This year is set to be another promising one for green bonds. The Climate Bonds Initiative’s growing public profile attracted widespread publicity for its target last year that green bond issuance should reach $100bn in 2015. The total fetched up at $42bn, but the CBI is undaunted: it has made the same $100bn call for 2016.
Debt capital markets bankers quizzed by GlobalCapital for our forthcoming Review of the Year 2015 and Outlook 2016 were bullish on the product, too.
The world is now making — after the Paris COP 21 conference — a slightly more serious effort to address the grave threat of climate change. That should bring an increase in construction of green infrastructure, such as wind and solar power plants, which will need financing, and some of that will find its way into the bond market.
There may also be new, more generalised financing initiatives, as rich countries gradually increase their so-far miserly funding for the fight against climate change in the developing world.
A stepping stone
What role green bonds will play remains to be seen. The ideal environmental outcome would be that the economy itself is greened, with proper financial incentives for green development, which could make specifically labelled green bonds irrelevant.
As GlobalCapital has previously argued, environmentally minded investors need to think hard about whether green bonds really meet their objectives, or whether they would do better to invest in the general debt of environmental leaders.
But for the moment, the labelled market fostered by the Green Bond Principles provides a way to raise awareness. It lets bond issuers, banks and investors try to do their bit, however indirectly.
China has picked up the labelled green bond ball and is running with it much faster than other countries, with plans to regulate the market and subsidise it through tax and risk weightings.
This will not please economic purists — it would make much better sense to get the industrial incentives for green infrastructure right, and let the financing take care of itself.
But having investors clamouring for subsidised green investments could help, and the policy is likely to be copied elsewhere.
Merging the project and green bond memes
In the meantime, one of the most promising green bond deals of 2015 took place so close to Christmas that many market participants may have missed it.
On December 21, Jefferies announced that it had closed a €978m green project bond, to refinance WindMW, an operating windfarm off the German North Sea coast.
A consortium of Blackstone Energy Partners and Windland Energieerzeugungs had built the 288MW farm, sufficient to power 360,000 households, using €850m of bank finance.
But a year into its operating life, a bond offered better terms: more debt, an average cost of funding in euros below 3%, and a less restrictive covenant package, with more leeway for the sponsors to take money out and bondholders accepting €102m of refinancing risk at the 2027 maturity.
Project bonds are rare in Europe, where investors are puzzlingly scared of them. They do have a chequered history — the high profile €1.4bn Castor deal in July 2013 ran into trouble when the undersea gas storage project it refinanced caused earthquakes and had to be abandoned. Bondholders were repaid, but it was a reminder that these deals can carry real risk.
So the WindMW deal was unusual just as a project bond. But, what was rarer still, it fell into the Venn diagram intersection of project bonds and green bonds.
The bond was labelled a green bond, and the issuer jumped through the hoops beloved of the Green Bond Principles crowd, by getting a second opinion as to its greenness from DNV GL. One hopes this did not cost much, since a windfarm is self-evidently green.
Finding every pocket of demand
The deal’s structure suggested it was not an easy sell, despite achieving a Baa3/BBB-/BBB- rating — investment grade across the board.
It was broken into eight tranches including some done as a US private placement, a Reg S tranche, some Schuldscheine, listed and unlisted euro notes and some special, unlisted “German notes”.
Considering that the leads of the Castor deal managed to sell it as a single tranche in euros — even if the European Investment Bank bought €300m of it — this aspect of the WindMW deal did not look like a bullish sign.
European investors were unfamiliar with offshore windfarm risk, and non-recourse project bonds in general. But there were over 20 European and North American investors and the deal was oversubscribed.
The green bond labelling and second opinion had helped to bring in some investors at the margin.
A long way to go
What the WindMW deal shows is the true potential of green bonds — but also the stark gap between this and reality.
Most of the $42bn of green bonds issued in 2015 made no direct difference to the environment. The issuers were doing the underlying green projects anyway, and could just as well have financed them with normal bonds at almost exactly the same terms. Any savings of a few basis points went into the issuer’s general coffers and would make no difference anyway to the viability of the projects.
The WindMW bond has made a difference to the environment. It is the sole and presumably best achievable financing for that windfarm, replacing a bank financing that was less profitable for the equity investors — even if €115m of the bond proceeds had to be spent to unwind swaps on the bank debt.
But as any level-headed investor would tell you, the decision to invest in the WindMW bond could only be made on the basis of the project’s fundamental economic viability. The green bond labelling was essentially irrelevant — a glaring signpost to something that was already obvious.
Sadly, while self-congratulating investors will roll up in droves to buy full recourse green bonds from highly rated agencies and companies, which involve no risk and bring little benefit, however detailed their investor reports, it is still only a sparse and hardy group of project finance investors that buy a deal like WindMW.
Bonds for green projects — including in some cases non-recourse project bonds like the WindMW deal — will be vital to greening the economy. Calling them green bonds, or climate bonds, can be good branding, and branding works.
But more than the label, what matters is the fundamentals. It’s time for green bond investors to move out of their comfort zone, and into project risk.