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China: The birth of the green bond

2017/09/23

Corporate finance is evolving. Top management teams and senior company executives are under growing pressure to adopt management practices and investment choices that are both socially responsible and financially rewarding. These objectives can sometimes be at odds with each other.

The pressure for firms to be socially responsible is growing at a rapid pace. This is authentic particularly in the Better China region, which is fast establishing itself as a specialist hub for energy finance. To see this, one may consider two defining milestones of 2017, affecting corporations operating in the region.

Firstly, in November this year, China’s nationwide carbon trading platform will be launched. It is set to become the world’s major carbon trading market. Instantly, thousands of companies will be confronted with the need to employ carbon trading specialists.
The pressure for firms to be socially responsible is growing at a rapid pace

Secondly, in the early months of 2017, listed companies in Hong Kong started mandatory disclosure of environmental governance indicators inclunding energy consumption and emissions levels.

These features imply that conventional notions of corporate finance and governance need revising. Top management teams require a new corporate vocabulary, and a rank-and-file workforce with new skills.

There is a new request for energy and environmental finance specialists throughout the corporate hierarchy.

Burnishing a large corporation with a new lexicon and associated skill-set is potentially very costly: re-training/hiring new staff to conduct environmental accounting; creating environmental and social governance reports for stakeholders and the wider public; and possibly putting in place a dedicated team of analysts and traders to develop and implement carbon trading strategies.

The birth of the green bond

Part scholars and practitioners, there is however a growing consensus that socially responsible businesses are rewarded for their efforts. Benefits range from intangible gains in reputation and brand price, through to tangible cost reductions arising from (additional) careful waste and emissions management, and/or the creation of secondary markets for the waste they generate in production.

There is a lot of interest by corporations in identifying ways to enhance their environmental credentials at a minimal cost. In this vein, green project financing has emerged as a popular choice. A meteoric increase has occurred in the market for green finance, driven in large part by the development of a financial product known as a “green bond”, with corporations like Apple, Repsol, and SolarCity being part a lot of noteworthy issuers.

Let’s look at some key facts behind the market for green bonds. The initial labelled green bond was issued by the European Investment Bank in June 2007. Just three years later, close to 60 labelled green bonds had been issued in 15 different currencies, with an average price of US$50 million. EDF, a world electricity company in France, issued the initial corporate green bond in 2013.

The green-bond trend has been sweeping across various fields for the completed decade, and is expected to march on. As of September 2017, about 1,150 labelled green bonds have been sold with an average issue price (for bonds issued so far this year) of US$214 million. The maturity dates of the bonds have been stretched to 2064. China is understood to be responsible for around half of all issuances and market price.

So what is a green bond?

Simply, a green bond is much like a traditional bond but for one key difference. Investors acknowledge to provide capital for some agreed rate of return, but with the requirement that the proceeds are invested into “green” projects. These can range from technological upgrading and efficiency improvements, through to renewable energy projects and beyond.

So far, Apple has raised US$2.5 billion in capital through green bonds. Oil company Repsol issued a US$500 million green bond targeted at financing efficiency improvements that will lead to considerable emissions reductions and improve their social image. SolarCity – recently acquired by Tesla – has made a habit of using green bonds, and has presently issued additional than 100 of them to help finance its operations.

It is the simplicity of green bonds, and their similarity to traditional financial products, that drives their appeal. There is little distinction between green and regular (or black) bonds. Since corporations frequently issue black bonds to help raise capital, they are familiar with the instrument. The jump from black to green involves little additional knowledge or cost for the corporation. For the very same reason (ie. familiarity), potential investors can understand green bonds without facing a steep learning curve. This helps to ensure request and market liquidity.

Opportunities abound in green financing

But there is still additional to consider, since investors (such as large pension funds or perhaps family offices) can as well obtain reputational gains from having a green component in their investment portfolio. The environmental credentials of green bonds are externally verified or certified. Accordingly, socially responsible investors are not required to conduct any additional due-diligence checks, thereby reducing the time and cost they face in making socially responsible investment choices. All such advantages are likely to result in an incrementally higher level of request for green bonds at the same time as compared with black bonds with similar characteristics. Sensible assessment of the timing and price of involvement in green finance will be challenging tasks for corporate decision makers, particularly the financial executives.

Challenges aside, opportunities abound. Infrastructure investment connected to China’s Belt and Road Initiative may as well present commercial opportunities. With additional than 900 planned infrastructure projects and committed investment by presently exceeding US$1.1 trillion, there will be exciting opportunities for green finance in Asia for years approaching.

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