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Why is the green bond market becoming so successful?
Andy Fewings and Michelle Davies of Eversheds say this source of funding will continue to grow as the renewable sector matures and the emerging markets become less risky.
Briefly, what is the background to green bond insurance and how does it work?
Green bonds are bonds which are issued to raise finance for environmentally friendly projects, such as low carbon/energy efficiency projects, onshore wind and ground mounted solar projects. Since the first bonds were created in 2008 by the World Bank and Swedish Bank, SEB, they have gained momentum and are expected to grow at an increasing rate, which is why a consortium of leading banks (including Bank of America, JP Morgan and Citigroup) have recently issued guidelines to ensure integrity is maintained in the green bond market.
An institution issues the green bond to investors and has a maturity date and a coupon which reflects the return on investment for the subscribers to that bond. Funds raised are then invested in green projects—such as those referred to above.
Why is the market of green bonds so successful at the moment?
A combination of factors:
• bonds are a much cheaper way of raising capital
• renewable technologies are maturing to a degree that they are able to attract this type of funding
• renewable energy is recognised as a viable energy source which can provide energy security and reduce energy poverty via distributed energy solutions—this is important for bonds which are raising capital to assist in less developed markets eg Africa
Green bonds are given a rating by a ratings agency and are backed by entities such as the European Investment Bank, Zurich and EDF. They are issued in sufficient quantities to be easily tradeable and procure investment from portfolio investors—which means they have a much more diverse investment pool.
They are attractive to institutional investors, such as pension and other funds, given the term and relative cash-flow certainty—which matches the long term liabilities of such investors. They also offer an opportunity for investors to consider the environmental impact of their investments.
What are the advantages and disadvantages of green bonds?
The advantages of investing in green bonds are:
• cheaper finance
• ability to raise significant sums
• underlying projects need to be strong or some other form of support eg multilateral involvement
The main additional advantage of funding projects with finance raised from green bonds is long-term money. Why this is such an important advantage requires an understanding of the availability of affordable and long term finance to renewable energy projects. While banks are still willing to finance quality projects, due to the regulatory environment in which they now operate, banks are usually also looking for syndication, shorter term debt and the ability to exit quickly in order to spread the risk of their investment. Insurance companies, as institutional investors, are also subject to increased regulation which is leading to a shift to shorter term debt.
The difficulty in accessing finance, coupled with the fact that, for example, the EU has very ambitious renewable energy and carbon reduction targets, means alternative sources of long term finance are needed to meet demand for projects.
Green bonds are used to provide such long term finance and are usually used to refinance out banks, which have provided the riskier short-term finance during the construction phase. This in turn improves liquidity at banks in order for further construction phase projects to be financed.
Is there anything those planning to get involved in green bonds should keep in mind?
Importance of strength and viability of underlying projects—the commercial rationale for the project must exist. Ability to drive the green agenda is not sufficient alone.
While green bonds can be used, for example, as equity to entice traditional project finance from a bank, the fact that the project matches green criteria in itself will not be enough to secure finance. The project must be economically viable.
What should lawyers advising in this area take note of?
Knowledge is key and an understanding of what capital is available, and on what terms, is important for clients to understand.
Lawyers need to be aware that green bonds are not usually used as the sole source of finance for projects. The ability to ‘mix and match’ with financing options is a key benefit for clients considering green bond finance.
What is the trend in this area?
This source of funding will continue to grow as the renewable sector matures and the emerging markets for which much of this finance is utilised become less risky. The amount of projects which will have been constructed in recent years due to favourable ROCS and fits that were constructed with short and mid-term finance over a long term repayment profile will all start to reach their final repayment dates over the next few years. Those projects will not be able to make the ‘bullet’ repayments required to fully repay the banks and will therefore need to source alternative finance.
As each of these projects will be mature in terms of its energy generation, relevant government subsidy and subsequent revenue, they can attract cheaper finance from longer term sources, such as funds backed by green bonds.
Interviewed by Nicola Laver.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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