Financing Water Resilience: Climate Bonds for China
By Lily Dai, Anna Creed, John Matthews 16 November, 2016
Matthews, Creed & Dai on the new water climate bond standard and the global & Chinese climate bond market
Climate finance at a global policy level has largely had a narrow focus: overseas aid, mostly from a few western countries, directed towards projects in the least-developed countries. Middle income nations such as China are largely excluded from these sources of finance, though the need for support for climate adaptation and mitigation projects is certainly no less urgent.
China has the world’s largest climate-aligned bond market, with a significant proportion of proceeds financing sustainable water projects
China has responded by rapidly developing a new national market for “green” and “climate” bonds designed to redefine climate finance from strictly public and national-level sources of support to a much larger pool of private sector investors. To date, China has issued USD16.7 billion labelled green bond, whereas 20% of the proceeds would be allocated to water projects. China also has the world’s largest climate-aligned bond market1, with a significant proportion of proceeds financing sustainable water projects. China’s central bank, the People’s Bank of China has estimated that the green bond market in China could reach USD46 billion in 2016.
Climate bond market: young, niche & rapidly growing
Globally, the green and climate bond market is only about a decade old. Beginning in 2007, the European Investment Bank (EIB) and the World Bank began issuing “green” bonds (also known as “climate” bonds) as a loan mechanism to show the use of proceeds applied to environment-positive projects. Though the terms are often used interchangeably, in the case of climate bonds, the use of proceeds were further refined to apply to climate change mitigation and/or adaptation projects. The standing of these institutions inspired market confidence as to the use of proceeds and the application of safeguard mechanisms, while a handful of other donor and multilateral institutions followed their lead.
However, as an investment category, green and climate bonds remained relatively niche markets with limited impact until about 2013. Issuances tripled to about USD10 billion that year after commercial finance and corporate institutions began promoting the market. These trends continued and expanded in both 2014 (USD35 billion) and 2015 (USD43 billion). To date, 2016 has seen even more explosive growth, probably running between about USD80 to 100 billion, which compares favourably with the Paris Agreement’s UNFCCC call for reaching USD100 billion for climate finance by 2020.
Green & climate bonds remained relatively niche with limited impact until about 2013…
…2016 saw even more explosive growth, probably running between about USD80-100bn
While the market pool has grown rapidly, some investors and investment journalists have become concerned that the credibility of these new bonds as environmental investments may be questionable with the new categories of issues.
But how green are green bonds?
Most were offered with the limited evidence of safeguards comparable than the original multilateral assurances2. How green are green bonds, and could the exposure of ineffective investments cause a collapse or systemic risk within the market category?
Credibility concerns & gaps in water
The need for open and independent standards was identified recently by a number of NGOs working with sustainability issues in the finance and investor communities. The Climate Bonds Initiative specifically has sought to address this challenge by establishing a Climate Bond Standard and Certification Scheme, to provide assurance and transparent, common benchmarks for the green bond market. These qualities will be key to supporting and growing the market.
Climate Bond Standard & Certification Scheme to provide assurance & benchmarks for the green bond market…
Water is a key focus for this Standard, since freshwater resources are often relatively hidden to investors, who may not readily see water embedded within energy, agriculture, and urban projects, much less how the water within one project may affect other issues and systems within the same basin. Moreover, the sensitivity of water-related investments to climate impacts highlighted special needs for these investments to demonstrate robustness and climate adaptation efficacy.
…water is a key focus since freshwater resources are often relatively hidden to investors
In mid 2014, a consortium of NGOs — Ceres, Climate Bonds Initiative (CBI), World Resources Institute (WRI), CDP, Stockholm International Water Institute (SIWI), and the Alliance for Global Water Adaptation (AGWA) — coordinated the development of criteria to score the quality of water-related investments for their relevance to climate mitigation and climate adaptation, so that they can be certified under the Climate Bond Standard. Together, they organized a series of technical and industry working groups, which defined scoring criteria for issuers and verifiers to provide investor confidence in climate bonds.
Scoring the quality of water-related investments
These criteria effectively score the climate resilience and climate adaptive potential of these bonds in addition to their environmental impact. Phase one of the work targeted traditional “grey” water infrastructure investments with the exclusion of hydropower, while phase two (now underway) focuses on both the use of nature-based solutions for water management as well as on hydropower criteria. Both phases evaluate the climate mitigation impact as well as the ability of the investment to contribute to climate change adaptation (and/or to continue delivering services even while its climate context continues to evolve — the degree of “climate proofing” of those services). These issues remain well understood and appreciated by technical groups such as engineers, scientists, and resource managers. But the level of sophistication, even basic awareness, with policy and finance groups is far more limited.
“The successful issuance & sale in 2016 of the first bond scored against the standard represents a vivid shift in investor awareness”
The successful issuance and sale in 2016 of the first bond scored against the standard represents a vivid shift in investor awareness, with dramatic reactions from the development finance, investor, and water management press3, as well as major public institutions (e.g., White House promotion of the CBI standard for 2016’s World Water Day4). The standard has gone some distance towards filling gaps between the climate change, water, and finance communities. While specialized and focused in its goals, the standard defines a niche that has the potential to provide broader credibility for both issuers and investors than has previously existed to reduce the reputational hazards that have characterized the market to date.
Indeed, the definition of climate finance itself may be expanding. While climate finance within policy circles demands a demonstration of “additionality” (i.e., going beyond traditional pre-climate change era projects to address realized or potential climate impacts) and requires stringent tracking mechanisms. By lowering barriers and raising standards, a new pool of non-ODA climate finance has emerged.
The standard’s format appears to be flexible…
… new criteria is being developed for nature-based solutions for water investments
Moreover, the format of this standard appears to be flexible and extensible. On the basis of the successful completion of the first phase of developing water criteria in early 2016, CBI, AGWA, and SIWI with support from the Rockefeller Foundation began developing supplemental criteria to evaluate and qualify nature-based solutions (NBS) for water investments.
NBS investments depend explicitly on the use of ecosystems to provide grey infrastructure-like services, such as through so-called natural or green and hybrid infrastructure. Such services could include stormwater and flood protection, water treatment, and water storage. These criteria are currently still under development with a broad spectrum of industry and topical experts and are expected to reach a public consultation period by early 2017, for application to new investments within six months of the commentary process.
1 Climate Bonds Initiative, 2016. Bonds and Climate Change: State of the Market 2016. https://www.climatebonds.net/resources/publications/bonds-climate-change-2016
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