Jason Kroft and Tamir Birk, Stikeman Elliott LLP
In just a few weeks, Ontario is expected to become the first government in Canada to issue “green bonds” (also known as climate bonds), a new and burgeoning type of security that raises capital to finance projects that help fight climate change or protect the environment.
The offering, expected to be up to $500 million in size, will help fund the Eglinton Crosstown LRT in Toronto and will be initially aimed at institutional investors. According to a Government of Ontario news release, “Green bonds will help Ontario finance transit and other environmentally-friendly infrastructure projects across the province, supporting job creation and strengthening the economy.” As such, Ontario green bonds will be reserved for projects that lower carbon footprints and enhance environmental conditions.
The Government of Ontario is relying on investors to buy the bonds out of a desire to curb climate change and help the environment. According to Ontario Minister of Finance Charles Sousa, there is pent-up demand among investors for green bonds and sustainable investment opportunities, which will enable his government to pay lower interest rates as compared to other types of bonds.
Green bonds also provide a diversification opportunity for investors, by providing them with exposure to renewable and green infrastructure projects. Indeed, the world market for environmentally friendly bonds is growing at a rapid pace, with approximately $40-50 billion worth of green bonds expected to be sold in 2014, up from $11 billion in 2013 and $3 billion in 2012. Some analysts predict those numbers could jump north of $100 billion in 2015.
Although green bonds were first introduced by the World Bank and other major AAA-rated financial institutions, today’s issuer mix has evolved to include an increasing number of corporate entities. In March 2014, for example, Unilever issued £250,000,000 worth of green bonds to fund a number of new factories. Other notable issuers include Canadian National Rail, Toyota and Regency Centers.
One of the biggest challenges that will continue to affect the green bond market is the lack of market standards for the asset class. There are currently no universal agreements or international standards that answer the question, “What is a green bond?” Since the money is purportedly earmarked strictly for environmental projects, investors would like to be assured that this will ultimately be the case.
The Government of Ontario, for example, considers eligible projects for green bonds to be “all projects funded by the province that have environmental benefits, exclusive of fossil fuel and nuclear energy projects, as determined by the Province of Ontario.” Yet, green means something different to each issuer, and each uses its own varying criteria in its analysis. Although there need not be one single definition, some sort of objective and systematic environmental assessment would go a long way in increasing transparency and quelling investor concerns regarding use of proceeds.
One organization that has achieved success in implementing market standards for green bonds is the International Capital Market Association (ICMA). Earlier this year, the ICMA launched itsGreen Bond Principles (GBP) initiative, a set of voluntary guidelines that provide for transparency, disclosure and integrity for green bond issuers and underwriters. The GBP are also aimed at providing investors with the information necessary to evaluate the environmental impact of proposed projects and how bond proceeds will be used.
Over 60 financial institutions have become registered observers of the GBP, including CIBC, Goldman Sachs, JP Morgan, TD, Citigroup and more. Although the GBP are voluntary, they are a good first step in helping guide the market as it continues to grow and evolve.
According to the GBP there are currently four types of green bonds, although that may increase as the market develops further. These include:
Green Use of Proceeds Bond: a standard recourse-to-the-issuer debt obligation for which the proceeds shall be moved to a sub-portfolio or otherwise tracked by the issuer and attested to by a formal internal process that will be linked to the issuer’s lending and investment operations for projects. Pending such investment, it is recommended that the issuer make known to investors the intended types of eligible investments for the balance of unallocated proceeds.
Green Use of Proceeds Revenue Bond: a non-recourse-to-the-issuer debt obligation in which the credit exposure in the bond is to the pledged cash flows of the revenue streams, fees, taxes etc., and the Use of Proceeds of the bond goes to related or unrelated Green Project(s). The proceeds shall be moved to a sub-portfolio or otherwise tracked by the issuer and attested to by a formal internal process that will be linked to the issuer’s lending and investment operations for projects. Pending such investment, it is recommended that the issuer make known to investors the intended types of eligible investments for the balance of unallocated proceeds.
Green Project Bond: a project bond for a single or multiple Green Project(s) for which the investor has direct exposure to the risk of the project(s) with or without potential recourse to the issuer.
Green Securitized Bond: a bond collateralized by one or more specific projects, including but not limited to covered bonds, ABS, and other structures. The first source of repayment is generally the cash flows of the assets. This type of bond covers, for example, asset-backed securitizations of rooftop solar PV and/or energy efficiency assets.
Ultimately, a more systematic approach to green bond offerings could go a long way in increasing their popularity, helping project developers access long-term capital for green infrastructure.
This article first appeared in Canadian Energy Law published by Stikeman Elliott LLP and is reproduced here with the kind permissions of the authors.