What’s in a municipal green bond?

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As the acceleration of green investing continues, questions, comments and misconceptions abound. As independent external reviewers for green, social, and sustainability bonds, we at Kestrel Verifiers aim to clarify these questions from various market participants.

What is a Green Bond?
“Green Bonds” is emerging as a common term to describe this entire sector, but there are actually several labels that fall under the “Green” umbrella — Green, Climate, Social, Sustainability and Blue Bonds. Each label is based on the use of proceeds for the specific project being financed with the bond.

We continue to hear the terms ESG, Impact, Sustainability and Green Bonds being used interchangeably and lumped together incorrectly.

“ESG” stands for Environmental, Social, and Governance. These terms relate to the values and practices of the issuer or company. Several providers have developed ESG scoring/rating services to quantify how well an organization is managing each of these elements. Assessing ESG is quite different than the (Green, Climate, Social, Sustainability and Blue Bonds) labels on individual bond issues.

“Impact” is a broad term used in this context to describe any positive benefit any asset may have. For example, a money manager may launch an “Impact or ESG Fund,” which may contain green bonds or other assets believed to have positive impact per the metrics established by the specific fund.

Who is driving demand for green labels?
From issuers to bankers, financial advisors, underwriters, fund managers, all the way to retail investors, each stakeholder in the life cycle of a deal may have an interest in identifying financial activities that are aligned with sustainable values.

ISSUERS
Common motivations to issue green bonds are: to improve investor/constituent engagement, diversify an investor base, potentially lower cost of funds and enhance reputation. Municipalities large and small are pioneering efforts to implement sustainability and environmental initiatives, from grassroots community efforts, to comprehensive climate action plans. Labeled green bonds present an opportunity to showcase these efforts to investors and drive stakeholder engagement.

FINANCIAL ADVISORS, BANKERS, UNDERWRITERS
By offering their clients innovative and impactful funding options, FAs, bankers and underwriters can help issuers advance sustainability initiatives, attract new investors and enhance their reputation as sustainability leaders. Increasingly these market participants are encouraging issuers to use best practices for labeled green bonds, such as using independent external reviews and reporting on impacts.

INVESTORS
Green bonds are attracting non-traditional muni buyers, foreign investors, impact investors and younger, more socially conscious buyers.

We are entering an era of what’s being called the largest transfer of wealth in human history. A CNBC article noted that it is estimated that 45 million of U.S. households will transfer $68 trillion of wealth over the next 25 years and a Financial Times report said younger investors’ "values are distinctively focused on making the world a better place, using financial capital for social return, having an impact and supporting sustainable development.”

Isn’t there a lack of standardization?
To clarify, there are indeed internationally established standards for green bonds. Some of the confusion about standards may stem from the fact that deals aren’t uniformly adhering to these established standards. Many issuers are utilizing independent external reviewers for green bonds and adhering to the established standards, others are labeling green transactions themselves often to standards defined at the local level.

THE STANDARDS
The International Capital Markets Association (ICMA) is the authority that oversees the labels Green, Social and Sustainability Bonds and has established the following frameworks for each:
- Green Bond Principles
- Social Bond Principles
- Sustainability Bond Guidelines

The ICMA has established that each label must align with four established pillars:
1. Use of Proceeds
2. Process for Project Evaluation and Selection
3. Management of Proceeds
4. Reporting

The Climate Bonds Initiative (CBI) developed The Climate Bonds Standard, which aims to provide a robust approach to verifying that funds and projects and assets being financed will contribute to a low carbon and climate resilient economy. Activities financed with Certified Climate Bonds are verified to be consistent with the 2 degrees Celsius warming limit set forth in the Paris Agreement. The CBI Standard fully incorporates the ICMA “Green Bond Principles” and requires a report prepared by an Approved Verifier, therefore issuers may not self-label Certified Climate Bonds. If the CBI Standards Board determines that all requirements are met, then bonds can be labeled and marketed as “Certified Climate Bonds.”

THE USE OF STANDARDS
The ICMA recommends an independent external review as a best practice for green bonds and we are seeing that increasingly issuers and investors alike are asking for second party opinions on the green credentials of the deal. Using an external reviewer for a green bond is analogous to having an auditor review an annual financial statement. That said, in the U.S. municipal market, issuers can still label Green, Social and Sustainable Bonds themselves.

The European Commission recently proposed several recommendations for EU Green Bond Standards, including the requirement that issuers use accredited verifiers. We feel this is a step in the right direction and hope the U.S. muni market will follow suit to bring uniformity, transparency and greater credibility into the green bond market here.

Can a deal lose its green designation?
The answer for muni bonds is “no.” For example, if an issuer funded a new green building and the building uses more energy than predicted, or a new recycled water facility or solar panels have less output than planned, as long as the funds are being used for their intended purpose, the green designation still holds.

Will adding a green label cause issuers to do more reporting?
No additional reporting is required, although the ICMA recommends voluntary impact reporting as a best practice for green bond issuers. Leading agencies, like the D.C. Water and Sewer Authority for example, produce an annual Green Bonds Report, which describes both the finances and the impacts of green bond funded activities. Other issuers provide updates in the form of voluntary disclosures. These can be simple reports, often containing basic financial and impact information.

For Certified Climate Bonds, the Climate Bonds Initiative requires the Approved Verifier to report on the project within 24 months of the bond issuance. Beyond that, CBI does not require any additional reporting for US municipal bonds beyond the normal continuing disclosures posted on EMMA.

Do green bonds outperform ‘regular’ bonds?
We at Kestrel have been working closely with various data providers to better capture green bond data at issuance and throughout the lifecycle of the bond. Once the data becomes available, we expect to see more evidence on pricing differential between green bonds versus non-green bonds, and green bonds with an external review versus self-labeled green bonds. In the meantime, we are hearing anecdotal evidence of more orders received for Green Bonds, as well as bonds selling faster into accounts post-issuance.

Monica Reid is CEO of Kestrel Consulting & Verifiers and Dana Villanova is head of business development.

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