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Can green bonds fuel the low-carbon transition?

19 April 2017
by Guest author

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Hideki Takada and Rob Youngman, OECD Environment Directorate

We know decarbonisation will require a massive shift of investment away from fossil fuel and into such areas as renewable energy, energy efficiency in buildings and industry, electric vehicles and public transport. A key challenge for policy makers is to understand how to make best use of available policy levers to help accelerate this shift towards low-carbon investment. This includes facilitating the financing of low-carbon investment, including financing through equity investment or – on the debt side – through bank loans and bonds.

Green bonds have gained considerable prominence in recent years as one way to finance the transition to a low-carbon economy. These bonds are an instrument which is used to finance green projects that deliver environmental benefits. The green bond market is still young – it got started only ten years ago – but has experienced rapid growth.  With growing market appetite for such bonds, annual issuance rose from just USD 3 billion in 2011 to USD 95 billion in 2016. Many initial green bond issuances were made by public finance institutions such as the European Investment Bank and the World Bank.

Green bonds have become increasingly popular amongst banks, corporates, and national and local governments to finance green projects. In 2016 Apple issued a USD 1.5 billion green bond backing renewable energy for data centres, energy efficiency and green materials, becoming the first technology company to issue a green bond. Other landmark issuances in 2016 included Poland’s sovereign issuance – making it the first country to issue green bonds to fund projects that address climate change.  Last year also saw the first municipal green bond issuance in Latin America (Mexico City), which raised USD 50 million to pay for energy-efficient lighting, transit upgrades and water infrastructure.  This year, in January, the French government announced the largest sovereign green bond issuance to date – EUR 7 billion – to fund the energy transition.

Why do green bonds trigger such interest?

Bond finance is a natural fit for low-carbon investments such as renewable energy infrastructure, which is characterised by high up-front capital costs and long-dated income streams. They also can offer several benefits to both bond issuers and investors. For example, by issuing green bonds, bond issuers diversify and expand their funding sources by attracting investors who would not normally purchase their bonds. “Over-subscription” of green bonds – i.e. cases where demand exceeds the amount of bonds being issued – can also provide benefits.  For example, excess demand for the French sovereign green bond issuance (EUR 23 billion versus the EUR 7 billion actually issued) allowed the government to raise several times more capital than initially targeted.  Issuers can also gain reputational benefits by highlighting their green activities. At the same time, green bonds can help investors satisfy ESG (environment, social and governance) objectives while also securing risk adjusted returns.

The new OECD report Mobilising Bond Markets for a Low-Carbon Transition, published today, takes a closer look at the importance of green bonds and policy actions to promote further growth of this market. The report also provides a unique quantitative framework for analysing potential bond market evolution and the contribution it can make to financing key low-carbon sectors: renewable energy, energy efficiency and low-emission vehicles. The analysis provides a projection of the four major markets (China, the European Union, Japan and the United States) between 2015 and 2035 under a two degree scenario identified by the International Energy Agency. The results of the analysis suggest that by 2035 green bonds have the potential to scale to USD 4.7-5.6 trillion in outstanding securities and USD 620-720 billion in annual issuance for these key three sectors in the four markets.

While these figures may seem large on an absolute basis, they are small (approximately 4%) relative to the scale of debt securities markets in general – in 2014 USD 19 trillion of bonds were issued in the four markets and USD 97 trillion of outstanding debt securities were held globally. In these deep pools of capital, there is plenty of room for the green bond market to grow.

The OECD report finds that bond markets have the potential to play a significant role in the transition to a low-carbon economy. Nevertheless, as the green bond market evolves, it faces a range of challenges and barriers. Greater transparency may be needed to avoid confusion, inefficiency and the risk of “greenwashing” where bonds are sold as “green bonds” but projects financed by those bonds do not deliver expected green benefits.  Policy makers are faced with the challenge of developing green guidelines and standards and, in particular, defining international rules without imposing overly stringent requirements that could raise issuance costs. Striking a balance between securing market confidence and reducing green transaction costs will be critical and the right set of policies will be crucial.  In addition, while the green bond market can facilitate the financing of projects, it cannot itself create a pipeline of bankable projects.  Governments will need to set ambitious policies to ensure low-carbon investment needs are met. Ultimately, credible and consistent energy and climate policy and attractiveness of low-carbon projects will be the drivers of investment.

For a closer look at the potential contribution of the green bond market to the low-carbon transition and policy options see: Mobilising Bond Markets for a Low-Carbon Transition just released today.

Join us on 28 April at 13:30 CEST to discuss Green Finance and Investment at our next free OECD Green Talks LIVE webinar.  For more information and to register: http://bit.ly/GreenTalks

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Useful links

Mobilising Bond Markets for a Low-Carbon Transition

Green Talks Live: Green finance and investment

Growth, Investment and the Low-Carbon Transition

Centre on Green Finance and Investment

Financing Climate Change Action

Green bonds: Country experiences, barriers and options

 

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