Green bond investment is key to averting dangerous climate change: California’s inaugural green bonds symposium
OPINION & ANALYSIS
By Sharon M. Szmolyan
“Climate risk is a material and systemic risk no long-term investor can afford to ignore.”
– Stephanie Maier, HSBC Global Asset Management
SANTA MONICA, CALIFORNIA – The California State Treasurer’s Office, Environmental Finance, and the Milken Institute gathered finance industry experts, government, academics and environmentalists at California’s inaugural Treasurer’s Green Bonds Symposium 2018, held at the Milken Institute.
If you Google “moral authority,” more than 6.7 million hits come up. It is an expression getting a lot of traction these days. Some believe it means having the right to weigh in on discussions around what to do about a tough issue. For others, it a measure of virtue; those living exemplary lives have moral authority.
From my perspective, an elegantly simple definition of moral authority is “the capacity to convince others of how the world should be.” This distinguishes it from “epistemic authority,” defined as the capacity to convince other of how the world is.
I refer to moral authority based on the perspective offered by Veerabhadran Ramanathan (photo at left) in his morning presentation: “Climate Change – Urgent problem requiring immediate investment in solutions.” Dr. Ram, as he’s known by friends, is Distinguished Professor of Atmospheric and Climate Sciences at the Scripps Institution of Oceanography, University of California at San Diego. He has both moral and epistemic authority. In considering the danger of climate change, the question he posed – “Would you put your children on a plane that has a less than one-in-20 chance of landing successfully?” – underscored the significance of presentations and panels to follow.
The symposium’s previous day invited 40 subject matter experts to plunge into a day-long Financial Innovations Lab, during which they attempted answering questions California State Treasurer John Chiang (photo at left) posed in the report, “Growing the U.S. Green Bond Market, Volume I: The Barriers and Challenges.” His report resulted from a ‘listening meetings’ tour in 2016 with investors and bond underwriters in Sacramento, San Francisco, New York, Boston and Los Angeles.
Chiang’s welcome focused on the positive: “Green bonds shine with the promise of becoming the ultimate financing tool with which to replace our existing fossil fuels-dependent infrastructure with greener, carbon-free alternatives. With green bonds, we stand to unleash the great power of our markets to build a bridge to a more sustainable world.”
Such a world is certainly attainable, according to the International Energy Agency (IEA). Electricity generation, including transmission and distribution, make up nearly one-third of global total greenhouse gas emissions, according to a 2012 report by the IEA. Investments in power generation efficiency, fuel switching, nuclear power development, renewables and carbon capture and storage can help reduce total emissions in this sector by 40 to 50 per cent, the agency says. Emissions from buildings (commercial and residential) make up one-fifth of the total global energy-related emissions. Investments in more energy-efficient building envelopes, heating ventilation and cooling (HVAC systems, lighting and appliances can help cut these emissions in half by 2050. Fossil fuel consumption in transportation is a major contributor to carbon emissions, accounting for nearly one-fifth of global emissions. The IEA estimates that investing in better end-use fuel and electricity efficiency in transport use can help cut emissions in the sector by nearly 30 per cent by 2050.
Green bonds can help achieve a sustainable world
The Securities and Exchange Commission (SEC) defines a bond as a debt obligation, similar to an IOU. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures, or comes due. There are many different kinds of bonds including U.S. Treasury bonds, municipal bonds, corporate bonds and foreign government bonds. And now there are green bonds.
Green bonds were launched in 2007 with AAA-rated issuance from multilateral institutions European Investment Bank (EIB) and World Bank, in line with their respective missions of alleviating poverty through support for environmentally and socially sustainable economic development. The first US$1-billion green bond, issued in March 2013, sold within an hour of issue. November 2013 saw the issue of the first corporate green bond by a Swedish property company. Since then, large corporate issuers of green bonds include SNCF, Berlin Hyp, Apple, Engie, ICBC, Crédit Agricole, Bank of America and Tesla.
Environmental Finance editor Peter Cripps notes in the “Mapping the SDGs” (the UN’s Sustainable Development Goals) issue, winter 2017, that real progress is being made in terms of integrating environmental and sustainability factors into investment decisions. He notes: “Japan’s Government Pension Fund – the world’s largest – is embarking on a mission to integrate environmental, social and governance factors across its investments. It has launched an ongoing request for proposals for an environmental index for global equities.”
The Financial Times views green bonds as the state and the financial industry establishing new classes of securities. Given economic and social systems are exposed to climate change, with governments typically the first line of defense in mitigating and responding to such challenges, green bonds are framing a series of solutions to address the vulnerability of infrastructure to current and future climate change impacts. Governments, in the face of rising risks, will be responsible for ensuring all forms of infrastructure are resilient to the projected impacts of climate change during their lifetimes.
Moody’s Investor Services, a sponsor of California’s green bonds symposium, now rates a state and community’s ability to repay money borrowed via bonds. The credit implications of physical climate change are captured in a broad set of rating factors detailed in a Moody’s November 7, 2016 report.
Moody’s is examining how prepared are states, counties and cities for climate extremes and instability. Coastal communities, where the majority of the U.S. population resides, have been put on notice: start preparing for climate change or risk losing access to cheap credit. The question requiring a substantive answer is, “What are you doing to mitigate that exposure?”
Green bonds and the danger of climate change
Climate shocks, cyclones or droughts can have significant and one-off credit implications, given their potential to disrupt economic and social activity. Superstorm Sandy caused $65 billion in damages. Hurricane Katrina caused an estimated $108 billion in damages, according to the U.S. Federal Emergency Management Agency. Moody’s Analytics estimates for Hurricanes Harvey and Irma are between $150 billion and $200 billion worth of damages. Resilience is assessed on fiscal flexibility and the capacity to adapt, as well as a country’s income levels and the presence of policies to mitigate climate change risk including natural disaster insurance.
The Paris Agreement calls for limiting global temperature rise to “well below 2 degrees C.” Because of uncertainties in emission scenarios, climate, and carbon cycle feedback, the international agreement is interpreted in terms of three climate risk categories and brings in considerations of low-probability (five per cent), high-impact (LPHI) warming in addition to the central (similar to 50-per-cent probability) value. The current risk category of dangerous warming is extended to more categories, which are defined as follows:
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more than 1.5 degrees C as dangerous;
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more than 3 degrees C as catastrophic; and
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more than 5 degrees C as unknown, implying beyond catastrophic, including existential threats (e.g. threatening humanity’s survival).
With unchecked emissions, the central warming can reach the dangerous level and the LPHI warming can become catastrophic by 2050. Let’s be very clear: an increase greater than 5 degrees C has not been experienced for at least the past 20 million years. To limit warming below dangerous levels, it will be necessary to extract as much as 1 trillion tons of CO2 (or 1,000 Gt) from the atmosphere before 2100.
In 2017, green bond issuance worldwide amounted to US$157 billion. Issuance could top US$200 billion in 2018, according to a report by the Investment Industry Association of Canada.
Between January 1, 2005 and June 30, 2017, the total amount of “climate-aligned” green bonds now totals $895 billion outstanding, according to a report by HSBC. This total is comprised of unlabelled climate-aligned bonds at $674 billion and labelled green bonds at $221 billion. A total of 3,493 bonds from 1,128 issuers across seven climate themes (transport, energy, multi-sector, water, buildings and industry, waste and pollution, agriculture and forestry) were analyzed in the report.
The milestone of $1 trillion in green finance by 2020, including a ten-fold increase in green bond issuance, has been set by global climate leaders. How quickly and severely the impact of climate change grows will depend on the speed and effectiveness of the global response and the undertaking of financing solutions that support the transition to a sustainable economy.
Types of green bonds (Source: Environmental Finance)
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Type
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Proceeds raised by
bond sale are
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Debt recourse
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Example
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Green "Use of Proceeds" Bond
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Earmarked for green projects
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Recourse to the issuer: same credit rating applies as issuer's other bonds
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EIB "Climate Awareness Bond" (backed by EIB); Barclays Green Bond
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Green "Use of Proceeds" Revenue Bond/ABS
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Earmarked for or refinances green projects
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Revenue streams from the issuers though fees, taxes, etc. are collateral for the debt
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Hawaii State (backed by fee on electricity bills of the state utilities)
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Green Project Bond
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Ring-fenced for the specific underlying green project(s)
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Recourse is only to the project's assets and balance sheet
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Invenergy Wind Farm (backed by Invenergy Campo Palomas wind farm)
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Green Securitised Bond
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Refinance portfolios of green projects or proceeds are earmarked for green projects
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Recourse is to a group of projects that have been grouped together (e.g. solar leases or green mortgages)
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Tesla Energy (backed by residential solar leases); Obvion (backed by green mortgages)
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Covered Bond
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Earmarked for eligible projects included in the covered pool
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Recourse to the issuer and, if the issuer is unable to repay the bond, to the covered pool
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Berlin Hyp green Pfandbrief; Sparebank 1 Bolligkredit green covered bond
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Other bonds
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Earmarked for eligible projects
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Recourse depends on the type of bond issued
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Convertible Bonds or Notes, Schuldschein, Commercial Paper, Sukuk
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The opportunity for growth in this new frontier in the U.S. will require purists and pragmatists to collaborate. Government will need to provide vital support similar to what governments around the world have done, including China’s, to create the regulatory framework of issuance parameters and an approval process with defined metrics, reporting and transparency requirements, to mitigate investor concerns while providing an extra level of assurance of a project’s benefits.
In Canada, a recent report, “Opportunities in the Canadian Green Bond Market,” by the Investment Industry Association of Canada cries out for a more developed domestic green bond market, in large part because it would provide an alternative financing structure for infrastructure projects, according to a column by Barry Critchley in the Financial Post. The list of Canadian green bond issuers is small, the report says. “Canadian corporations have not yet participated in the domestic market as issuers, as they have in other countries. This could change given the positive investor reception towards mandates and competitive pricing of green bonds,” the report says.
Engagement, strategic alliances needed
Engagement needs to be an essential part of the solution going forward; bond issuances may need to be in amounts a majority of the population can actually afford. Another challenge is the only 53 per cent of Americans think humans are causing global warming, according to a survey conducted in 2017 by the Yale Program on Climate Change Communication and the George Mason University Center for Climate Change Communication. Of that 53 per cent, only about 16 percent say that they’re “very worried” about it.
In his presentation to the Green Bonds Symposium, Veerabhadran Ramanathan chose forging alliances with religious communities because of their deep meaningful engagement with a very wide spectrum of people and communities. In the case of the Catholic Church, the leader of 1.2 billion people, with churches and diocese worldwide and hundreds of millions of people who visit weekly, has the kind of power no environmental group could dream of. According to Pope Francis’s 2016 encyclical, addressed to “every person living on the planet,” the impacts of climate change are about “the intimate relationship between the poor and the fragility of the planet.” This modern church is clearly not seeing a contradiction between religious conviction and rigorous, scientific research.
Ramanathan predicts climate change disaster between 10 to 15 years from today. Curbing global warming (and cleaning up our Earth) is a moral imperative. So is our proper relationship to other human beings, to future generations, to the natural world.
Ramanathan and his research are impossible to challenge. He made the discovery in the 1970s that one ton of chlorofluorocarbons has the same warming effect as 10,000 tons of carbon dioxide. Since 1999, he has published major papers on atmospheric brown clouds – toxic plumes, primarily a mixture of relatively short-lived (compared with CO2) climate pollutants, including black carbon (soot), methane, ozone and industrial gases such as hydrofluorocarbons and chlorofluorocarbons. His groundbreaking research project with drones documents these noxious clouds of pollutants travelling across the world.
Los Angeles knows these brown clouds very well, as this photo (at left) of L.A. Civic Center masked by smog on January 6, 1948 shows. During some days in the not so recent past, the air was so polluted parents kept children out of school. Vast plantings of lemon and orange trees withered in less than a week. The young and the elderly, suffering throbbing headaches and shortness of breath, filled hospital emergency rooms and doctor’s offices. Members of the Highland Park Optimists Club evidently spent at least part of their 1954 banquet in smog-gas masks. (Photos from UCLA Library Special Collections – Los Angeles Times Photographic Archive).
But thanks to citizen activism, scientific advances and landmark environmental legislation enabling the U.S. Environmental Protection Agency to regulate air pollutants, this pollution rarely cripples people in the city of angels as it did, or as it still does in cities across the globe. Hanging over large swaths of Asia are noxious cloud cocktails large enough to cover the continental United States. They’re believed to be altering critical monsoon patterns necessary for subsistence farming, and contributing to the melting of Canada’s arctic and as well as the Antarctic.
British charity Oxfam published a media briefing prior to COP 21 in Paris in 2015, which noted that the richest 10 per cent of the world’s population produce half of all climate-harming fossil fuel emissions. The poorest half of the globe contributes a mere 10 per cent.
Ramanathan, having developed cutting-edge climate models for the National Center for Atmospheric Research, was able as early as the mid-1980s to publicly predict a warming planet would become one of the greatest threats to humanity. He has taken on advising California Governor Jerry Brown, federal officials and the United Nations on the consequences of global warming.
From my perspective, the indicators of change are illuminating the world like New York’s Time Square on New Year’s Eve. It has been noted worldwide that if there is to be any justice realized from the Paris Climate Accord, governments will have to deliver something for the have-nots, wherever they live.
Encouraging signs
Global consciousness of climate change and its impacts has united an international community of activists. Investors with US$45 trillion of assets under management have made public commitments to climate and responsible investment. Environmental, social and governance (ESG) practices are playing a greater role in institutional investment strategies. Environmental Finance, in its winter 2017 issue, reported an October 2017 survey of 500 institutional decision makers in 30 countries, of which 44 per cent said they consider ESG factors to be just as important as fundamental financial factors in investment analysis. Moreover, 43 per cent say ESG factors are an important part of their organization’s manager selection process.
Worldwide, an estimated $93 trillion in infrastructure spending is needed through 2030 to support economic growth while meeting Paris Agreement emissions targets. Fifty nine per cent of institutions say there is ‘alpha’ to be found in ESG. (Alpha is used in finance as a measure of performance. It is the active return on an investment gauged against a market index or benchmark, and is considered to represent the market movement as a whole). To confirm ESG’s place in institutional money management, 60 per cent believe that incorporating these practices will be a standard practice for all managers within five years.
Sixty-six per cent of Californians say they would invest in green bonds because of their potential environmental impact. A recent analysis by the National Bureau of Economic Research concluded that for the U.S. to reach its Paris Agreement targets by 2050 carries an $8-trillion price tag. A robust green bond market is seen as essential to finance the country’s transition to a sustainable future.
As Ramanathan has pointed out, a sustainable future is achievable. Global CO2 emissions grew at a rate of 2.9 per cent per year between 2000 and 2011. They slowed to a near-zero growth rate by 2015. The United States and China are credited as the primary drivers of this trend, with their respective commitments to increase production of renewable solar and wind energy. Studies estimate that by 2015 there was enough renewable energy capacity to meet nearly 24 per cent of global electricity demand. Technologies ranging from cleaner diesel engines to methane capture exist, and are in use in much of the developed world.
So the signs are encouraging. But as an article co-authored by Ramanathan and Yangyang Xu, published last year in the Proceedings of the National Academy of Sciences of the United States, points out, aggressive policies will still be required to achieve carbon neutrality and climate stability.
Sharon M. Szmolyan, MBA is a regulator contributor to EnviroLine. She is a catalyst, founder and managing partner of the Alberta Media Investment Fund. Her focus is risk management in the entertainment and energy industries, and she divides her time between Los Angeles and Calgary.
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