How can we ensure environmental integrity for green bonds?

December 4, 2018


Lately, much attention has been directed towards green bonds and how these instruments can ease the challenge of funding countries’ climate action plans. These Nationally Determined Contributions (NDCs) – countries’ individual emission reduction plans and targets - lie at the core of the Paris Agreement and are currently in need of financing. Given the scale of investments needed for countries to move to climate-resilient, low carbon pathways, it is evident that more private sector investment is urgently needed to achieve the Paris Agreement.

Public resources, however scarce they are, can have an important role in mitigating risks within individual projects, for example, by creating greater assurance that investors will receive returns on investment by offering partial loan guarantees and country risk insurances. Green bonds are one such approach to leverage public resources and stimulate NDC private investment, making ambitious Paris Agreement targets a reality. Green bonds allow projects to harness financial benefits through access to international capital markets and additional sources of finance and thus provide the private sector with an attractive long-term debt financing option.

But what makes green bonds green? One of the most pronounced critics, Stan Dupre, CEO of the NGO 2° Investing Initiative, dismissed green bonds as ‘shooting for the moon in a hot air balloon’ because they are seen by some as nothing but hot air and a form of ‘greenwashing’ and should not be encouraged as means to achieve the Paris Agreement. In the center of the discussion is the lack of agreement over a global set of standards, which are vital if the positive environmental impacts of green bonds are to be independently verified and comparable across countries and projects.

However, there is general agreement that investors in climate-themed green bonds are gaining more clarity over the environmental integrity of their investment. Peter Cripps from Environmental Finance suggests that typical climate-focused green bond investors usually want assurance that a project is in line with the Paris Agreement goal. Green bonds that have a covenant that expects the issuer to refinance capital in green projects, similar to the ‘Green Investment Schemes’ under the Kyoto Protocol, and report on such green investments would contribute to more transparency in this market.

I see an increasing need for more robust standards for measurement, reporting and verification of greenhouse gas (GHG) reductions to ensure transparency and additionality of green and climate-themed bonds. Approaches that capitalize the value of the mitigation benefits can help investors gain certainty over the environmental integrity of mitigation outcomes. Banks that structure loans for infrastructure investment around monetized carbon reductions could incentivize green lending through new customized green products, develop a market for franchise lending in developing countries, and rigorously shift investment decisions towards green investments.
The climate-themed bonds such as the Paris Climate Bond introduce a climate covenant that allow the contractual enforcement of climate outcomes that contribute directly to the goal of the Paris Agreement and are measurable, comparable and independently verifiable, including how to best capitalize the value of the mitigation benefits. Thereby, they will give investors’ confidence that climate-focused investments are used in accordance with the climate goals of the Paris Agreement.

For the United Nations Development Programme, green bonds are a critical instrument to accelerate investment into zero carbon projects in emerging markets by increasing the liquidity of international debt capital markets. If designed in a way that gives greater assurance on the environmental integrity of the mitigation outcomes, green bonds can become a sustainable climate finance instrument under the Paris Agreement. This way, emerging market countries will be in a better position to mobilize climate finance and accelerate implementation of their NDCs, in line with the transparency requirements of the Paris Agreement.