The current trajectory of

The Future of Green Bonds STANDARDS & INCENTIVES OCTOBER 2016 Supporting investment in climate change solutions The current trajectory of climate change, expected to lead to a global warming of 4-6 C, poses an enormous threat to the future of the world s nations and economies. Avoiding such catastrophic climate change requires a dramatic reduction in global greenhouse gas emissions. The Paris COP21 Agreement, signed by 174 countries, commits to curb emissions to meet a maximum 2 C global warming target 1 and aims for only 1.5 C warming. Through the Paris Agreement governments have sent a clear and powerful signal that the scale and pace of decarbonisation must accelerate. This objective is supported by wider economic and technological trends including, for example, the rapidly falling cost of renewable energy. The challenge now is implementation. Finance will be one of the key issues to address. At the same time, entering an age of unprecedented urbanisation and related infrastructure development. Global infrastructure investment is expected to amount to USD 94 trillion to 2030 2, almost double the existing global infrastructure stock. To ensure sustainable development and halt climate change, this infrastructure needs to be low-carbon, without compromising the kind of economic growth needed to improve the livelihoods and wellbeing of the world s most vulnerable citizens. Green bonds have emerged as a key tool to mobilize capital to meet these challenges. As the Bank of England s Mark Carney says: The development of this new global asset class (green bonds) is an opportunity to advance a low carbon future while raising global investment and spurring growth. Green bond issuance has become a global phenomenon, with becoming a leading issuer this year and Indian issuance growing. Green bond market growth has many wider benefits. It can be a catalyst for wider national action on green finance and green infrastructure planning, as governments grow confident that there is private sector capital available for green solutions. But to adequately meet the challenges it aims to address, the market needs to grow much bigger, and quickly. The question now is how this can be done in the short timeframe available. Standardisation and commoditization are essential facilitators of fast growing markets, from mobile phones to housing bonds. Given the urgency of climate change investment needs, incentives will also be needed. Global momentum for green finance Paris COP21 Agreement commits to a target of maximum 2 C global warming target 1 and aims for only 1.5 C. Sustainable Development Goals, approved by the United Nations in September 2015. Green finance rising on the economic agenda and recognized as critical to supporting sustainable growth globally at the 2016 G20 leaders summit in 3. Green bond issuance in 2016 is expected to be more than double 2015 s. 1. of temperature rise by the end of the century 2. New Climate Economy, : Better Climate, Better growth 3. http://www.g20.org/english/dynamic/201609/ t20160906_3396.html

Green bonds Green bonds are regular bonds with one distinguishing feature: proceeds are earmarked for projects with environmental benefits, primarily climate change mitigation and adaptation. 3 benefits of green bonds They can support more long-term financing for low-carbon and climate resilient projects. Using capital markets to refinance operational projects allows issuers to tap into institutional investor capital. Asset-backed securities free up the constrained balance sheets of banks to fund new infrastructure projects. For issuers, green bonds attract new investors with SRI and ESG mandates and can have reputational benefits. For investors, green bonds carry an environmental benefit without having to sacrifice financial returns, enabling them to address their preference for sustainable investments. History The green bond market emerged in 2007-08 with the first few issuances by Multilateral Development Banks (MDBs). From 2007-2012, the market mainly featured issuance of green bonds by actors such as the European Investment Bank (EIB), International Finance Corporation (IFC) and World Bank (WB), along with a local government funding agencies and national development banks. and saw the start of more active participation from private sector issuers, including corporates and banks. Annual issuance of labelled green bonds rose from just USD 3 billion in 2012 to over USD 42 billion in 2015. Total issuance this year has already surpassed the 2015 total and stands at USD 51.4 billion 4. Current estimates for 2016 range from USD 80 to USD 100 billion 5, with much of this growth being due to the impact of Chinese issuers in the market. As appetite has grown, the market has become increasingly diverse with growing issuance from new issuer types, in new currencies and countries. Green bonds are about assets not entities A key characteristic is that green bonds are about funding of specific green assets and projects, not green entities per se. In practice, green bonds can finance clean energy and water projects, sustainable land-use, low-carbon transport and energy-efficient buildings. To investors, green bonds offer a stable, rated and liquid investment with long duration. To issuers, they could tap the US$100 trillion global institutional fixed income investor base. Moreover, the shift to the capital markets from banks will free up limited bank balance sheet capacity for earlystage project financing and other important infrastructure lending Mark Carney, Governor of the Bank of England and Chair of the Financial Stability Board Breakdown of the green bond market by issuer type as at 30th September 2016 $50 bn $40 bn $30 bn $20 bn $10 bn $0 bn Bank Corporate ABS Muni/provincial/city Development Bank 2011 2012 2016 estimate: $80-100 bn 2015 2016 YTD Issuance by currency USD EUR CNY SEK GBP AUD CAD ZAR BRL NOK Others $0 bn $50 bn Until the end of 2015, the most active issuers came from Europe or North America with few emerging market issuers. In 2016, rapidly emerged as a leader in green bond issuance. The amount of labelled green bonds from Chinese issuers in 2016ytd (including in the domestic and overseas markets) exceeds USD 18 billion 6, accounting for about 27% of global issuance during the same period. Other emerging markets have made encouraging steps. Green bond committees comprising the full range of market actors have been formed in Mexico and Brazil to support market developments. New regulation has been developed in India and announcements of intention have been made in Kenya and Morocco. Demonstration issuance and investment from public entities can play an important role in kickstarting green bond markets, as shown by the pioneering role of MDBs. The French and Nigerian governments have announced sovereign bond issuances for 2017 7. The development of regulations and standards can support market growth, while preserving market integrity and reducing market friction. The Chinese government has developed Guidelines for Establishing a Green Financial System, which Issuance by source 2016 ytd Canada 1% Sweden 1% Netherlands 9% Germany 9% Rest of the World 10% 11% includes the promotion of green lending and the role of securities in supporting green investment. Incentives may also be needed to scale up green bond markets to meet infrastructure needs. These are further explored in the following sections. Geographic base of issuer is broadening* 100% 80% 60% 40% 20% 0% Sweden Norway Netherlands Germany USA Rest of the World Canada 11% Supranationals 23% USA 19% India 1% Norway 1% 4. as of September 30th 5. http://www.bloomberg.com/news/articles/2016-01-26/ green-bond-market-will-grow-to-158-billion-in-2016- hsbc-says; https://www.environmental-finance.com/content/ events/green-bonds-europe-2016.html 6. Note: not all of these meet CBI taxonomy for green bonds due to the inclusion of clean coal 7. http://www.developpement-durable.gouv.fr/img/pdf/2016-09-02_-_sr_-_ms_-_greenbonds-2.pdf; https://pageone.ng/2016/09/23/nigeria-paris-agreement-green-bond/ India *figures exclude MDB issuance 2015 2016 YTD 2 The Future of Green Bonds: Standards and Incentives The Future of Green Bonds: Standards and Incentives 3

Global market update COUNTRY UK India US Mexico Australia COUNTRY DEVELOPMENTS City of London Green Finance Initiative promotes green bonds LSEX promotes green bonds listing which includes recent Chinese & Indian bonds Bank of England supports development of a green bond term sheet Green financial system guidelines published in 2016, following green bond requirements in Dec 2015 becomes largest country of issuance for green bonds in 2016 Tax incentives for green bonds proposed Central bank expects 2016 issuance to be RMB 300bn (USD 46bn) Government issues green funds guidelines with rules aligned with the Green Bond Principles and Climate Bonds Taxonomy Government announces plan to issue a green sovereign bond in 2017 Green bond issuance guidelines published by securities regulator Nine issuers so far, in both Indian Rupees and USD Greenko s recent USD 500m B+ green bond is eight times oversubscribed Largest green bonds market Tax credits available for Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs) issued by municipalities Green ABS backed by Property Assessed Clean Energy (PACE) loans NY MTA issues USD 1.2bn of certified Climate Bonds in first few months of 2016 First US green muni bonds issued in - the US muni market has grown and in 2016 accounts for almost half of US issuance. Nacional Financiera issues green bonds in USD and Pesos USD 2bn Mexico City Airport green bond in Sept 2016 is 6.5 times oversubscribed Climate Bonds Committee launched with investors and other capital markets actors Sub-sovereign issuance from the State of Victoria in 2016 3 of the 4 largest Australian banks issue green bonds in 2015 and 2016 Canada: $2.4bn USA: $29.2bn > $10bn outstanding $2bn - $10bn outstanding < $2bn outstanding Issuance expected Sweden Colombia Mexico: $2.6bn Luxembourg Peru: $0.2bn Costa Rica: $0.5bn Brazil: $1bn Swedish company Vasakronan becomes one of the first corporate green bond issuers in Swedish investors have been drivers of the green bonds market since 2007 Swedish government announces inquiry into issuing sovereign green bonds Department of National Planning-led green bonds project underway, working to bring first domestic green bonds to market Green Exchange launched for bonds UK: $1.1bn Brazil Nigeria Kenya : $15.9bn Spain: $0.6bn Netherlands: $12.1bn Norway: $2.1bn Sweden: $5.6bn Germany: $12.4bn Morocco: Green sovereign Bangladesh Philippines Denmark: $0.6bn Austria: $0.6bn Italy: $0.9bn Nigeria: Green sovereign South Africa: $1.2bn Finland: $0.5bn Estonia: $0.05bn Latvia: $0.1bn Kenya: Green sovereign First corporate green bonds issued by BRF and Suzano Papel Sustainable Market Development Council launched in September, with investors, issuers and banks represented President announces sovereign green bond will be issued in 2017 Government announces plan to issue green bond in 2017 The central bank is investing a share of foreign exchange reserves in green bonds Guarantee from the ADB for a geothermal green bond India: $2.5bn Canada Hong Kong Morocco : $15.8bn Multilateral Development Banks: $41.6bn Japan: $1.8bn Philippines: $0.2bn Australia: $1.7bn South Korea: $1.4bn Hong Kong: $0.9bn Sub-sovereign issuance from Canada s province of Ontario in and 2016 and state-owned entity Export Development Canada Prime Minister has mandated the Minister of Infrastructure and Communities and the Minister of Finance to prepare for the launch of a new Canadian Green Bond Government announces it is working on a green bond strategy Real Estate Trust LINK issues first local green bond First Moroccan green bond expected to be issued by government entity for this year s COP22 4 The Future of Green Bonds: Standards and Incentives The Future of Green Bonds: Standards and Incentives 5

Steps to scale up the market Market standards and governance The green bond market, despite its infancy, has already seen a variety of best practices, market standards and governance models emerge. There are a number of tools available to guide market participants: 1. Green Bond Principles (GBP) 8 : voluntary process guidelines around disclosure, reporting and monitoring of the bond s use of proceeds. These include an overview of eligible asset categories. 2. External reviews: opinions provided by an external organisations on how the bond complies with the four pillars of the GBP. 3. Climate Bonds Standard 9 : a framework that includes science-based sectorspecific criteria for eligible projects in addition to the GBP guidelines green bonds can be certified against the Standard. Based on the adoption and implementation of green bond standards, three models have emerged worldwide: Highly regulated: green bond issuance is highly regulated, with rules around disclosure and reporting of use of proceeds. An approved list of eligible assets is made available and mandatory requirements around external reviews may also be included. The green label needs to be approved by the regulator before the issuer is allowed to go to market. The leading example of a highly regulated market is the Chinese one, where green bonds must comply with the People s Bank green bond requirements in order to be issued. Voluntary: there is no binding regulation around green bond issuance and the bond is labelled accordingly by the issuer. The issuer can make use of an external review to increase investor confidence in the bond, comply with the Green Bonds One barrier to the development of green bond markets is the lack of clear and widely accepted definitions around what is green. This has also raised concerns around greenwashing, where the green label is misused to attract investors and leads to the financing of projects of ambiguous environmental value. This can shake confidence in the market, defy the purpose of labelling to reduce market friction and hamper efforts of a low-carbon transition. Principles or seek certification against the Climate Bonds Standard. Examples include the deep capital markets in Europe and the United States, which have seen close to USD 82 billion 10 issuance despite the lack of specific regulation around green bonds. Hybrid: Regulators promote and draw up voluntary guidelines to support the development of green bond markets, without requiring compliance with the set guidelines. Examples include: India: the Securities and Exchange Board has promoted green bond guidelines 11 ; : the Ministry of Ecology has an official catalogue of eligible green projects and assets based on the Climate Bonds Standard taxonomy 12 ; UK: Bank of England is developing a term sheet of standardised terms and conditions for green bonds. Each of these approaches is viable and carries advantages and disadvantages. More consistent standards can support market development, reduce market frictions, address the risk of greenwashing and ensure that green investments are contributing to tackling climate change. At the same time standards that are too stringent could have the undesired effect of over-restricting market participation or making compliance too burdensome for private companies to engage. The case for incentives The public sector has supported infrastructure financing for the past 150 years and is ultimately responsible for creating a clear framework to support infrastructure development. Support tools and incentives can be particularly helpful in the earliest phases of a market, as investors gain confidence and new technologies develop a performance and credit history. Central and local governments, regulators, and central and development banks can take measures to scale up green bond markets: Tax-based incentives such as tax credits or equivalent direct subsidies can both attract capital from investors and reduce financing costs for issuers. Tax incentives for bonds financing green buildings as well as renewable energy projects are present in the US. has proposed tax incentives for labelled green bonds specifically but has yet to follow through. Various countries have incentives for infrastructure financing, which could be transferred to green infrastructure investments. Credit enhancement or guarantees from governments and development banks can support access to low-cost capital in debt markets for companies that promote new technologies or are located in countries with low credit ratings. An example of credit enhancement is the Asian Development Bank s backing of a certified Climate Bond issued by the Philippine firm AP Renewables 13. To make a substantive contribution to addressing climate change, we need a trillion dollar a year of issuance by 2020 1,000 800 600 400 200 0 USD bns Actual CBI target OPIC and USAID also offer credit enhancements for green projects. 2015 Green securitisation facilitates the flow of capital to smaller projects or entities which do not have access to the bond market. While the majority of green bonds have been senior unsecured, a small but growing portion of the market is in asset backed securities which currently make up 5% of annual issuance. Public entities can work to promote securitisation of green loans. The Climate Aggregation Platform, launched at COP21 and funded by the Global Environment Facility (GEF) 14, is exploring options to promote issuance in emerging markets; and the IFC is developing a green warehousing facility for Indian rooftop solar loans. Green bond indices, ratings and stock exchange segments that promote green bond trading are increasingly available. Stock exchanges in London, Luxembourg, Oslo, Stockholm, Mexico and Shanghai have developed requirements for issuers to be included in separate green bonds lists. Luxembourg Stock Exchange has recently launched a Green Exchange dedicated to green financial instruments 16. Rating agencies Moody s and Standard & Poor s have developed green bond rating tools 17. The first climate-aligned green bond index, tracking the performance of labelled and unlabelled green bonds in launched in September 2016 15. Cross-border investment in green bonds through international collaboration promotes market harmonisation and helps to develop capability. Collaboration not only allows laggards to leverage frameworks developed internationally but also connects projects in developing and emerging countries which account for most of the financing need. Such projects 2016 2017 2018 2019 2020 will also be valuable to Institutional investors in the US, Europe and Japan that are currently struggling to find yield in depressed economies. The market is already witnessing some of these developments through the emergence of green finance hubs such as London and Shanghai. The Green Infrastructure Investment Coalition 19, launched at COP21, aims to connect green bond issuers to investors. A number of more innovative tools have yet to be used in the green bond market but could be explored by governments and regulators: Preferential risk weighting from financial regulators could operate to reduce the risk weightings for climatealigned investments. This policy has been used in the past to support other priority areas, for example in lending to small and medium enterprises in the UK and in. Alternatively, the risk weightings of high-carbon investments could be increased if there is better disclosure on the environmental performance of non-green bonds. When implementing such strategies any potential unintended consequences on financial stability should be avoided. A lower risk weighting for green bonds would also enable investment from highly-regulated pension and insurance funds in a greater variety of issuers. Preferential operations and loans from central banks to green could incentivise green bond issuance and investment, spurring market growth. The People s Bank of has recently announced that it may provide lowcost loans to banks to help them finance environmental projects 20. Targeting some reserves for green bond investment as carried out by the central bank of Bangladesh, could also be an effective strategy 21. Central banks could explore providing targeted liquidity-providing operations 22 at a lower rate or including green bonds in asset purchasing programmes and quantitative easing Green QE. When exploring each of these potential areas for action, central banks should make sure their actions do not crowd out private institutional investment. The future of the market Investor demand for green bonds continues to be strong with high oversubscription rates being the common. As companies continue to transition away from high-carbon assets and energy intensive business practices, the use of green bonds to finance this transition will continue to be a driver for issuance. With the strength of demand along with multilateral and sovereign support, we estimate that the green bond market could reach USD 1 trillion of issuance per annum by 2020 to meet climate needs. To place in context, the global bond market is estimated to be USD 100 trillion, broadly split between government (49%), financial (39%) and non-financial (12%) issuers. 8. http://www.icmagroup.org/regulatory-policy-and-market-practice/green-bonds/green-bond-principles/ 9. http://www.climatebonds.net/standards/about 10. as of September 30 11. http://www.sebi.gov.in/cms/sebi_data/boardmeeting/1453349548574-a.pdf 12. http://www.developpement-durable.gouv.fr/img/pdf/1605-labelteec_referentiel-eng-v-ok.pdf 13. https://www.adb.org/news/adb-backs-first-climate-bondasia-landmark-225-million-philippines-deal 14. http://guardian.ng/property/climate-aggregation-platform-formed/ 15. http://blueandgreentomorrow.com/2016/09/02/ ccc-launches-new-partnership-climate-bonds-initiativececep/ 16. http://www.forbes.com/sites/dinamedland/2016/09/27/ luxembourg-launches-worlds-first-green-stockexchange-lgxthe-full-green-monty/ 17. https://www.moodys.com/research/moodys-launchesnew-green-bond-assessment-service--pr_346590; https://www.globalcreditportal.com/ratingsdirect/renderarticle.do?articleid=1704625&sctartid=399652&fro m=cm&nsl_code=lime&sourceobjectid=9777755&sourcerevid=1&fee_ind=n&exp_date=20260905-21:28:10 18. Add source 19. http://www.giicoalition.org/ 20. http://www.businesstimes.com.sg/banking-finance/chinacentral-bank-may-provide-low-cost-loans-tosupport-greenfinancing-paper 21. ADD reference 22. money supplied by central banks to the economy 23. The estimation is an order of magnitude based on top-down analysis of current and projected infrastructure investment and financed by bonds rather than a detailed projection of expected green bond issuance. 6 The Future of Green Bonds: Standards and Incentives The Future of Green Bonds: Standards and Incentives 7

Examples of Leadership in the Green Bonds market CATEGORY ACTION RESULT Development bank demonstration issuance IFC and EIB issue USD 1bn and 1.5bn benchmark-sized bonds New Development Bank BRICS raises USD 450bn to support clean energy projects in multiple countries WB, IFC and EIB have issued in 18, 10 and 11 different currencies respectively Large scale issuances stimulate green bond market development and trigger corporate market growth GB programmes in regional development banks such as NDB, AfDB, ADB, NIB spur green bond market development Issuances in multiple currencies give evidence of investor demand in different markets and cater for a variety of investor needs Public institution strategic investment Treasurer of California USD 300m investment in World Bank green bonds IFC, KfW announce cornerstone investor programmes Bangladesh Bank invests foreign exchange reserves in green bonds Public announcement and media coverage stimulates demand from other investors Sovereign issuance Sovereign green bond issuance has been proposed by the governments of: Nigeria,, Kenya and Morrocco Sovereign bonds act as demonstration issuance for green bonds in new markets or can stimulate further issuance in existing markets. Sovereign green bonds are particularly important in emerging economies where corporate bond markets are not developed and credit quality is low for corporate issuers Credit enhancement & guarantees The ADB provided a guarantee for 75% of the Philippines APRI green project bond and committed to buying 15% of the bond OPIC and USAID offer green bond credit enhancement instruments Credit enhancements provide the bond with a higher rating which in turn means the issuer can access a lower cost of debt financing. Given that debt payments can make up a substantial portion of the cost of a project in emerging markets, credit enhancement can be the difference between a project s success or failure Regulatory Support People s Bank of, published official green bonds guidelines and opened up the interbank bond market to foreign investors The Securities and Exchange Board of India developed green bond guidelines in line with international practices Bank of England, is developing a green bond term sheet French Ministry of Ecology, Sustainable Development & Energy issue green fund guidelines Regulatory support through the publication of guidelines in India and have catalysed large green bond markets in both countries with 2016 issuance reaching $15bn and India s reaching $1.5bn A green bond term sheet will standardise the issuance process for a green bond and bring down the transaction costs of issuance The guidelines align with the GBP and Climate Bonds Taxonomy. Leveraging international standards can also reduce transaction costs Tax incentives US tax credits for renewable energy and energy efficiency municipal bonds People s Bank of proposed tax measures These greatly attract retail investors, which are almost 50% of the US muni market investor base Tax exemptions proposed for green bonds to attract investors Instruments London Stock Exchange Oslo, Stockholm, Shanghai Stock Exchanges Luxembourg Green Exchange LSEX provides green bonds segment; recent listings of Chinese and Indian issuances Green bond segments include requirements for the bonds to be included A Green Exchange platform launched in 2016 for trading of green securities Market development initiatives Formation of Green Bond Development Committees in Mexico and Brazil Sustainable Market Development Council launched in Brazil in September 2016, including 25 members from the financial, investor and commercial communities Climate Bonds Working Group hosted by the Mexican Stock Exchange Issuance from stateowned entities Agricultural Bank of USD 1bn green bond Bank of USD 3bn green bond and Shanghai Pudong Development Bank (USD 3bn) First green bond from a Chinese state-owned commercial bank, issued in London in two tranches in both CNY and USD The Bank of is the largest issuance from one of the top five state-owned banks and was issued in three currencies Sub-sovereign issuance State of Victoria, Australia first green bond issuance Ontario, Canada multiple issuance Victoria has indicated intention of issuing further certified bonds. Ontario has foreshadowed a third green bond issuance for early 2017 Disclaimer This report does not constitute investment advice and the Climate Bonds Initiative is not an investment adviser. The Climate Bonds Initiative is not advising on the merits or otherwise of any bond or investment. A decision to invest in anything is solely yours. The Climate Bonds Initiative accepts no liability of any kind for investments anyone makes, nor for investments made by third parties. Published by the Climate Bonds Initiative and E3G October 2016. The Climate Bonds Initiative is an investor-focused not-for-profit, mobilizing debt capital markets for a rapid tran sition to a low-carbon economy. All source data derived from Bloomberg. All figures are rounded. 8 The Future of Green Bonds: Standards and Incentives