Climate bonds are the newest addition to the talks on the financial side of Renewables. These bonds have the potential to change how energy projects are financed all across the globe. In fact, countries like Australia, China, and several countries in Europe are already heading up the fight.
So how do these bonds work? They function similarly to regular bonds. Bonds provide the borrower with external funds to finance long-term investments. Thus a bond is a form of loan: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds will usually have a specific term or payback period. Climate bonds are specifically linked to climate change solutions.
Currently there are several high risks involved with financing an energy project. Most clean energy projects are financed with just the one project, which leads to higher risk. A few of those risks could include political changes that are happening every day, rules and regulation changes, and general economic risks make investing in Renewable Energy a high risk that many financial institutions are just not willing to take. Climate bonds may have the ability to change all that.
According to Renewable Energy World, the International Finance Corporation (IFC) issued a US $1 billion bond in February to support renewable energy and energy efficiency projects, making it the largest climate-themed bond issuance to date. Subsequently, it attracted high rolling investors from California and Washington who are looking to make a bigger impact than what has been done previously.
If these climate bonds could yield the same result as other financial bonds, what would stop an investor from funding these projects? If we could bundle smaller projects into larger investments, thus reducing the risks involved, we could truly make a dent in Renewable Energy sector by decreasing our dependence on foreign oil, reducing emissions leaking into the atmosphere and therefore speeding up our fight against climate change.
There are still some challenges with the proposed climate bonds. “There's a bit of cynicism,” says Stuart Kinnersley of Nikko Asset Management, a big investor in World Bank green bonds: “There's a general belief that you're paying more for this extra bit of green, even though you're not.”
There are no additional fees, however the projects that best fit for these types of bonds would be over $500 million, hence the need for smaller projects to be bundled into a larger whole. The projects would need to be scaled properly. Not all projects are a good fit to be bundled together. HSBC estimates $10 Trillion being spent on renewables in this decade alone. As these technologies become less risky, they will be financed mostly by bonds.
It may be awhile before this type of financial vehicle can really get going but it's only a matter of time before they become the norm. As these climate bonds gain popularity and the cost of solar and wind power increasingly decline, we could start seeing these products morphing into real solutions. They're gonna get hot!
Climate Bonds Initiative’s 8 points plan to promote the transition to a low-carbon economy
- Create deal flow – Bond investors need scale; renewable energy and energy efficiency projects (markets) need to be aggregated into larger offerings suitable for the appetite of the big investors;
- Engineer investment grade offerings – High demand of low risk investments. Renewable energy investments are seen as a “novelty”, we need to change this perception. In order to do that, a grand pact between governments and institutional investors is needed. Governments engineer a stream of large scale investment opportunities and does everything it can do to make sure they are investment grade; in return institutional investors turn on the taps;
- Be clever about public sector risk-sharing – Financial leverage (e.g. policy risk insurance and currency risk insurance) and regulatory leverage.
- Build green enabling institutions – Green Investment Units and Banks are needed;
- Give tax incentives for climate bonds – very little treasury loss can be a big boost to investment;
- Build an economic recovery narrative – the transition to a green economy revamps our economy across every sector and addresses the climate change threat;
- Use Climate Bond Standards as a screening and preferencing tool – a tool that helps investors monitor and verify the climate effectiveness of their investments;
- Make it easy for politicians – bond investors and business issuers have to get better at packaging politically sellable solutions, help politicians see how they can successfully sell those plans to voters
Climate Bonds Initiative’s 8 points plan to promote the transition to a low-carbon economy
- Create deal flow – Bond investors need scale; renewable energy and energy efficiency projects (markets) need to be aggregated into larger offerings suitable for the appetite of the big investors;
- Engineer investment grade offerings – High demand of low risk investments. Renewable energy investments are seen as a “novelty”, we need to change this perception. In order to do that, a grand pact between governments and institutional investors is needed. Governments engineer a stream of large scale investment opportunities and does everything it can do to make sure they are investment grade; in return institutional investors turn on the taps;
- Be clever about public sector risk-sharing – Financial leverage (e.g. policy risk insurance and currency risk insurance) and regulatory leverage.
- Build green enabling institutions – Green Investment Units and Banks are needed;
- Give tax incentives for climate bonds – very little treasury loss can be a big boost to investment;
- Build an economic recovery narrative – the transition to a green economy revamps our economy across every sector and addresses the climate change threat;
- Use Climate Bond Standards as a screening and preferencing tool – a tool that helps investors monitor and verify the climate effectiveness of their investments;
- Make it easy for politicians – bond investors and business issuers have to get better at packaging politically sellable solutions, help politicians see how they can successfully sell those plans to voters
Climate Bonds Initiative’s 8 points plan to promote the transition to a low-carbon economy
- Create deal flow – Bond investors need scale; renewable energy and energy efficiency projects (markets) need to be aggregated into larger offerings suitable for the appetite of the big investors;
- Engineer investment grade offerings – High demand of low risk investments. Renewable energy investments are seen as a “novelty”, we need to change this perception. In order to do that, a grand pact between governments and institutional investors is needed. Governments engineer a stream of large scale investment opportunities and does everything it can do to make sure they are investment grade; in return institutional investors turn on the taps;
- Be clever about public sector risk-sharing – Financial leverage (e.g. policy risk insurance and currency risk insurance) and regulatory leverage.
- Build green enabling institutions – Green Investment Units and Banks are needed;
- Give tax incentives for climate bonds – very little treasury loss can be a big boost to investment;
- Build an economic recovery narrative – the transition to a green economy revamps our economy across every sector and addresses the climate change threat;
- Use Climate Bond Standards as a screening and preferencing tool – a tool that helps investors monitor and verify the climate effectiveness of their investments;
- Make it easy for politicians – bond investors and business issuers have to get better at packaging politically sellable solutions, help politicians see how they can successfully sell those plans to voters
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