The Paris Agreement and the Sustainable Development Goals set ambitious targets for transitioning to a low carbon global economy, including keeping the rise in the global temperature to well below two degrees Celsius. The International Finance Corporation (IFC) estimates that South Africa, which is a signatory to the Paris Agreement, requires more than US$588bn between 2016 –2030 in climate-smart investment to meet its Paris Agreement policy commitments, making the development of a green financial system, and green financing solutions increasingly pertinent. Green bonds are likely to be an important instrument to facilitate climate-smart investment.
What is a green bond?
A green bond refers to any type of bond instrument where the proceeds will be applied exclusively to finance or refinance, in part or in full, new or existing eligible green projects. Green bonds are intended to fund projects or capital expenditure that will have positive environmental or climate benefits. The specialised use of the proceeds is one of the key differentiators between a green bond and a conventional bond. The green label does not fundamentally change the bond’s risk profile which, as with a conventional bond, depends on the underlying credit quality of the issuer.
There are four types of green bonds: standard green use of proceeds bonds; green revenue bonds; green project bonds; and green securitised bonds. In the South African context, listed green bonds that have been issued have been limited to standard green use of proceeds bonds where, like a conventional bond, recourse is to the issuer’s balance sheet and the use of funds is specifically restricted to the identified low carbon project.
Globally, the Green Bond Principles (GBP), published by the International Capital Markets Association, are a widely-used guideline for green bond issuers around the use of proceeds, project evaluation and selection, as well as management of proceeds and reporting. In addition, the GBP recommend that issuers make use of an external review to confirm the alignment of their bonds with the GBP guidelines. External review includes review by a consultant or institution with expertise in environmental sustainability, independent verification by a qualified party, certification against an external green assessment standard or obtaining a rating by a qualified third party such as a rating agency. External review is also important in maintaining the integrity of the process and avoids potential ‘greenwashing’ where green bond proceeds are allocated to assets with little environmental value which can be damaging for the development of the green bond market.