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A new report released by the Climate Bonds Initiative and HSBC shows that the market for green bonds, a debt instrument for financing projects that tackle climate change, is exploding. And the sustainable built environment is expected to benefit greatly, with green buildings and urban improvement bonds expected to comprise more than 50 per cent of the market in the long term.

The report, Bonds and Climate Change, The State of the Market in 2014, found that the green bonds market is today unrecognisable compared with three years ago, when labelled green bonds – bonds that specifically fund low-carbon projects – were “a niche market pioneered by a handful of development banks”.

However, 2013 saw US$11 billion in labelled green bonds issued, and at 10 June 2014 an additional US$18.35 billion had been issued with the figure now over $20 billion. The market is on track to reach $50 billion by the end of the year and an additional $100 billion next year.

“The green bonds era has begun,” the report said.

While it’s a positive step, the report notes that it isn’t close to the $100 trillion a year above business as usual needed to be invested to address dangerous global climate change. But bonds will be critical in raising that capital.

“Mobilising bond markets as a low cost financing tool will be essential for the realisation of a low carbon and climate resilient economy,” the report said.

“Niche financing solutions will not be sufficient, and neither will public sector funds alone. Capital markets are essential.”

Demand for the green labelled market has been exceptionally high, with bonds significantly oversubscribed.

“Investors have shown strong demand for new types of issuers and bonds including asset-backed securities such as that from Toyota, which was linked to hybrid and electric vehicle loans, and corporate bonds linked to internal water and energy targets (Unilever) and green building portfolios (for example, Unibail-Rodamco, Vasakronan, Regency Centres),” the report said.

Demand hasn’t just been from investors with ESG requirements, but also mainstream investors.

Climate bonds made good sense, the report said, because:

  • the capital is available
  • interest rates – and so financing costs – are at an historic low, ideal for big infrastructure investments
  • the solutions are understood – large scale deployment of existing renewable energy technology; a modal shift to low carbon transport; energy efficiency investments

The total green bond market – referred to as “the universe of climate-themed bonds”, which includes labelled green bonds and unlabelled (directed towards climate-related projects but not specifically labelled as green) – is now estimated to be US$502.6 billion dollars.

Transport, mostly rail, makes up the largest proportion of climate-themed bond market with US$358.4 billion, as public transport is seen as a sustainable option. Next are energy and finance, with US$74.7 billion and US$50.1 billion, respectively.

Buildings and industry come in at number four, with US$13.5 billion committed.

Boom time for green property bonds

For the buildings sector, the market has more than doubled in value in a year, and now represents two per cent of the total climate-themed bond market.

The largest segment comes from energy efficient appliance/product manufacturers, with LG Electronics, the largest issuer, included due to 93 per cent of its product range being certified with the Energy Star label. Next are energy services companies followed by green property.

This was the first year for green property bonds to be included, with Swedish developer Vasakronan and a number of Australian REITs with high energy performance ratings across their portfolios.

Standards being developed for property

The question of what makes a green bond green has been a key concern, as the market could face reputational risk if bond proceedings are allocated to assets that have doubtful or little environmental value.

Sander Paul van Tongeren, executive director and cofounder of the Global Real Estate Sustainability Benchmark, who joined the working group this month said green property bonds were “an essential and logical next step to integrate sustainability credentials in the offerings to the financial market”.

“Recent offerings show that there is a clear demand from both institutional and responsible investors to gain exposure to green bonds in general and green property bonds specifically,” he said. “However, the latest green property bonds also show that there is a need to standardise the criteria and methodology to assess the green credentials and achievements.”

The Climate Bonds Standard

At present there are no standards, though the Climate Bonds Standard, a wide coalition of academic and industry experts developing open access guidelines for which climate-related investments can be associated with green bonds, has been formed.

In property, the Climate Bonds Green Property Technical Working Group, which includes Flux consultants director Ché Wall, recently released a draft standard and certification scheme to ensures the credibility of certified climate bonds issued for green building.

The working group said large cuts in building greenhouse gas emissions was crucial, and thus high standards necessary.

“If all buildings achieve a 20 per cent efficiency upgrade but a 40 per cent increase is required to avoid two degrees [of greenhouse gas induced climate change], then 20 per cent is clearly not enough,” a working group document stated. “The risk is to ‘lock in’ weak levels of performance until the next investment period, which may not occur for another decade or more.”

The proposed eligibility criteria would see commercial buildings included if they are in the top 15 per cent of their regional market in emissions performance, or for financing upgrades that deliver a carbon saving of at least 50 per cent.

The proposed eligibility criteria recently closed for public submission, with final eligibility criteria to be released in the coming months.

Property to have the lion’s share of bonds long-term

Climate Bond Initiative chief executive Sean Kidney said he expected green property and urban improvement bonds to make up more than 50 per cent of the green bonds market in the long run.

“But this will depend on confidence among investors that the buildings are making a genuine contribution to the transition to a green economy we need to head off catastrophic climate change,” he said.

Examples of the most likely green bond opportunities in the energy efficiency building space are:

  • green mortgage-backed securities (green securitisation) in countries where building codes for new builds meet the objectives of the Standard
  • building portfolio owners with a mixed portfolio of EE rated commercial buildings seeking to improve the portfolio performance or securitise existing low carbon assets
  • aggregation of finance from existing schemes such as ESCO contracts, property assessed clean energy financing, environmental upgrade agreements and similar