JONES DAY TALKS®: Riding the Green Bond Wave: Focus is on Standards as Volumes Surge
Takeaways from this discussion:
- Green bond issuance is surging worldwide, surpassing US$257 billion in 2019.
- Major corporates, including many not usually associated with climate initiatives, are bringing green bonds to market, spanning the investment grade and high-yield spectrum and including more exotic instruments such as convertibles and covered bonds.
- Green bond qualifying standards in Europe differ from those in the United States. An EU Green Bond Standard may be adopted as early as Q4 2020.
- First-time issuers should plan time to calibrate their green bond framework and prepare for reporting requirements, enhanced investor outreach, and potential for liability.
- "Greenwashing" remains a concern.
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Read the full transcript below:
Dave Dalton:
According to the Climate Bonds Initiative report, green bond and loan issuance surged to 257 billion US in 2019. Green bonds raise capital for projects with environmental benefits like renewable energy, low-carbon buildings, or low-carbon transportation. But what exactly qualifies as a green bond? What are the standards? And who are the players in this rapidly growing investment class? We have a Jones Day panel with plenty of green bond experience and insight here to explain. I'm Dave Dalton. You're listening to Jones Day Talks.
Dave Dalton:
Linda Hesse leads Jones Day's ESG initiative across all geographies and practice areas. A Paris based partner, she advises clients on capital markets activities. Rory Hood is a partner in the firm's financial markets practice based in New York. He recently advised the underwriter of a green bond issue for a multinational consumer products company on its $1 billion US green bond offering. And Natalia Sauszyn of counsel and the financial markets practice, works in specialized debt capital markets matters, and is also based in Paris. She recently represented a financial services company on its screen covered bond issuance priced at 1.25 billion euros.
Dave Dalton:
Linda, Rory, Natalia, thanks so much for being here today.
Linda Hesse:
Thanks Dave for having us.
Dave Dalton:
Linda, let's start with you. Big topic. Interesting topic. About $257 billion US in green bonds and green loans were issued last year, 2019. That's up 50% from 2018 where about 170 billion USD were issued. That's big. That's significant in terms of both volume and where this trends going. But let's step back for a second. For those not entirely sure, can you define what a green bond is for us?
Linda Hesse:
Sure. Dave, first of all, is one tool in the sustainable finance toolbox. It's debt securities, specifically designed to support climate related or environmental projects. It's really designed to raise money so that issuers can meet their goals with respect to environmental criteria. There's also sustainability bonds, which are quite similar, but they use the proceeds to finance or refinance a combination of environmental and social projects. So both of those together are what we would call traditional green or sustainability bonds. We also have a newer category that's called sustainability linked bonds, and those are linked to specific KPIs or key performance indicators that help an or meet certain targets. And those are kind of a subset or a different set of what we would call green or sustainability bonds. We'll do a later podcast on sustainability linked bonds, hopefully sometime in the near future.
Dave Dalton:
Are you encouraged or... The way the market seems to be taking off. The acceleration here. You got to be pleased with that A, but B what do you attribute that to? I mean, where's this interest coming from suddenly? I mean, it's not inconsequential when you double the amount of issuance in one year. That's incredible. What's going on here?
Linda Hesse:
I think that we really are seeing this growth because of the need to invest in infrastructure and new ways of financing our economic transition. Europe's always been ahead in the green bond space and more generally when it comes to ESG. And just as a point of history, the green bond market kicked off in about 2007 when the European Investment Bank and the World Bank together issued the first green bond. But the US caught up quickly and is now one of the, in fact, the largest issuer of green bonds. So they come in at 50 billion, but the next two countries are China at 31 billion and France at 30 billion. So I think that's kind of an interesting set of data points. And when you think of the relative size of the economy of the United States, China and France, you can see that those are pretty big numbers.
Dave Dalton:
Interesting. France in the top three, right?
Linda Hesse:
In the top three. Absolutely. But you also need to remember that the global bond market is valued at a hundred trillion dollars. So the green bond market, while growing quickly and quite sizable now, is simply a drop in the bucket.
Dave Dalton:
Sure. But with a lot of room to grow apparently. And we'll talk more about where we see this going later on in this program. Let's go over to Roy for a second. Roy. Talk about who issues and underwrites these bonds. Are we looking at corporates, countries, or jurisdictions, not-for-profits? Who's bringing these investment instruments to market?
Rory Hood:
Thanks, David. So we've seen a lot of activity in the investment grade market, particularly large household names. A lot of them have issued green bonds over the last year in particular. We've also seen green bonds issued outside the investment grade market in both the high yield and convertible debt market. And interestingly, there have been some issuers that you would not typically associate with green initiatives that have issued green bonds under the framework. So it's not just your companies that you would traditionally think of as green, but all different types of issuers, which is interesting.
Dave Dalton:
That's encouraging, but talk more about that. You don't have to name names, but when you say companies, you wouldn't normally associate with green initiative type things, you're talking heavy manufacturing. What kind of companies are you seeing get into the space that maybe people weren't anticipating?
Rory Hood:
Sure. We've seen manufacturing, oil and gas, meat producers. So all different types of businesses and the variety is I think also encouraging as we see the market grow. It's not just one subset of issuers that are choosing to use this product, which is great.
Dave Dalton:
Yeah. I think it brings some credibility in the market too. It's not just one niche or one sector or certainly not one industry that's encouraging to an investor. And it certainly shows that the movements taking hold. Speaking of investors, what's the appeal here for an investor or a portfolio manager? Why are these bonds so popular?
Rory Hood:
We've seen a number of investors actually put out affirmatively what they're looking for in terms of their green investing. And so it's really gives the investors the ability to kind of tailor their values and their goals to their investment philosophies. The buy-side always wields in any market wields a lot of power. And you've really seen the buy-side drive these green bonds and quite frankly, ESG overall. And then there's other benefits too, right? Like positive press and kind of brand value. They get to be a leader in an area that is gaining importance both politically and in the media. There's also... Certainly there can be tax benefits in certain jurisdictions that investors are, of course, always interested in. So there's a whole host of issues that investors deem important and each particular investor is going to have their own set of values and what they want to further.
Dave Dalton:
Sure, sure. It's a great option. And I know the returns are... Well, let's talk about that for a second, Roy, and let's veer off script for a second. But in terms of where these bonds are issued, in terms of the interest rate or where they're priced, I should say. Are they compatible with other corporate say with a AAA investment grade bond? Are they about the same in terms of yield?
Rory Hood:
They're close. I've seen studies that say that the green bonds will price slightly tighter than your traditional bonds. It's not a huge disparity, but it does depend of course, on the issuer and the likelihood of default. But your large kind of investment grade market, the bankers will tell you that you will get a slightly tighter spread on a green bond, which of course is attractive from the issuer side.
Dave Dalton:
Definitely. All right, let's go over to Natalia for a second. Haven't talked to you yet, Natalia. Thanks again for being here today. You've represented several issuers of green bonds. How does the process or mechanics of putting together this kind of offering differ from that of a more traditional corporate bond issue?
Natalia Sauszyn:
Thanks Dave. In terms of deal structure, green bonds are similar to traditional bonds with one major difference. It's the selection of eligible green assets that will be financed through the issuance. Which translates for us lawyers in more transparency, disclosure and reporting. Issuers will need to prepare a green bond framework, which will describe the eligible green projects or assets to be financed by the issuance and the way the proceeds will be managed and tracked. The framework will be available on the issuer's website and will be mentioned in the use of proceeds section of the issuance documentations. And as far as Europe is concerned, issuers mostly rely on the green bond principles of the International Capital Market Association when preparing their framework and green issuance.
Dave Dalton:
Okay. Talk about the framework a little bit. Is that something legal counsel advises on? That's not an off the shelf kind of product, I wouldn't think. That sounds like some very intricate nuanced work. Is that something like I said, legal counsel or representation would work with a client on to make sure that's positioned properly in the framework?
Natalia Sauszyn:
It depends on each issuance, but it happened already for us in several transactions that we were asked to review the framework. And there is always an added value for us lawyers to review sections on use of proceeds and certain undertakings that issuers will try to put in there. Sometimes there are mismatches between what they actually want to apply the proceeds for and what the reality is. Yes, I would say that's a common work between issuers, their counsel in all cases. Also outside experts that have expertise in nonfinancial reporting.
Dave Dalton:
Sure. Okay. Natalia, let's talk about qualifying for green bond status. Who or what screen's potential offerings or issuances to ensure that the proceeds from these bonds are actually directed toward green projects? And is this process difficult? Talk about what actually happens if a client is thinking about bringing a green bond to market. Who decides to screen?
Natalia Sauszyn:
First of all, qualifying for green bond status is somewhat different in the U S and in Europe. Let's focus on Europe. In Europe, the green bond principles of the International Capital Market Association have now become key tools for issuers. Just as a reminder, they're voluntary guidelines and they are based on four components, which are the use of proceeds, the process for project evaluation and selection, the management of proceeds, and the reporting. And issuers as already mentioned, will often supplement or build their process for selecting and screening eligible green assets with external reviewers. On set reviewers will provide a second party opinion, verification, certification, sometimes even a scoring of assets that will be financed, and the ESG performance of the investment.
Natalia Sauszyn:
The earmarking on the funds towards green assets is often described in an annual report, a green bond report, or sometimes even in the specific section of annual reporting for issuers. The reports are mostly based on audited information. The allocation of the proceeds may be presented in detail that were generic terms sometimes on a project by project basis, sometimes on an aggregated portfolio basis. Reporting would not only include the allocation tracking, but also an impact reporting.
Dave Dalton:
Impact reporting? I've heard that term in ESG investment circles. Can you explain what that is? Impact reporting?
Natalia Sauszyn:
Impact reporting is a reporting that looks to measure positive environmental outcomes achieved, the impact of the projects being funded. For example, the carbon footprint. Any type of environmental benefit...
Linda Hesse:
That savings on water. For example, Natalia, I think is for example, it will depend... You can... I mean, there's a whole bunch of criteria that you can then measure against. I think is when you're talking about impact. Is that right?
Natalia Sauszyn:
Exactly.
Dave Dalton:
So it's quantifiable then? Very quantifiable potentially, right? I mean, you can... It's a number.
Natalia Sauszyn:
It's a number. A scoring. A rating.
Dave Dalton:
Okay.
Natalia Sauszyn:
Nonfinancial, but yep. It is.
Dave Dalton:
Talk about where we are in Europe right now. We're in an exciting turning point, aren't you in Europe? Natalia?
Natalia Sauszyn:
Yeah. Very exciting turning point. As part of the EU Action Plan for Sustainable Finance, the commission is working on developing standards and labels for green financial products, including an EU green bond standard. That EU green bond standard resembles the green bond principles of the International Capital Market Association. But it's four key components are more process-oriented and put the EU taxonomy as a cornerstone of EU green bonds. And you're probably going to ask what the EU taxonomy is. The EU taxonomy is the EU classification system to determine whether an activity is environmentally sustainable. That means that screening what is green will soon become more harmonized throughout the EU and more trackable.
Dave Dalton:
That's encouraging. When might all that come together? Any idea?
Natalia Sauszyn:
The EU taxonomy regulation has been adopted by the EU Parliament and it was published in the official journal. It entered into force on the 15th of July this year. And so now...
Dave Dalton:
What great timing. This is us at Jones Day Talks. We're always right where we need to be in terms of bringing content out. That's awesome. So let's go back to Linda for a second. Thinking about what Natalia said about what's happening in the EU and also looking at what's going on in the US, where do you think we are in terms of getting to that point? Where we have clear and definite standards regarding what qualifies as green bond? Are we still in progress here? Is it close? What do you see happening?
Linda Hesse:
Questions about whether we have clear and definite standards is something that's been bedeviling the ESG space in all sorts of areas. I think probably green bonds is the place where we have the most certainty and the most clarity. So even though we don't have full certainty or clarity, it's better than it is elsewhere.
Dave Dalton:
Sure.
Linda Hesse:
As Natalia mentioned, the EU is very aggressively pursuing its regulatory framework that it announced for sustainable finance, that it announced in 2018. And we're expecting a renewed finance strategy before the end of this year in 2020. And the key components are the non-financial reporting directive, the disclosure directive, and the taxonomy that Natalia just mentioned. And we're looking for the various pieces to start really coming together by Q4 of this year. So we'll see the European Climate Pact is going to be unveiled. We'll have hopefully a EU green bond standard. And all of that to support the goal to be carbon neutral by 2050.
Dave Dalton:
2050 will be here before you know it, right? But good progress. Great progress, in fact. Let's look at some of this from a client perspective. Someone who's considering bringing a green bond issue to market. And let's start with Roy first, but everyone can weigh in and I hope you do. This is a new asset class, relatively new at least. It's growing rapidly. But Rory, what kinds of questions clients have when thinking about this type of issue? And is there anything in particular they need to be concerned about? What are you hearing from clients?
Rory Hood:
Sure. So mainly a lot of times the clients have previously issued bonds. So they kind of have the process of issuing bonds and dealing with underwriters and banks. They know all that. And so what's new to them with the green bond process is really focusing on their framework and their criteria and working with their advisors to develop what they want their principles to be. In the US, the US has been a little bit more market driven on the frameworks and the issuer working with the investment community and the banks to figure out what they want their goals to be. Even some issuers, even appointing chief sustainability officers in connection with their green bond offerings. So they're really focusing on what they want their message to be, both from the green bond offering perspective, but also from an IR and investor communication perspective.
Rory Hood:
They want to know about the reporting. So when you issue green bonds, there is a reporting element to make sure that the proceeds are being used in the way that you've described. And an outside verification of that reporting. So they're focused on the sort of logistics of that process. And then there's always the conversation at any time you're offering securities in the United States about potential liabilities and whether the issuance of a green bond can increase that. It's one of those things. No good deed goes unpunished. When you're putting yourself out there, creating new disclosure, you're promising to do certain things with investor money. If things don't go as planned and the value of the bonds depress, there will always be somebody looking to say, "You didn't do what you said you were going to do." And so those conversations are had at the outset as well.
Dave Dalton:
Right. So it's interesting. There's sort of a nuts and bolts component to your interaction with the client in terms of, "Okay, we've done bond on writings, but maybe this is a new one. How do we do this?" And yet there are concerns once this gets to market, are we remaining... I don't know if compliance is the right word? But as you put it, are we doing what we said we were going to do? So there's that kind of caution, I guess, moving forward. To Linda, Natalia, what are you hearing from clients? What concerns them? Where are they in this?
Natalia Sauszyn:
I think the two most challenging aspects of putting together a green bond offering would be A, the timing for first-time green issuers. The need to prepare in advance, have their project selected, draft prepared, a framework before they go ahead with the issuance. And B, the desire to overachieve and over-promise that we often encounter. Issuers tend to describe, put a lot of undertakings, and clearly they might not want to commit to something they can not hold promises to. So danger is that at best, it affects the issuer's credibility and the worst, sets a liability risk.
Dave Dalton:
Sure. And there are times their intentions may have been good. They probably were good, but I guess caution, right? Don't over promise. Don't overreach. Don't get out over your skis, as my nephew who is a downhill skier would say, I guess. So there's that. There's another aspect of all this, a term that is flying around in the investment media and in the publications and so forth. Green washing. Green washing is bad, right? Linda, talk about green washing. What is it? Where do you see it? How prominent is it? This is maybe the downside or some of the risks here. What does green washing mean in context of a green bond issuance?
Linda Hesse:
I think those are, again, one of those terms that, that does get bandied around quite a bit. And it is an important consideration because if issuances are increasingly seen as green washing, then the credibility of the market generally might be called into question. And then investors will be less likely or less enthusiastic about investing in products. So really what we think when we think of green washing, what is meant is that there is a project or a set of activities that we're going to wrap up in a kind of green paint. And we're going to kind of take the old, dirty paint can and we're going to put some nice green paint on it. And we're going to say, "Oh here is a green product." And I think then people say, "Well, that's actually not a green product at all. It's something that you would have done anyway. It doesn't actually lead to a marked improvement in terms of your activities or in terms of the sustainable economy generally."
Linda Hesse:
So green washing is generally understood as being a way to take a non-green activity and wrap it up in a green wrapper and try and sell it as something that is environmentally sustainable. When in fact, it's not. On the other hand, I think we do need to keep space in this market for what we call transition financing. So companies that are looking to transition their business need to be able to get financing to do that. One other thing that we talk a lot about is stranded assets. So if assets become considered non-viable or undesirable to the point where the owner of the asset can't get financing for it, we're going to actually be seeing some problems because there is a lot of cleanup. There's a lot of transition that needs to be financed. So by kind of unfairly qualifying some things as green washing, we do a disservice to the global undertaking that we all have in front of us.
Dave Dalton:
That's interesting. I hadn't even thought about that angle. If you get too paranoid or vigilant or cynical or whatever, there are projects that should happen. You call it a transition financing, I think, that need to be funded and should be funded. So maybe it's... You can't cross the line, but you're not always sure where the line is, I guess. Right
Linda Hesse:
And that's right. Where the line is, is exactly the question. That's where we lawyers can offer useful advice, because you do want to be both faithful to what your project goals are, but you don't want to over promise as Natalia mentioned.
Dave Dalton:
Sure.
Rory Hood:
And I think an interesting element too, is that the lawyers and possibly regulators may define the line, but going back to the buy-side point, I do think it's an area where the market will define the line a bit by putting out what they're willing to invest in.
Dave Dalton:
Mm-hmm (affirmative). I'm sure you see that all the time. Great point. Hey, all three of them, this has been wonderful, covered a lot of ground here, some great content. I know we're going to do this again in a couple of months. And probably a whole series of ESG and green finance related programs. And we're looking forward to that, but let's wrap up with this for today. And we'll start with Linda. We talked about the growth in the green bond market. Over the last year we said, basically issuance volume has doubled in the last from 2018, 2019. What do you see happening in the next year to 18 months? Let's start with Linda. What are your predictions? What are your feelings in terms of where we're going and all this?
Linda Hesse:
I think I can safely predict that we will see quite extraordinary growth in this area. The European Green Deal Investment Plan alone notes that the cost of reaching their 20 30 climate and energy targets will require additional investments of 260 billion euros a year by 2030. And if we add their broader environmental and social objectives, you're talking another 100 to 150 billion a year. So there's a lot of undertakings, endeavors, infrastructure to be financed. And I think Rory made the big case that the buy-side is lapping up these offerings. The other thing is that we've only seen the tip of the iceberg. In 2019, it was energy and building that ate up 60% of the green bond issuances. And that isn't even really taking into account transport and water, which we all know is the next wave. So I think we can definitely see expanding demand and then expanding offer.
Dave Dalton:
Absolutely. Astounding potential. And Natalia, what do you see coming over the next year, year and a half?
Natalia Sauszyn:
Well, first of all, the rise of the EU green bond standard, as already mentioned. Probably also we will see more and more sophisticated products, not just green bonds, but green convertible bonds. There's been one additional tier one note issued lately in Europe, which was also labeled green, with contingent convertible features. And so I think that will be exciting. Also probably we'll see prudential incentives. The president of the European Central Bank has announced that the ECB was exploring a potential push in green bond buying. So that of course will in turn increase the green deal flow.
Dave Dalton:
Sure, sure. Lots of upside it sounds like. Rory take us home, finish us up. Do you have any other predictions or anything you'd add to what Linda and Natalia said?
Natalia Sauszyn:
Think Linda and Natalia were spot on. I mean, this to me, this is not a fad. This is not something that's going to go away quickly. We're going to see increased growth. And as Linda mentioned that Europe was very much leading the way and the US is quickly catching up. So I expect increased activity. It's just a situation where you've got to give the buy-side what they want. And you see on almost a weekly basis, big investment firms putting out what they're looking for in terms of ESG and green projects investing. So it's going to keep coming.
Dave Dalton:
I think so. Hey, you all three have been great. Linda, Natalia, Rory, thanks so much for coming today. And we're going to do this again soon, but thanks so much. Great program, incredible information. Look forward to talking to you all again.
Linda Hesse:
Great. Thanks Dave.
Natalia Sauszyn:
Thank you.
Rory Hood:
All right. Take care. See you all.
Dave Dalton:
You can find contact information and complete bios for Linda Rory and Natalia at jonesday.com. While you're there, visit our ESG insights page where you'll find information, publications, podcasts, videos, newsletters, and other valuable content. Subscribe to JONES DAY TALKS® at Apple Podcasts and wherever else quality podcasts are found. As always, we thank you for listening. I'm Dave Dalton. We'll talk to you next time.
Dave Dalton:
Thank you for listening to JONES DAY TALKS®. Comments heard on JONES DAY TALKS® should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on JONES DAY TALKS® are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit jonesday.com.
