the Philips loan, ABN Amro, BBVA and BNP Paribas.

Of course, many loans are green without being called so — such as wind and solar financings. But the new crop of green loans takes from the bond market the idea of branding a deal as green.

Some of the deals ape green bonds, with a defined use of proceeds.

But the Unibail and Philips loans — since copied by Barry Callebaut and Electricité de France — introduced something unknown in the bond market. The borrower can spend the money how it likes. The deal’s greenness resides instead in pricing that varies, depending on whether the issuer hits company-wide sustainability targets. These can be defined by the company, or by an SRI rating agency such as Sustainalytics.

Relationship banks agree a baseline fair margin for the credit, then accept a reduced rate if the borrower hits targets, or a higher one if it misses them. So far, these deals are revolving credit facilities, likely to be undrawn, so the sacrifice for banks is limited to the commitment fee. Lenders invited into the deals have accepted the idea readily, arrangers say.

ING is thinking about whether the idea could work in the bond market, though there are clear difficulties. But the concept is a fertile one. Many ESG bond investors vary the yield they require to buy a given security, depending on how sustainable the issuer is. The new green loans embed that kind of investment decision into a deal fashioned and branded by the borrower.

No one knows where the idea will go — but it’s going to be interesting to find out.

So far, though investors welcome their new work, this has not changed anything much. But it matters because of the rating agencies’ enormous organisational strength and reach, and the unique position they occupy in debt markets.

In one corner of the ESG world, the green bond market, many participants are bewildered by the complexity of environmental issues and want someone to tell them what is green. A host of voices are willing to do so — but whom to trust? Many is the investment banker who has wished Moody’s and Standard & Poor’s would just come in and sort out the mess.

On green bonds, they are now trying. Moody’s was first to launch a Green Bonds Assessment, in March 2016, and it has now given 17. Taking its lead from the Green Bond Principles, Moody’s does not try to say how green a bond is, but examines the quality of governance, management and reporting around the deal.

S&P has gone further. Its Green Evaluation, launched in April 2017, has been assigned nine times. As well as transparency and governance, it assesses climate change mitigation or adaptation. 

No one pretends this is a full scientific analysis of a project. Analysts do not put on wellies and make measurements. The assessments are based on an S&P framework, and a model run by Trucost, the environmental data group it bought last year.

This model ranks all installations of a similar kind, globally, in a sector — say, car factories. The project being assessed gets slotted into a percentile on that scale, for its water, waste and carbon credentials. This score is then adjusted for the virtue or otherwise of its sector.

With their expertise in all aspects of ratings and access to huge global datasets, Moody’s and S&P are well placed to dominate the green bond evaluation market, if they choose to.

Meanwhile, they are producing much more explicit information and research about how ESG factors influence their ordinary credit ratings — an influence that will only rise, as climate change progresses.