Week 4 Flashcards
what is the main source of funding for companies?
debt - not stocks and equity
Why is equity still important to consider in terms of funding?
credit markets provide the bulk of finacing for companies but equity is important as there is the requirement for an equity cussion to allow for borrowing without issues of excess leverage and financing viability
What are the downsides of being a bond holder in terms of engagement?
limited engagement - not voting power
Why is equity better to look at in terms of transition risk?
equity markets are the primarly lens to view transition risk manifested - primarily place for negative shocks of climate change
equity is the first loss tranche on the liability side of a company - equity is a junior claim to debt
Why is debt still an interesting place to look in terms of transition risk?
debt is required to finance the funding for the energy transition - turn to debt markets first for renewable energy and sustainable energy projects
what are green bonds?
used to finance environmentally friendly projects such as renewable energy, energy efficiency, water conservation and climate change adaption
for investors they are part of the sustainably themed approaches
What are the three main labelling schemes for green bonds?
ICMA green bond principles
climate bonds standards
european green bonds proposed legsilation 2022
Who determines whether a bond is green?
not really any regulation on green bonds - apart from China where there is ban on green bonds for energy companies
mainly labelling authorities - ICMA green bond principles and some regulation
What are the ICMA green bond principles?
- use of proceeds
- the issuer must communicate the environmentally sustainability objectives of the eligible green projects
- the net proceeds should be credited to sub-accounts - process for project evaluation and selection
- management of proceeds
- reporting - the annual report should include a list of the projects to which green bonds proceeds have been allocated, a brief description of the projects the amounts allocated, and their expected impact
What is the point of a sub-account?
not used for soverign bonds
idea of the fungability of money at least formally we are saying that we are putting the money aside to break this fungibility of money issue
easier to monitor how the money gets spent - there is a record for investors to be able to verify how it is spent
What is the Luxembourg green exchange?
2007 listed the first green bond to enter the market
the European banks; climate awareness bond
entry is restricted to issuers and asset managers that provide full disclosure and fulfil their reporting obligations
What are sustainability linked bonds?
unlike green bonds they dont have use of proceeds instruments - they are can be used to finance any corporate activity
the issuer commits to reaching ambitious, science-based and measurable sustainability performance targets (SPTs) around predetermined KPIs and to having these reviewed by an external party
what happens if you dont meet the targets associated with the sustainability linked bonds>
coupon payments go up
Who has the biggest bond market and the biggest green bond issuance market?
The US has the biggest bond market
the europe has the largest issuance of green bonds - Europe are leading the way to transition to net zero
Who is the main issuers of green bonds?
soverign green bonds are gorwing
however the largest issuer is finance corporate
What is the most common use of proceeds reason?
Energy 52%
only 3% for adaption
most of ht money raised through green bonds goes to mitigation only a little bit goes to adaption
Why is there more issuance of bonds for mitigation rather than adaption?
Difficulty with financings adaption - not tied to a cash flow stream
most mitigation problems generate a cash flow stream - solar powered plants will sell electricity and generate cash flow streams - easier to finance
Are green bonds a flawed concept?
money is fungible - even if funds raised through a green bond issue go to a sustainable investment, other funds are freed that could fund brown operations
–> most funding is internally sourced therefore you are not preventing the funding of potentially brown or environmentally degrading projects
credit risk is embodied in the issuers balance sheet
the fact that a bond is green and other debt is not does not provide any special privilege or seniority per see in bankruptcy
- the green bond couldn’t lower the credit risk associated with the bond
there may be no risk mitigation involved in the issuance of green bonds
how do you work out the credit risk?
probability of bankruptcy given default
x
loss given default
why do companies issue green bonds?
signalling
- advertising that they are doing the right thing
greenwashing
- fungability of money is an issue
- greenwashing doesn’t change a companies emissions doesn’t matter if they issue a gb or not
investor clientele
- ESG funds pitch that they are ESG funds but have to prove it by buying ESG assets - easy way of saying you are an ESG fund
What did Flammer (2019) find about US Corporate Green Bonds?
sampled 217 bonds issued by public companies
issuers tend to be a larger companies, in industries with high environmental materiality
issuers tend to be leaders in ESG performance
RESULTS
- positive cumulative abnormal return announcement effect of a green bond issue
- effect is stronger for issuers in industries with high environmental materiality
emissions reduction of 21.6 tones of Co2 per $1m of assets
REDUCTION OF 27.7%
no greenwashing
How are the green bonds emerging in emerging markets?
regulation and official guidelines - china
liting requirements - south Africa
private institutions - Brazil
How is the IFC involved in green bons?
IFC provides public money and due to its investment in the fund it brings in private sector institutional investors
- reduces the risk for private investors because the public money that goes in is the junior tranche
- private money is the senior tranche
idea of blended finance
estimates a 30 trillion dollar potential market for blended finance
What are the potential benefits for investors for green bonds in emerging markets?
- long term maturities with stable and predictable returns - with given risk exposure
- provide environmental benefits
- satisfy ESG requirements for sustainable investment mandates eg. IFC Performance standards
- Enable direct investment in the greening of brown sectors and social impact activities
- provide increased transparency and accountability on the use and management of proceeds
What are the potential benefits for issuers for green bonds in emerging markets?
- provide an additional source of green financing
- match maturity with project life - in the case of green project bonds
- improve investor diversification and attract buy and hold investors
- enhance issuer reputation
- attract strong investor demand, which can lead to high oversubscription and pricing benefits
- support issuers with environmental risks management
What did Davivienda do?
third largest bank in Colombia
issued £150 million green bond, the largest green-bond issue by a private FI in latin America
uses funds to finance construction of green buildings
Why is there a difficulty in getting green bonds to smaller countries?
difficult to attract private investment if there is no structured market
IFC good here, as it provides a network and helps place a green bond where there is no bond market in the country
What is the green cornerstone bond program?
a partnership between the IFC and Amundi Asset Management
the goal is to develop expertise in green investments in EMEs and to channel global institutional investments towards these investments
EGO - Emerging Green one completed in 2018
What are the conduits for green bonds in emerging markets?
a network of accredited EME banks
a green cornerstone bond - set up by the IMF and Amundi
- on the asset side there are EME banks’ green bonds
- the liability side is divided into three tranches
> senior tranche for institutional investors
> mezzanine tranch for IFIs - international financial institutions
> junior tranche for IFC
Can you give me some information about Amundi’s Emerging Green One bond?
launched 28th feb 2018 having raised $1.4bn making it the largest fund by a factor of 4
aim = buy labelled green bonds issued in emerging market banks
initially invested in unlabelled EM bonds but switch entirely to green bonds over the funds 7yr life
once yr in it switched to 15.81% green bonds
invested in 14 green bonds
- investors get yield with impact
- a combination of top-down and bottom-up approaches
- a green standards-setting initiatives
- creation of new asset class - EM green bonds
What are some of the elements of the IFC technical assistance program?
Training
Information dissemination
enahcned issuer reporting
knowledge sharing
Can you name any other investment bank structures for green bonds?
Green Credit Continuum Program - july 2019
Asia climate bonds - sept 2019
What did ENEl do?
first introduced a sustainability-linked bond
- an early issuer of green bonds
ENEL business model is fully sustainable - no need to signal this to the market
- in 2019 ENEl issued the first sustainability-linked bond - a bond with financial incentives to meet sustainability performance targets (SPTs) within a pre-determined timeline
SDG- linked bonds marked the beginning of the sustainability linked bond markets
if you meet the target then you have a lower cost of cap, lower coupon payments
if not met then higher cost of cap and higher coupon payments - can start high and then lower if objective is met
What is a key motivation for green soverign green bonds?
signalling - support growth of a local green bond market
Where does a greenium come about?
more releavant for EME issuers eg, egypt
greenium is associated with greater climate vulnerability
What makes a soverign bond green?
the green bond promise little or nothing that would be legally enforcable
key is the use of proceeds - that it is being channeled for a particular purpose - there is no obligation for this under the soverign green bonds
What are two examples of loose green bonds?
Fiji
- to be enforcable the contract must be specific, concrete and verifiable - the project is to be determined by the issuer thus not something you can enforce
Egypt
- no market consensus on what attributes are required to be green or sustainable - therefore no assurance that investor expectation will be satisfied \
What is the issue with the soveriegn debt sustainability and the transition to net zero?
how do you overcome national debt sustainability constraints to finance climate change mitigation and adaption
there is a fiscal capacity and constraint - need to understand how easy it is for countries to borrow and meet debt obligations
What are nature-based carbon sinks?
concentrated in a few countries and some of these countries have debt sustainability issues
debt for nature swaps and carbon credit markets
but this is an issue as previous sinks such as the amazon rainforest previously were sinks and now they are sources
What did the geneva report recommend as being some solutions to this debt and natural capital issue?
- fiscal transfers to overindebted countries to directly fund mitigation and adaption –> green climate fund (GCF)
- debt relief –> debt for climate swaps
- green finance –> green bonds and carbon credits
How would a two-way pricing system work?
high price if you dont achieve the target and a low price if you achieve the target
the price is paid to the investors
What is the issue currently with existing public carbon sinks and how they are valued?
countries with the largest carbon sinks are currently not being compensated adequately for the public good they provide the world in maintaining or building these natural resources
- global demand for voluntary carbon credits reached 100bn tonnes of Co2 in 2020 and it is likely to grow 100x on the 1.5oc pathways
What are some of the problems with the current carbon credit and carbon sink markets?
currently the market is too fragmented
demand for carbon credits is too low because carbon credits are purchased mostly on a voluntary basis
carbon credit supply based on the preservation of nature-based carbon sinks should be standardised
carbon credits based on avoided emissions should also be allowed to incentivise decarbonisation
eg. closing a coal fired plant and replacing it with wind
has to be done correctly otherwise it is greenwashing
