Catalyzing the global green bond market

Investing in green bonds can push the kind of environmental and financial logic underpinning the retrofit of the Empire State Building.

The energy efficiency retrofit of New York’s Empire State Building is an oft-repeated story. And for good reason. The building owner’s $20 million investment will reduce the skyscraper’s energy use by more than a third, saving $4.4 million a year. That’s a 4.5-year payback – an impressive return by nearly every investment measure. What’s infuriating is that this gem of an example isn’t being replicated in commercial and residential buildings around the world, which account for 40 percent of our energy consumption. The reason why is a dearth of financing vehicles to bankroll green activities, from energy efficiency to low-carbon-technologies to water-saving infrastructure and forest preservation. “The Empire State Building project was self-financed, but not every building owner has millions to put into a building retrofit,” said Alisa Valderrama, financial policy analyst at the Natural Resources Defense Council, in outlining the challenge. “There’s a $1.3 trillion market in energy efficiency retrofits, but there’s very little action on the ground.” The absence of green fixed-income investment opportunities – green bonds, specifically – is especially glaring. Last year, the total amount of green bonds issued globally was only about $3.5 billion, nearly all of them originated by international financial institutions such as the World Bank.
“It’s very small, nascent,” said Shilpa Patel, head of strategy and metrics at the International Finance Corporation, speaking at a recent Green Bond Summit hosted by Boston-based State Street Global Advisors. There’s certainly a need. Green bonds could provide as much as 1.4 trillion euros ($2 trillion U.S.) of the capital needed to meet Europe’s carbon-reduction goals by 2020, according to a new Barclays/Accenture report. Globally, the investment opportunities from low-carbon technologies will be as high as $5 trillion by 2030, a new Mercer report estimates.Water-related infrastructure, a vastly undercapitalized arena in the U.S. and globally, is also rich with opportunity, whether for financing advanced water treatment plants for water reuse, buying land along watersheds or building groundwater recharge systems to protect over-extended global water supplies. Smart grid infrastructure, mass transit and other sustainability solutions also offer promising prospects for fixed-income investment. So why isn’t the green bond market taking off, even as early adopters in this space, like Nikko Asset Management, are seeing promising double-digit returns? The first problem is liquidity. The small number of investors in this space means there are minimal options for buying and selling these bonds. A robust secondary market that has numerous pension funds and other institutional investors active in this arena is a must for these bonds to achieve scale. The second problem is standards. The new green building market is thriving because there is a market-recognized standard, LEED, for rating new buildings on their green qualities. Its 100-point scoring system and third-party certification process gives real estate investors confidence that they can properly value a green building, thus making their projects marketable to other investors. Green bonds lack such standards. While some bond issuers consider new, more-efficient coal plants in Eastern Europe to be green-bond worthy, others use stricter standards, such as wind and solar installations and high-performance energy efficiency projects. Until there is a broad consensus on standards and verification systems for measuring performance, the green bond market will be limited. The third problem is policies. Forward-thinking government policies that catalyze a bigger pipeline of investable projects are desperately needed. Incentivizing energy efficiency, smart grids and mass transit are no brainers, but it is equally important to find ways to make rainforest

carbon credits and and other ecosystem protection measures investable products. Making these latter categories investable means knocking down outmoded, traditional definitions of ‘investment.’ “How do we construct cash flows that will enable you to save forests,” asked Sean Kidney, chair and co-founder of the London-based Climate Bonds Initiative. The investment community has an obvious role as well. To beat their competitors in this emerging market, finance firms should be boosting their expertise and taking friendlier view on longer-term paybacks and other long-term benefits from investing in this space. Developing new product lines should be a high priority as well. State Street’s recent summit that attracted more than 100 participants from international development banks, bond issuers and other financial firms is an encouraging sign.So, too, is the bullishness of Swedish banker Christopher Flensborg, who has helped issue more than $2 billion of green bonds for the World Bank, some of which is now being held by institutional investors such as CalSTRS and the New York State Retirement Fund. “I’m very confident,” said Flensborg, who is traveling the globe drumming up support from prospective clients. “By showing that this is possible and by investors going out and showing they can do things like this, I think we can motivate other people.” Let’s hope these efforts lead to far bigger breakthroughs – and soon.
Mindy Lubber is president of Ceres, a leading coalition of investors and environmental groups. Lubber also directs the Investor Network on Climate Risk.