Bonds
Bonds are long-term debt securities—essentially contractual promises to pay a specified amount (principal) by a specified date (maturity) with interest. Borrowers (issuers) offer bonds into the capital markets and the purchasers of these bonds act as lenders. Bonds typically are one of the more secure clean energy investment mechanisms, as bond lenders are typically in senior position vis-à-vis other investors in a project and receive payments before any other investors. When considering bonds, investors will examine the yield, credit rating, duration (tenor), and whether the bond is included within a standard index (CPI 2013). As a low risk finance instrument, bonds can provide a steady and safe rate of return for institutional investors.
Renewable energy developers can issue bonds either against individual project cash flows (i.e., from a power purchase agreement or other contractual arrangement), or bonds can be “backed” by a range of collateral types, including company balance sheets (aka a parent company guarantee) and stock. In the former case, the debt would be “non-recourse” to the corporate parent, though bondholders would have recourse to the project assets in the case of a default. In the latter, the company must come up with the money to pay penalties or other damages including principal and all unaccrued interest in the case of a default. Unsecured bonds can carry higher interest rates, but in some cases highly creditworthy borrowers—e.g., the German and Canadian governments (as of this writing)—can obtain low interest rates without posting collateral.
In addition to developers, other entities, including governments (national and subnational), development banks, and corporations may also issue bonds for the purpose of renewable energy development. Bonds can be issued to fund construction or operation (term financings); generally the interest rate will be lower for operational assets as risk exposure is greater in the construction phase.
Green bonds are a type of bond, whereby bond proceeds are used for “green” investments with positive environmental benefits (see ICMA’s Green Bond Principles web page). At the end of 2014, the total value of all green bonds was approximately $50 billion USD. Green bonds are typically issued to public or private entities by international, regional, or national development banks, as well as private companies. Bond issuers can underwrite the bond to lower risk profile and attract investment.
There are no official international standards for green bonds, so currently they may be issued by any type of entity for any purpose. Accordingly it falls to individual investors the exercise diligence to confirm that the bonds are in fact funding activities and businesses that fall within their definition of “green”. Several large banks—both commercial and development—have been active issuers of green bonds in recent years. Together, through the coordinating efforts of organizations such as the Climate Bonds Initiative (climatebonds.net), these institutions have adopted a set of principles that outline common definitions, covered areas of investment, and other standards.
For Policymakers to Encourage Development of Bond Markets
(adapted from the Climate Bonds Initiative’s Policy Areas Supporting the Growth of a Green Bond Market)
Provide Public Support for Emerging Bond Markets
In countries and jurisdictions where bond markets are just emerging, public agencies can take critical first steps to drive market development. In particular, city governments can issue municipal bonds, and “green” or clean energy development banks can issue a range of project, revenue or securitized bonds. Issuance of green bonds by public sector entities enables market development by raising awareness and educating investors on green bonds and can also provide early stage funding to mobilize private finance.
Ensure Robust Design of Governing Elements
Development of standard definitions, eligibility criteria, and monitoring and compliance procedures are critical in supporting effective green bond markets. In particular, robust verification and certification processes and institutions support the integrity of green bond markets by helping investors track and validate investments. They can also help policymakers ensure green bond markets are aligned with broader clean energy and sustainable development policies and strategies. Notably, two standards have emerged here: the Green Bond Principles and Climate Bond Standards. Both were developed in collaboration with leading experts to support monitoring, reporting and verification of green bonds as well as the establishment of a definition of “green investments”. Each of these resources is publicly available to support effective design of green bond programs.
Facilitate Aggregation or Pooling of Assets
In the case of smaller-scale renewable energy and energy efficiency projects, aggregation of assets can enable increased investment, especially from large-scale institutional investors active in the bond market. Typically this process occurs through fund managers purchasing senior/low-risk renewable energy and energy efficiency loans from banks, aggregating the loans, and then selling them as a specific type of bond on the bond market. This process, also known as securitization, can be used to transfer portions of the cash flows associated with a collection of assets (e.g., the operational phase of a renewable energy project) to the investor in alignment with their risk profile. In some cases, this allows banks to provide lending for potentially riskier or earlier phases of project development. To foster creation of effective and transparent securitization processes, it is important to establish open and robust standards. Further, the public sector can engage with aggregation facilities to ensure green securitization standards and requirements are met
Design Complementary Policies and Aechanisms
Policies such as feed-in tariffs, carbon taxes, and standardized power purchase agreements can also support development of green bond markets. Such enabling policies send strong signals to potential investors that a stable market is in place, thus improving the risk-return ratio for investment. Further, various instruments to de-risk renewable energy investments can buttress strong bond markets. Examples of risk mitigation instruments include: guarantees, credit enhancements, mezzanine debt, and insurance products. Tax incentives can also support green markets by providing tax credits or exemptions for bond investors and/or rebates for bond issuers. Governments and/or development banks may also consider developing green or clean energy investment quotas for certain state-owned funds (e.g., pension, infrastructure, sovereign wealth funds, etc.) or directly investing in green bonds. (CBI Policy Areas). Finally issuance of bonds in local currencies can significantly reduce currency risk and improve the ability of the borrower to fulfill the bond requirement.
Governments may act as credit enhancers (e.g. guarantors) on other bond issuances. In the latter case, the government can assist issuers in obtaining a lower interest rate, and therefore reducing the overall cost of project. For renewable energy projects, this could help to produce a lower cost of energy which can compete with conventional forms of generation.
Governments can also direct their affiliates—for example development banks—to issue bonds which can be used to fund projects that conform with policy goals. Germany’s KfW bank has done this, both using green bond issuances, and in supporting domestic renewable energy deployment.
For Bond Issuers (Borrowers)
A renewable energy developer considering bonds as a means of term-financing a renewable energy project or portfolio of projects should consider the following:
Ensure the Underlying Project or Projects are Sound
As is the case with any bond issuance, the underlying project must meet investor requirements, such as cash flow, debt service coverage ratios, creditworthiness of sponsors, etc. Investors will not commit capital to a project (at least, not at interest rates that make economic sense for issuers) that does not demonstrate a reasonable expectation of return.
Conform to Existing Frameworks
Several voluntary standards, governing principles, and certifications have been established for issuers of green bonds over the last several years (see reference list below). In order to successfully sell green bonds into the marketplace and source capital for sustainability projects, issuers should strongly consider conforming to these frameworks.
Data and Tracking
Assuring green bond investors that their capital will have the intended impact requires monitoring, reporting, and validation. Communicating performance indicators to investors and even opening projects to third-party evaluations and audits will generate the credibility required to attract investment. Project/Bond Size: Similar to ABS investors, buyers in the bond market will typically want to see large issuance amounts to earn a higher absolute return on their investment. Assuming that a developer would not seek debt for the entire value of the project (some equity would likely be required as “skin in the game”), a $100 million bond issuance would imply a large renewable energy project, well into the “utility-scale” size designation. Therefore, bonds are not the most efficient mechanism to fund distributed projects, unless they are issued against a portfolio (however, distributed projects—because of the contract variations between projects and other factors—can be difficult to bundle).
Transaction Costs
Also as in the case of ABS, the transaction costs associated with issuing bonds can be such that only large offerings make economic sense for issuers. Developers that intend to issue bonds against their project cash flows will have to “ring-fence” the project (essentially, legally isolate it from the corporate parent) and either register it with the national securities regulator, or will have to pay fees associated with circumventing securities regulations (in the United States, this can be done through the “safe harbor” of Rule 144A of the Securities Act of 1933). Bond issuances have transaction costs associated with legal and investment bank fees. Issuing a bond at certain scale helps ensure that the transaction costs do not negate the cost savings associated with the lower cost of debt (relative to a commercial bank).
Credit Enhancements
Building in credit enhancements into the bond structure will allow issuers to reduce the interest rate, though these structures could impose their own costs that could offset some of that value. For example, some bonds feature a “cash sweep” provision where certain distress conditions trigger a redirection of all cash earned by the project through its power purchase agreement to the bondholders at the expense of the equity. Additionally, greater amounts of equity in the project will give bondholders more comfort that their investment is backed not just by revenue from the project assets, but also by an equity stake that can be liquidated. Support policies that boost project economics can also function as credit enhancements for bonds. For example, solar projects in Ontario, Canada have access to a feed-in tariff that provides a certain level of payment for solar energy that is often at a premium to the project’s cost of energy. A project with a guarantee of a premium payment from an investment-grade rated government, is be highly valuable to bondholders, and this allows Canadian developers to obtain favorable interest rates. Similarly, Ormat, a Nevada-based geothermal developer has issued bonds backed by a portfolio of geothermal projects that received loan guarantees from the U.S. federal government. Such guarantees ensured that Ormat was able to finance the three plants with a highly advantageous cost of capital.
- MidAmerica Topaz: $1 Billion Bond Offering Completed for World’s Largest Solar Project, 28 June 2013
- MidAmerica SolarStar: Solar Star Funding, LLC Announces Completion of $1 Billion Notes Offering for Solar Star Projects, 27 June 2013
- Northland Power (Ontario): Northland Power Announces Pricing of Solar Project Bonds, 3 October 2014
- Soitec: Standard Bank Group Arranges First Renewable Energy Bond in South Africa, 8 May 2013
- Bank of America: Bank of America Issues $600 Million “Green Bond”
- KfW: Green Bonds: Measuring Impact
- World Bank: About World Bank Green Bonds
- European Investment Bank: Climate Awareness Bonds
- Hawaii: Greater Access to Clean Energy Improvements
References
Ceres. 2014. “Green Bond Principles, 2014.”
Climate Bonds Initiative. 2015. “Climate Bonds Standards.”
Climate Bonds Initiative. “Explaining Green Bonds.”
Climate Bonds Initiative. “Policy Areas.”
International Capital Markets Association. “Green Bond Principles.”
Lowder, Travis and Michael Mendelsohn. 2013. “The Potential of Securitization in Solar PV Finance.” Golden, CO: National Renewable Energy Laboratory.
UNEP Financing Initiative. 2015. Principles for Responsible Investing.
Webinars
Green Bonds and Innovative Climate Financing Mechanisms
Green Bonds: Trailblazing Issuers Accelerating the Low Carbon Economy
Additional Resources
Dominguez Ordonez, Carlos , David Uzsoki, Sangay and Thinley Dorji. 2015. “Green Bonds in Public-Private Partnerships.” Winnipeg, Canada: The International Institute for Sustainable Development.
Griffith-Jones, Stephany , Jose Antonio Ocampo, and Stephen Spratt. Undated. “Financing Renewable Energy in Developing Countries: Mechanisms and Responsibilities.”
Sean Kidney, Beate Sonerud, and Padraig Oliver. 2015. “Growing a Green Bonds Market in China.” Winnipeg, Canada: The International Institute for Sustainable Development.
The World Bank. Undated. “Green Bond Process Implementation Guidelines.”