World Bank rates green bonds
Nina Röhrbein looks at instruments that aim to combine solid SRI credentials with precious yield and a high standard of transparency and stability
As the yields of traditional, developed-market government and corporate
bonds remain low, more talk surrounding climate change, green and forest bonds has emerged in recent months, particularly in the responsible investment community.
Supranationals like the World Bank are the largest issuers of green bonds, accounting for around $8bn (€6.5bn) of the $17bn market. Corporates account for $3-4bn and some government initiatives for $5bn, according to Stuart Kinnersley, CIO at Nikko Asset Management (Nikko AM) Europe which, in collaboration with the World Bank, started offering a green bond fund in February 2010.
“The market is growing but not necessarily at rocket speed,” says Kinnersley. “Investors show interest in socially responsible investment (SRI) fixed-income products but only a handful exist right now. Green bonds can certainly fill that space.”
A total of 48 World Bank green bonds, issued in 17 different currencies, have so far raised over $3bn. Investors include the second and third Swedish National Pension Funds AP2 and AP3, the California State Teachers’ Retirement System (CalSTRS) and the UN Joint Staff Pension Fund.
Nikko AM’s offering is achieved through two actively managed funds - one $40m fund domiciled in Luxemburg and aimed at European and Middle Eastern investors, and a $500m fund domiciled in Japan for domestic investors. Both primarily invest in World Bank-issued green bonds, and 10% of the asset management fees paid by investors are donated to the International Development Association (IDA), which supports anti-poverty initiatives in the poorest developing countries, or entities promoting similar causes.
According to Kinnersley, the green bond funds fulfil all the requirements of other fixed-income products but come with added transparency - in other words, investors know where their capital is going.
“Bond yields have continued to fall because investors carry on buying them as safe havens,” he says. “But while, fundamentally, many developed bond markets may look expensive, the yields in emerging markets tend to be higher. This, combined with sounder fiscal positioning than in developed markets, led us to structure the fund so that half of the benchmark is emerging markets.”
Accordingly, the Luxembourg fund’s benchmark is 50% JP Morgan Global Bond Index Emerging Markets and 50% Citigroup World Government Bond index.
Liquidity remains one major concern for investors. However, according to Kinnersley this is not a problem with the green bonds.
“The green bonds are senior debt issued by the World Bank that have all the characteristics of being AAA-guaranteed, which is why the marketplace will absorb them in times of stress,” he says. “We have an understanding with the World Bank that it will buy the bonds from us in the event of mass redemptions. After the Japanese tsunami struck, for example, the World Bank rang us up willing to buy them back if there had been any selling. But we did not incur any redemptions.”
The final destination of their investments is the other crucial area of concern for investors.
At the World Bank, all green bond proceeds are ring-fenced for projects designed to tackle the causes and consequences of climate change in the developing world.
The project cycle starts with a country partnership strategy before any potential projects are identified. The potential projects that meet green bond criteria are then screened and reviewed, based on eligibility for green bond support. Eligible projects are selected before green bond proceeds are allocated and disbursements made.
“Different green bond proceeds may go to one particular project or support a number of projects,” says Judith Moore, senior environmental specialist for the World Bank. “We have a pool of projects and we generally do not invest all the money in a project at once. Instead, disbursements occur as milestones are reached throughout each project’s lifecycle. For one of our $100m projects, we have disbursed only $30m so far. The rest is due to be posted in the future.”
The projects fall into two categories: climate change mitigation; and climate change adaptation. They include wind and solar power, waste-to-energy, technologies to reduce greenhouse gas emissions, waste management, transport and energy efficiency, reforestation and sustainable forest management projects, as well as projects offering protection against extreme events such as floods and droughts, improving food security and growing stress-resilient crops.
Current locations include Brazil, Colombia, the Dominican Republic, Mexico, Belarus, Montenegro, Turkey, Ukraine, Egypt, Jordan, Morocco, Tunisia, India and China.
While the projects are fairly consistent, the World Bank has recently started to include more climate-adaptation projects to move from a 10/90 or 20/80 split in favour of mitigation projects, towards a 35/65 ratio in favour of mitigation.
“Initially more projects fell under mitigation,” says Moore. “However, we have always wanted to have a blend of mitigation and adaptation projects. The World Bank is well positioned to support adaptation because it tends to be longer term and not something that would be easily picked up by other financial organisations. One of our latest adaptation projects is trying to protect the upper watersheds in Tunisia, the source of 75% of the country’s drinking water, and to upgrade the productivity of nearby farms.”
The World Bank Green Bond portfolio seeks to apply a gold standard in its selection of eligible projects. As a result, development projects that generate excellent benefits, including potential reductions in greenhouse gasses, may not be included in the Green Bond portfolio because of the sensitivities of some investors. For example, as part of its energy efficiency projects, the World Bank backs natural gas projects. According to Moore, however, the green bond portfolio does not include projects for natural gas extraction by hydraulic fracturing - or ‘fracking’ - because of the concerns many investors have on this issue. Coal engages similar sensitivities. The World Bank does not support any nuclear projects either.
“There is a clear demarcation between how we invest and how the end proceeds are invested,” says Kinnersley. “Our investment return is determined by the currencies we choose. The World Bank consolidates all those proceeds, converts them into dollars and then disburses them accordingly.”
At present, the biggest volumes of capital flow to Latin America, while the greatest number of projects takes place in China. The World Bank has no green bond projects in sub-Saharan Africa because projects in that region are supported through the IDA. This means that they receive funding for low-interest loans, credits or grants from donors, rather than through the capital markets.
The counterparties of this activity are the governments of its 188 member countries but the World Bank is exploring ways in which it can work more creatively with the private sector, according to Moore.
“It is easier to fund projects when governments consciously want to make progress in moving down the low-carbon development path,” she says. “Both Mexico and China, for example, have been very keen on moving their economies towards a low-carbon path, which is why there has been a lot of discussion and design of projects. At times, programmes are suspended because political or corruption issues need to be resolved. But our mandate is to work with countries through their problems, rather than to abandon them.”
There have been no defaults to date, and currently less than 0.5% of outstanding loans are in so-called non-accrual status, meaning repayments are pending. This delay in payments is managed by loan-provisioning policies.
“A key benefit for investors is that they do not take on any project-specific risk,” says Kinnersley. “Because the bonds are AAA-rated, even if there was a default, investors would not be impacted.”
To verify the success of the projects, the World Bank has a number of indicators and targets that have been agreed with the counterparty. For the most recent Tunisia project, for example, indicators that are regularly reported on include: crop yield; livestock yield; change in land use; percentage of upgraded pastures; and percentage of households that have access to better drinking water. Once a project is completed an implementation completion report is made publicly available.
Since inception, Nikko AM’s European green bond fund has generated an absolute return of over 5% annualised in dollar terms. It won the Most Innovative Development in ESG (environmental, social, governance) prize at IPE and TBLI’s annual ESG Leaders Awards Ceremony in November 2010.