Corporate TreasuryFinancial Supply ChainCan green finance become an essential treasury tool?

Can green finance become an essential treasury tool?

Examining green and social impact bonds, environmental swaps and green bond principles and how can it become an essential treasury tool.

Demand for green bonds is outstripping supply, as institutional investors come under increased pressure from clients looking for investment projects that help rather than hinder the environment. The rise of green bonds coincides with increasing investor appetite to incorporate environmental, social and governance (ESG) factors in to their portfolios. With total assets linked to sustainable investment strategies now exceeding $30 trillion globally, it is unsurprising that non-equity asset classes are migrating from interesting niche to pioneering mainstay.

With the Green Finance Strategy announced for the UK and the EU launching the voluntary green bond standard, it has become pertinent to examine green and social impact bonds, environmental swaps and green bond principles under the microscope.

Green & social impact bonds and environmental swaps

Harry Merrison, Investment Manager at Kingswood, an AIM-listed (AIM: KWG) integrated wealth management group, with more than 7,000 active clients and circa £2 billion of Assets under Management and Advice, comments on green & social impact bonds and environmental swaps: “The benefits are both moral as well as monetary as investors can earn 30% income tax relief on investments up to £1m at the same time as driving positive change and diversifying their portfolio. Returns are typically derived from government sponsored activities which also provides holders a level of protection. Liquidity risk is currently a drawback for some investors, though with the number of Green Bonds ballooning, liquidity is set to ease.”

He further elaborates on green financing:

Green Project Bond

Green Project Bond proceeds are used to fund environmentally friendly projects such as clean water infrastructure, renewable energy and pollution prevention and control. Increasingly popular with responsible private investors, charities and institutions the value of annual issuances has climbed from $2.6bn in 2012 to a predicted $200bn by the end of 2019.

Green Revenue Bonds

A Green Revenue Bond finances a specific income generating municipal project, such as a toll bridge. Generally, regarded as more risky due to the single revenue stream, the investor is compensated with a higher yield paid back over a longer term time horizon.

Green Securitised Bonds

Green Securitised Bonds are collaterised by one or more sustainable assets. Securitisation is the fastest growing product in green finance and the Organisation for Economic Co-operation and Development (OECD) has estimated that the issuance of green ABSs could reach $380bn annually by 2035.

Green Bond Principles

The Green Bond Principles (GBP), issued by the International Capital Market Association (ICMA), is a set of guidelines that recommends transparency and disclosure and promotes integrity for green bond issuance. There are four core components:

  1. Use of proceeds
  2. Process for Project Evaluation and Selection
  3. Management of Proceeds
  4. Reporting

Investing in Green Bonds

Green bonds should not be considered niche – The European Investment Bank issued the first green bond in 2007. Since then the World Bank and numerous others have followed in their steps. There are numerous specialised funds managed by global powerhouses such as Blackrock, Axa and Allianz. Investors can quantify success against specialist green bond indices such as the S&P Green Bond index, a multi-currency benchmark that includes multilateral, government and corporate issuances. Though, not all success is quantifiable.

Social Impact Bonds

A Social Impact Bond (SIB) is a contract with a public sector or government authority with the objective of delivering tangibly enhanced social outcomes. Whilst ‘bond’ is in the title, this should not be confused with the conventional variety, as no income or principal will be received should objectives fail to be met. Consequently, SIBs should be considered quite a lot more risky than Green Bonds though would not be affected by reinvestment risk, market risk or interest rate risk.

The SIBs raison d’être can be mapped against the UN’s 17 Sustainable Development Goals (SDGs).

Environmental Swaps

Environmental Swaps are financial transactions whereby indebted nations can ameliorate a portion of their debt in order to promote conservation. These are sometimes referred to as debt-for-nature swaps and have been in existence since the late 1980s.

An essential treasury tool?

One of the newest and fastest growing asset classes helping to facilitate the ESG movement are green bonds, a debt instrument used by corporate treasurers to exclusively finance new or existing green projects.

However, despite the increasing size of the green bond market since its launch in 2007, corporate treasurers have been slow in adopting the asset class. One of the reasons for this could be that the market is still without an official regulatory body with the power to definitively define what constitutes as green, leaving investors worried about the prospect of inadvertently supporting greenwashing or funding unsuitable projects.

Treasurers tend to worry about putting the reputation of their business at risk when issuing a green bond, with the company likely to face increased scrutiny over how capital is deployed, as well as the environmental merits of the project(s) itself.

As more and more corporate treasurers around the world continue to see the benefits of embracing the green bond, the fledgling financial instrument is well on its way to becoming a mainstream financing tool for treasurers.

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