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Taking Stock of the Green Bond Market in Muni’s
April 22, 2016
Happy Earth Day 2016! Given the occasion, I think its only appropriate to discuss Green Bonds in the municipal bond market.
What are Green Bonds? Although there may be different definitions of what constitutes Green Bonds, generally speaking, these are bonds that have been issued to fund environmentally beneficial projects. Typically, the security and structure of the bonds are not tied to the environmental projects being funded. Most Green Bonds come in standard maturities, have CUSIPS or other standard designations, and generally look and act like regular, “non-Green” bonds, including bond ratings.
There’s no single set of standards for what constitutes a Green Bond, or the types of projects that are eligible to be funded by these bonds. It really comes down to what an issuer needs to finance and what investors believe is an environmentally beneficial project and are willing to finance. Projects that have been funded thus far include those that seek to address climate change, public transportation improvements like rail expansion, preservation of open space or brownfield remediation, drinking water projects, habitat restoration, renewable energy projects like solar or wind, etc.
Green Bonds have been around since 2008, when the World Bank – led by the efforts of Heike Reichelt – started issuing the bonds to fund projects around the globe that fight climate change. According to their website, since 2008 the World Bank has issued approximately $8.7 billion in Green Bonds in more than 115 transactions in 18 different currencies.
While the World Bank is clearly the leader in issuing these types of bonds, corporations and local governments in the U.S. have also issued them to fund a wide variety of green projects. For example, in 2012 Warren Buffet’s Berkshire Hathaway issued more than $1 billion in Green Bonds to fund a solar farm in California. Another major U.S. corporation, Apple, issued $1.5 billion in Green Bonds earlier this year. Globally, some $42 billion in Green Bonds were sold in 2015, up 13% from the amount issued the year before according to the Climate Bonds Initiative.
How about in the municipal market? Green Bond issuance continues to grow. The first Green Bonds in the muni bond market – a $100 million financing – were issued by the Commonwealth of Massachusetts in 2013. Given the financing’s success with both institutional and individual investors, the state followed up with a much larger, $350 million Green Bond sale in 2014. According to Bloomberg data, a total of $3.8 billion in Green Bonds were issued in 2015 in the municipal market. That’s a big jump over 2014, but still a relatively small percent of the overall amount of bonds issued in the market in 2015. Nonetheless, the list of issuers of Green Bonds is impressively diverse, both geographically but also by size of issuer and purpose: state issuers include California, Connecticut, Hawaii, Massachusetts, Vermont, and Washington; cities include Washington D.C. and Asheville, NC; higher-ed facilities include the University of Texas and the University of Cincinnati; public housing agencies like New York City Housing have issued Green Bonds; and transit authorities include the New York MTA have also issued these bonds to interested investors.
At this point, however, its not clear in which direction the market for municipal Green Bond goes. Since 2014, there’s been a wave of muni issuers essentially testing investor appetite for these types of securities. And a market for third-party certification of “green bond standards” in the muni market is now starting to grow, with entities like Vigeo and the Climate Bonds Initiative now providing assurances to investors. Even Moody’s is exploring some sort of green bond rating system.
The emergence of firms that provide a third-party “green” certification is a positive development for the Green Bond muni market. It’s a small but important step towards a measure of standardization, which should broader their appeal to more investors. For the Green Bond market to really grow, it will be important for issuers to work from a more consistent playbook in terms of how these bonds are issued and how bond proceeds are spent. What would Green Bond investors like to see? Things like a common and transparent approach to project selection and criteria; common definitions for what constitutes a Green Bond; common measurement of environmental impacts; and consistent post-issuance reporting requirements. For this to happen, it takes leadership from market leaders to bring issuers and investors together to hammer these things out. We’re already seeing it from a major issuer – California State Treasurer John Chiang. He’s recently stated that he’s interested in growing the California Green Bond market. But before moving forward, he’s undertaking his own due diligence first. He’s been out traveling to a number of cities to hear directly from bond investors.
Green Bonds do have their critics and the criticism goes as follows: “All municipal bonds are ‘green’ already because they provide some sort of public purpose, therefore Green Bonds is a marketing ploy”; “Issuers are not seeing an immediate pricing benefit from Green Bonds so they’re not worth the effort”; and, “Green Bonds are being used to fund projects that would have been funded anyway.”
Let’s take these one at a time. First, not all municipal bonds are issued to help the environment in some way. A big chunk of bonds issued every year in the market are refunding bonds, whose only purpose is to refinance securities that are already outstanding. And not every new-issue bond serves an environmentally beneficial purpose: bonds are routinely issued for road construction or, less frequently, for things like sports stadiums. Next, calling bonds “Green” is a marketing strategy – but marketing shouldn’t be taken as a pejorative thing. Issuers are trying to connect with investors who want to know that their investments are funding environmentally beneficial projects. There are a host of investors, both in the muni market and in the taxable bond markets, who want to invest in these projects. Firms like Blackrock and State Street have dedicated Green Bond funds. Trillium and Community Capital have been investing in these types of projects for decades. What’s wrong with a muni issuer trying to diversify its investor base by attracting capital from these different investors? If an issuer does have success finding new investors for its bonds, it will be a benefit to the issuer’s taxpayers over the long-term.
The final charge, that Green Bonds are funding projects that would be funded anyway, is probably accurate. But, to be fair, its also a little too early to make that call conclusively. Up to this point, issuers have been testing the market and gauging interest from investors. If the investor community responds with strong demand for additional Green Bonds, that signal should give issuers the incentive to authorize more environmentally beneficial capital projects. That’s how a market for any product should develop.
I think it’s a very positive thing for the bond market to innovate and to move forward, even if it’s a small step. Green Bonds give investors yet another reason to choose to invest in a city or town’s capital projects. But for the market for Green Bonds to really expand from here, and to start providing issuers and taxpayers a clear benefit, its important for issuers to collaborate so that there’s more consistency and transparency on how these bonds are sold, how bond proceeds are spent, and how environmental benefits are measured.