An agreement was reached at the Paris Summit – but now we need the financial markets to help deliver it

29/03/2016 / Kaj

Now that 195 nations have promised to signed up to the Paris climate agreement, the hard work begins. The signatories have all committed to ramping up their fight against climate change, but what happens next will prove crucial. The new five-year national plans to reduce global warming will provide the roadmap for action.

Continuing along the lines of today’s five-year plans is not enough. The UN has calculated that doing so would result in a temperature rise of about 2.7°C, well above the target maximum of 1.5°C to 2°C agreed upon in Paris.

Even if countries can match this ambition with results, people in many parts of the world still face a future of more frequent flooding and storms. And our societies will face new risks trying to achieve meaningful change. Companies that use fossil fuels will become increasingly threatened. And as urban populations grow (the number of people living in cities expected rise globally by 1.4 million per week until 2030), we will face new pressures accommodating them.

But while national governments will have to bear the brunt of responsibility of these challenges, we must not forget that climate change has no borders. It is an issue that is both patently global and profoundly local, as individual communities are always the first to experience the effects of climate change.

So, as the world switches its focus toward the 2°C target, we must also transform the strategies for achieving it. In Paris, there were three sets of key players that proved to have aspirations beyond those of national leaders:
1) The mayors and their cities
2) the business community, and
3) the financial sector

It is here that we must look for new forms of collaboration!

In this blog I will focus on the financial sector. Its role was explicitly referenced in the Paris Agreement in Article 2.1. c), which talks about a need to make “finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”

Major players in finance – including international institutional capital organizations have already pledged to invest (UN Climate Conference 2014).The International Energy Agency estimates in a report 2012 that the world will need $36trn or $1 trillion annually,of investment in energy supply and efficiency, to stay below the 2°C by 2050.

‘Green bonds’ is a new buzz-phrase that we will begin seeing much more frequently. Through them, governments, cities and industries can interact with the financial market to ensure they secure the necessary levels of investment. It is now, at the beginning of five-year national plans that we should be strengthening the role of green bonds and allowing financial capital to flex its muscles. We need to channel capital into sustainable infrastructure and innovation that will drive job creation.

I visited the London Stock Exchange a few weeks ago to get an overview of what is happening in the green investment market. While there, I met Sean Kidney from The Climate Bonds Initiative, a not-for-profit that aims to use debt markets to fund climate change solutions. According to Kidney, the total value of climate-aligned bonds is, currently, around $600bn. China, the US, France and the UK are responsible for most of this, with the bonds used to invest in transport, energy, waste, clean air, construction, industry, water and agriculture.

‘Green bonds’ now account for around 10 percent of all climate-aligned bonds – a development that can open new doors and lead to interesting collaborations between public, financial and industrial sectors. The Climate Bonds Initiative expects that the value of green bonds to soon hit $70bn. Reaching a total value of $100bn may not be far away.

But despite green bonds’ growing importance, there is shortage of easy-to-understand explanations of the different types available. So, even if you’re not a market expert, the following definitions can help identify the four varieties of green bond:

1. User Proceeds Green Bond
Issued by a corporation (like Toyota, for instance) or a Development Bank (like the World Bank), the proceeds of these bonds are earmarked for green projects. The purpose and impact of the projects is spelled out in the bond documentation, which explains how the money should be used. Annual reports show how the projects have developed, and provide companies with a way to communicate their sustainability work.

2. Municipality Green Bond
This is a green bond with the same structure as the “user proceeds green bonds”, but with its own rules. It allows governments and municipalities to integrate other incentives (such as those in their tax system) into the bond’s policies.

3. Renewable Infrastructure Green Bonds
These bonds are directed towards renewable energy and other infrastructure projects. With higher risks reported for direct investment in solar or wind energy projects, such bonds usually offer a larger return on investment.

4. Asset-Backed Securities Green Bond
Here we find a multitude of green projects. This is a green asset that offers cash flow to the projects being funded, as well as providing cash flow to the holder of the green bond.

In 2015, the largest issuers of green bonds were the European Investment Bank ($11.6bn) and the World Bank ($8.1bn), which issued them for the first time last year. Looking at the current level of investment, it’s possible that green bonds reach a value of $1tn annually by 2020, according to The Climate Bonds Initiative.

National governments are stepping up their support, with China, India, France, UK, Germany and the front runner Sweden, thanks to their ongoing dialogues with stakeholders in the climate market. And also to mention that a Swedish banker, Christopher Flensborg at SEB was the person who launched the first Green Bond together with the World Bank. The South Korean Government was another of the international actors that was early to see the value of strengthening exports by directing capital to key domestic development areas via green bonds.

Companies such as Apple, Toyota and Hyundai are also issuing green bonds. The latter two have been using green bond solutions to offer affordable loans to consumers for hybrid cars.

Energy services company SolarCity has recently initiated a green bond of $125 million. It offers to install solar cells at customers’ homes through a leasing system. Instead of a monthly bill of $100 paid to the energy company, SolarCity signs a 15-year lease with consumers that sees them giving $50 to the energy company and $25 to SolarCity – a saving of $25 a month for a green and economically sustainable solution.

The Nordics scaling up
Nordic countries have been particularly interested in this sector. Thus far, green bond investing has mainly been pioneered by Swedish pension funds, Kommuninvest, Nordic Investment Bank, and other banks like SEB and Nordea.

But sustainability in lending is going to be one of the region’s big issues as the Nordic countries focus on targets to be fossil-free, carbon neutral or climate neutral. Cities and institutions are using their climate change strategies to minimize risks by reducing the proportion of their pensions funds wrapped up in companies dependent on fossil fuels.

Gothenburg is the market leader and an early adopter of green bonds, with investments largely in the renewable energy sector. Elsewhere too, cities are opening up similar projects to encourage investment in green housing, ‘smart’ transport and the internet of things (IoT) that can all increase energy efficiency. The financial investment body of Swedish Local Governments, Kommuninvest, is bringing together 18 municipalities to fund green projects through a $6 million green bond.

Stockholm County Council (SCC) has just signed a $480 million syndicated loan with six banks, of which about $120 million is a dedicated green bond. The projects it funds have been laid out in the council’s green bond framework, and can be categorized as:
• Public transportation, including a target of 75% of fuel coming from biofuels.
• Buildings.
• Waste management, including recycling.
• Water management, including reducing ‘medical substances in water’.

Companies in sectors like energy utilities (Fortum Heat), real estate (Vasakronan), forestry (Sveaskog) and construction (Skanska), have been leading the market so far. The latter industry has established a certification system for climate-smart buildings, which facilitates the establishment of green bonds.

With such rapid growth in the financial green sector, we must begin developing clearer definitions and standards in sustainability, says Maximilian Horster, a director in financial markets at the climate strategy company, South Pole Group in Switzerland. Certification, indexing, regulations, labeling and ratings are necessary to secure sustainability and quality, Horster argues. South Pole Group often advises governments on how to analyze and develop platforms to connect climate friendly projects with investors.

“For the municipalities I can see the development of a financing mechanisms for local energy efficiency and renewable energy measures by making use of Green Bonds”, Horster explains. “Together with the EU Innovation platform, Climate KIC, we support cities with a Low Carbon City Lab to coordinate and facilitate these developments and fitting financing instruments.”

Kaj Embrén
@KajEmbren at Twitter

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