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THE EUROMONEY
ENVIRONMENTAL FINANCE HANDBOOK
2010
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Green bonds: a model to mobilise

private capital to fund climate change
mitigation and adaptation projects
by Heike Reichelt, The World Bank1

The capital markets will need to play an important role in mobilising

private funding for climate change mitigation and adaptation projects.
However, to raise the funds required to make an impact in the fight
against climate change, investment products must be designed to
appeal to investors with a substantial asset base. Pension funds and
sovereign wealth funds have large allocations to fixed income. Green
bonds are an example of an innovative fixed income investment product
that appeals to investors for this asset class and can pave the way for 1
the next phase of products to mobilise significant capital to finance
the greatest challenge faced by our generation.

Climate change is a problem of

global proportions
Estimates of financing needed to mitigate the effects of
climate change range from about US$200bn to US$1,000bn
a year.2 At least tens of billions of dollars each year should
be added to finance the cost of adaptation caused by an
inevitable amount of global warming that the world will
experience.3 Clearly, the task is too great for government
resources alone to tackle, especially in developing
Heike Reichelt
countries.4 Private investment is urgently needed to
supplement scarce government funds and credit. On a Head of Investor Relations and New Products
large scale, this can only be generated through the global The World Bank
financial markets, with innovative solutions across asset tel: +1 (202) 477 2880
classes. New products must have the right financial fax: +1 (202) 477 8355
incentives to attract private investment5 and use public
e-mail: [email protected]
credit efficiently.

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Climate-related investment the end of 2008, pension funds alone had about US$25
trillion of assets under management.12 Although many have
opportunities
been increasing allocations to alternative assets classes,
Climate-related investment opportunities have emerged in fixed income still makes up about 25% to 40% of their
response to investor demand across asset classes. A rise in assets. And sovereign wealth funds managed almost US$4
the number of investors who incorporate environmental, trillion, with about 35% to 40% of their assets allocated to
social and governance criteria (ESG) into their analysis6 has fixed income.13 Regardless of whether these investors
supported this trend. Many are going a step beyond an pursue ESG strategies or not, the numbers show that there
ESG approach and specifically developing environmental is a large untapped potential in the fixed income space to
strategies7 and incorporating climate change into their access capital for climate-related sustainable development
decisions.8 Considering climate as part of the investment through investors that value both liquid high-grade
process has potential short- and long-term financial
investments and contributing to climate change solutions.
implications and longer-term consequences for humanity.

Investors can choose climate-related investments in a

Extraordinary challenges require
variety of asset classes.9 So far, such opportunities have
extraordinary solutions
been more concentrated in equity – both private and
public – rather than fixed income. Private equity allows The World Bank has been designing investment products
investors to target ‘green’ investments like renewable that raise awareness for and support the financing

2 energy more directly, but it also lacks liquidity and

requires significant up-front due diligence costs. And
climate change mitigation and adaptation. As an issuer
of debt securities, it has focused on products for
allocations to private equity tend to be small. Although investors’ fixed income allocation. The popularity of the
allocations to public equity are larger and are considered ‘cool bonds’ and ‘eco notes’ launched in 2007 and 2008,
more liquid, most options offer opportunities to invest in
big companies where renewable energy is only one of
many business areas. Green bond 101
Green bonds are a ‘plain vanilla’ fixed income product
Though the equity markets are an important source for that offers investors the opportunity to participate in the
channelling resources into projects that support solutions financing of ‘green’ projects that help mitigate climate
to problems created by climate change, tapping that capital change and help countries adapt to the effects of climate
can be challenging – especially in times of crisis in the change. The bonds have similar features to regular bonds
financial markets.10 Government fiscal stimulus packages by the issuing entity, including credit risk and size.
focusing on green investing are starting to support these Because of the standard financial features and the
companies in search of financing,11 but resources are dedication to climate change, they are of interest to a
limited. There is dire need to find other sources of private broad range of investors – from retail and high-net-worth,
capital and try to benefit from public credit enhancement to to institutional investors with large allocations to fixed
use available public credit efficiently. income. They are especially attractive to investors who
incorporate ESG into their analysis, pursue specific
To succeed in channelling larger sums of capital into green
environmental strategies and/or have a separate asset
initiatives, investment products must appeal to investors
class for climate-focused investments. A key feature of
with large volumes of assets under management. In
these bonds valued by many investors is the due
today’s markets, these are with pension funds,
diligence process that the issuer of green bonds
endowments, asset managers and sovereign wealth funds.
conducts to identify and monitor ‘green’ projects.
According to International Financial Services London, at

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showed that investors are interested in products that The success of these initiatives showed investors’ interest
offer both appropriate risk-adjusted returns and in climate-related investments and – through the associated
contribute to the climate. Other issuers, such as the hedging activity – created incremental demand for carbon
European Investment Bank (EIB), also appealed to credits and green equity. However, the amounts raised
similar investors with the climate awareness bond were not as large as they could have been, because these
issued in 2007. 14 structured products sought mainly to attract individual

Green bond issuance to date22 Exhibit 1

Summary of first US dollar-denominated green bond terms

Issuer International Bank for Reconstruction and Development (IBRD)
Rating Aaa/AAA
Total amount US$300m
Investor State of California Treasurer’s Office
Settlement date April 24, 2009
Maturity date April 24, 2012
Coupon Floating rate
Lead manager SEB

3
Summary of inaugural green bond terms
Issuer International Bank for Reconstruction and Development (IBRD)
Rating Aaa/AAA
Tranches Tranche 1 Tranche 2 Tranche 3
Launch date Nov. 6, 2008 Nov. 14, 2008 Feb. 6, 2009
Amount kr2.325bn kr375m kr150m
Settlement date Nov. 12, 2008 Nov. 24, 2008 Feb. 13, 2009
Aggregate amount kr2.85bn
Maturity date November 12, 2014
Coupon 3.5% (per annum)
Lead manager SEB
Syndicate Credit Suisse International - senior co-lead manager
Landesbank Baden-Württemberg - co-lead manager
Investors AP2 (second Swedish national pension fund)
AP3 (third Swedish national pension fund)
Länsförsäkringar Bank & Försäkring
MISTRA
Skandia Life
The United Nations Joint Staff Pension Fund
Others

Source: The World Bank

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Project eligibility criteria for World Bank green bonds and project examples Exhibit 2

Proceeds from World Bank green bonds are used to support projects that address the climate challenge as selected by
World Bank environment specialists based on a predetermined set of criteria that promote low-carbon development.
These bonds allow investors to take advantage of the World Bank’s rigorous process of appraising and implementing
suitable projects, as well as monitoring their effectiveness in countries that the investors would not normally be able to
invest in without an expensive due diligence process.21

Examples of the types of mitigation projects supported by green bonds are:

• rehabilitation of power plants and transmission facilities to reduce greenhouse gas (GHG) emissions;
• solar and wind installations;
• funding for new technologies that result in significant reductions in GHG emissions;
• greater efficiency in transportation, including fuel switching and mass transport;
• waste (methane emission) management and construction of energy-efficient buildings; and
• carbon reduction through reforestation and preventing deforestation.

Examples of the types of adaptation projects supported by green bonds are:

• protection against flooding (including reforestation and watershed management);
• food security improvement and stress-resilient agricultural systems (which will slow down deforestation); and
4 • sustainable forest management and preventing deforestation.

Following these criteria, projects like the following would be eligible for support from World Bank green bond proceeds:
• energy efficiency investments in China that reduce the energy consumed and associated GHG emissions
in medium-sized and large industrial enterprises, and in central heating and gas services
for municipalities;
• generating alternative energy in rural areas of China through methane capture and other biogas technologies
associated with rural farm production;
• helping to install new energy-efficient and solar thermal technologies in public buildings in Montenegro;
• scaling up renewable energy systems in Argentina; and
• an integrated climate change approach, that supports renewable energy and energy efficiency, reforestation and
sustainable forest management, and soil carbon conservation in Mexico.

Source: The World Bank

investors. They were not pure fixed income products and, investors who had both significant allocations to fixed
thus, not designed for institutional investors’ fixed-income income and a strategic interest in investing in the climate
allocations. Green bonds are starting to focus these large with their assets, and reached investors who would not
investors on climate-related financing activity and otherwise have purchased World Bank bonds. This
broadened the investor base for climate-related products. validated the notion that an issuer can broaden its investor
Green bonds take investor interest in ‘green’ capital base by providing ‘green’ products and that investors are
markets finance a step further. The World Bank green focusing on climate-related investment opportunities as
bonds, for instance, appealed to large institutional part of their fixed income allocation.

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World Bank green bonds: paving bonds so far are small, relative to the estimated amounts
needed to fill the climate change funding gap, they serve
the way for innovative fixed
as a first step and model to mobilise private sector
income solutions
financing from large institutional and retail investors for
In November 2008, responding to investor requests, the climate change solutions. As more investors integrate
World Bank offered a fixed income product dedicated to climate change risks and opportunities in their asset
supporting climate change mitigation and adaptation management process, there will be stronger incentives for
projects in developing countries.15 The product was market participants to design more financial instruments
developed in close collaboration with SEB and the group of for investors interested in putting their assets to work for
investors for the inaugural World Bank green bonds. financially sound investments that also have a positive
Proceeds from World Bank green bonds are credited to a impact on climate change. Having standardised criteria for
special account that supports World Bank loan project eligibility (as far as possible) and other minimum
disbursements on qualifying projects in client countries.16
financial characteristics (size, rating, structure) plus a
The appeal of the product lies in its simplicity – the credit rigorous governance and due diligence process for project
quality of the bonds is the same as that of other World finance will help index providers put green bonds into a
Bank triple-A rated bonds, it is a ‘plain vanilla’ structure, a fixed income ‘Green Index’17, so that investors who
liquid instrument – it can be traded as easily as other manage their assets based on an index add the bonds to
‘plain vanilla’ bonds issued by the World Bank, and offers their portfolios.
a competitive return. With these characteristics, it fits the
requirements of core portfolios of large fixed income
The investor interest in World Bank green bonds has
already captured the attention and imagination of other
5
investors. In addition, bond proceeds support activities
issuers – including governments – who recognise green
that have a positive impact on climate change.
bonds as a way to tap private capital to support their own
World Bank green bonds generated significant interest climate change mitigation and adaptation efforts.18 As
worldwide. They reached investors who did not normally issuers recognise the product’s potential, they can replicate
purchase World Bank bonds. Investors took the it to take advantage of the opportunity to diversify their
opportunity to diversify their fixed income portfolio investor base, raise funds for their ‘green’ activities and
holdings through a product that met the risk-adjusted raise awareness for their climate change efforts.
return expectations for their core portfolios and let them
World Bank green bonds can be seen as an experiment that
take advantage of the World Bank’s due diligence process
demonstrated that the capital markets can be a source of
in identifying and monitoring suitable projects in
funding for climate-related initiatives. But triple-A rated
developing countries.
public credit that can be used to channel funds to mitigation
and adaptation projects is scarce. To mobilise resources in
Looking to the future: finding the the massive scale that is needed to tackle climate change,
next generation of green bonds the next step must be to design fixed-income products that
optimise the trade-off between volume and credit.
The urgency of the climate change issue and investors’
interest in ESG issues is supporting the growth of a Investment opportunities must be created that will attract
‘climate’ asset class to which institutional and individual the maximum volume of finance with an efficient use of
investors are increasing allocations. Green bonds are a direct or indirect sovereign credit. Innovative solutions are
fixed income product that supports initiatives that cut needed to blend government credit into activities in which
greenhouse gas (GHG) emissions and help countries adapt mitigation or adaptation activities generate cash flow
to climate change. Although funds generated from green returns that, with appropriate credit-enhancement, can be

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moved from investors’ small allocations to alternative 2007 to 2008, there was a rise from 30% to 50% in the proportion of
asset owners questioning existing and potential managers on how
investments, to the mainstream fixed income allocation in
they integrate climate change into their decision-making activities.
the portfolios of the largest investors. Green bonds could 9. Investment consultants analyse implications that climate change
develop from a simple, high-grade product to a more scenarios have on portfolio structuring and recommend possible

complex one that appeals to investors with different risk actions investors can take to manage the climate change risk in their
portfolio and take advantage of investment opportunities in various
habitats - those looking for high-grade products (with
asset classes. Mercer is undertaking a new project in this area as a
credit-enhancements) and others searching for higher yield collaborative effort that will be carried out with some of the leading
potential, taking on more credit risk. Products such as pension and wealth funds from around the world.
19 20 10. According to the World Wealth Report 2008, investment by
‘rainforest bonds’ or ‘energy efficiency bonds’ with
individuals in the clean technology sector rose by 41% from 2005, to
different risk characteristics and tranches could be issued a total of US$117bn in 2007. But the World Economic Forum’s
or credit-enhanced by multilaterals or governments to Report on Green Investing states that by the end of 2008, the
volume of clean energy investment had dropped by over half from its
support specific climate change activities. Private capital
peak at the end of 2007, and public market funding for clean energy
can be mobilised if products are designed that fit the businesses also decreased significantly, with valuations down by
risk/return characteristics, offer portfolio diversification, nearly 70% during 2008.
provide liquidity and give investors opportunities to benefit 11. Such as: American Recovery & Reinvestment Act of 2009 (see:
http://www.epa.gov/cleanenergy/documents/local_guide_to_arra.pdf).
from the success of projects that address climate change.
12. International Financial Services London (IFSL) Research, March 2009.
Notes: 13. Fernandez and Eschweiler (2008) estimate that total assets of sovereign
1. The author would like to thank: From the World Bank: Doris Herrera- wealth funds are invested about 35% to 40% in fixed income, 50% to
Pol and Kenneth Lay for their leadership and guidance; Arjan 55% in public equity, and 8% to 10% in alternatives – with the bulk in

6 Berkelaar, Andrea Dore, Farah Imrana Hussain and Couro Kane-Janus,

Urvi Mehta and Judith Moore for their contributions to the article and
private equity followed by real estate and hedge funds.
14. For a summary of the terms of these bonds, see: The Euromoney
green bonds; Christopher Flensborg (SEB) for his work in developing International Debt Capital Markets Handbook 2009: Capital markets
the green bond product; Steven Falci (KBC Asset Management) for his as greenhouse gas emission reduction drivers, pg33.
input and work on the topic; and CICERO and oekem research for their 15. To date, Scandinavian investors including AP2 (second Swedish
support to innovation in capital market finance for climate change. national pension fund), AP3 (third Swedish national pension fund),
2. United Nations Framework Convention on Climate Change (UNFCCC), Länsförsäkringar, MISTRA, Skandia, and the State of California
2008 – UNFCCC 2007 Report on Investment Flows, Dialogue Working Treasury, the United Nations Joint Staff Pension Fund, and others
Paper 8, Stern, Nicholas; The Economics of Climate Change: The have invested over US$665m in World Bank green bonds.
Stern Review, 2007. 16. Selecting the climate change criteria for mitigation and adaptation
3. Development and Climate Change: A Strategic Framework for the activities was part of the product development. The World Bank’s
World Bank Group, Technical Report 2008. environmental, energy, and climate change experts recommended
4. It is estimated that dedicated resources cover only about 5% of key criteria that would support low-carbon development. SEB agreed
funding needed for mitigation and adaptation. that projects that met these criteria would be of interest to their
5. To stimulate investment opportunities, McKinsey & Company has investors. In addition, the criteria underwent an independent third
published extensive research on how financial institutions can party review by the Center for International Climate and
develop a climate change strategy to profit from a low-carbon Environmental Research at the University of Oslo (CICERO). CICERO
economy, including a detailed analysis showing the potential GHG concurred that, combined with the governance structure of the
savings for various technologies (global carbon abatement cost World Bank and safeguards for its projects, the criteria provided a
curve). McKinsey & Company, Pathways to a Low-Carbon Economy, sound basis for selecting climate-friendly projects. Oekom research,
February 2009. a rating agency for sustainable investments that is based in Munich,
6. United Nations - Principles for Responsible Investments (PRI), July Germany, also analysed the product. Based on their analysis, oekom
2009; In 2009, 63% of surveyed asset owners put responsible research is supportive of World Bank green bonds as an investment
investment elements into contracts for the external managers of product that may be of interest to investors pursuing sustainable
their investments, up from 38% in 2008. investment strategies.
7. KBC Asset Management, Secular Growth Opportunities in Global 17. Equity indices have been created to respond to investor demand for
Equities: Environmental Strategies, May 2009. investment strategies that incorporate opportunities and risks
8. Investor Statement on Climate Change Report 2008, Institutional associated with the effects of projects and companies’ business on
Investors Group on Climate Change (IIGCC): asset owners are the climate, including ABN Amro’s Eco Price Return Index, HSBC’s
increasingly taking steps to encourage their asset managers to Global Climate Change Benchmark Index, the GEI series launched by
incorporate climate change into their investment analysis – from KLD and Jantzi, in addition to larger providers such as S&P, FTSE

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and Dow Jones. There are also corporate bond indices that enable investors opportunities to invest capital in emerging market
credit investors to make return-driven investment decisions that countries implementing a green agenda.
take into account risks and opportunities issuers face as they 21. See World Bank Sustainability Report: Focus on Sustainability,
address climate change, but so far there is no ‘Green Bond Index’ 2005/2006, Chapter 4: http://go.worldbank.org/HL5D9KMEN0; How
that includes only bonds like the World Bank green bonds that raise the Project Cycle Works: http://go.worldbank.org/GI967K75D0;
proceeds specifically to support investments in climate change Safeguard Policies: http://www.worldbank.org/safeguards;
mitigation and adaptation activities. Disclosure policy: www.worldbank.org/disclosure; The Quality
18. For example, in March 2009, a ‘US Green Bank’ was proposed to Assurance and Compliance Unit: www.worldbank.org/qag; An
provide financing support to clean energy and energy efficiency Independent Inspection Panel: www.worldbank.org/inspectionpanel;
projects in the US that suggests financing from ‘green bonds’ issued The Independent Evaluation Group (IEG): www.worldbank.org/ieg.
by the US Treasury. It was proposed that the US Department of 22. See: http://go.worldbank.org/LFS55Z7LL0;
Treasury would provide the Green Bank with an initial capitalisation of http://treasury.worldbank.org/newsinvestors.
US$10bn through the issuance of green bonds (see: http://frwebgate.
access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:
h1698ih.txt.pdf).
19. An initiative by the Prince of Wales is developing a proposal in Contact us:
collaboration with investors and institutions such as the World Bank
The World Bank
to raise funds from investors through ‘rainforest bonds’ as part of a
mechanism to compensate nations with rainforests for not 1818 H Street NW, Washington, DC 20433, US
deforesting. More information is available at:
http://princes.3cdn.net/f29d276ce664b2db67_y6m6vtxpe.pdf.
tel: +1 (202) 477 2880
20. The World Bank, in partnership with government officials in two web: www.worldbank.org
pilot countries, is looking at possibilities for governments to finance
energy efficiency activities through structures linked to green e-mail: [email protected]
investments, such as through ‘energy efficiency bonds’ that offer
7

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