How do Asset-linked corporate bonds work?
The corporate bond market is the sector currently most active at present, with strong investor demand for investment grade product. The Climate Bonds Initiative believes that companies could be encouraged to steer effort to low-carbon industries if they were able to tap new investors interested in those low-carbon activities.
Asset-linked corporate treasury guaranteed bonds are simply corporate bonds where the funds have been ring-fenced to “qualifying” areas of investment.
For a bank, they can be ring-fenced to existing loan pools, say for wind and solar energy, or to planned project loans. (The Climate Bond Standard specific that funds must be expended within 12 months of the bond will be decertified.)
Ring-fencing does not require an SPV or legal separation. It simply requires internal tagging and internal procedures to ensure that the amount of the pool does not drop below the amount of the bond. In that sense an asset-linked bond is similar to arrangements for a covered bond cover pool, but without recourse to the pool.
This is the same model used for the earmarked bonds issued by the World Bank (“Green Bonds”) and the EIB (“Climate Awareness Bonds”, each linked to low carbon investments. “Wind bonds” issued by utilities operate on the same principle. The same principle can be applied to corporate bonds more generally to access interested investors.
Special purpose bonds have been issued before – such as war bonds in the UK in the 1940s and highway bonds in the US in the 1950s – and could be again for the purpose of investing in the low carbon economy.
There are challenges as RWE’s 2012 wind bonds demonstrated – the company changed its mind about what to do with the money raised six months after issuing the bond. This indicates the need for clear Standards for issuance and for third party verification of corporate claims – but the principle remains.
The advantage for the investor with an asset-linked bond is that they have no credit exposure to what are still seen as “novel” assets, but get the reputational and socially responsible investing benefits.
Benefits?
- Access to new investors interested in the climate theme.
- Reputational.
- Opportunity to educate investors about the cover pool, preparing them for later asset-backed security issuance.
The first certification was done last year for an Australian bank. That is expected to debut early this year as a 7 year, $500m bond.
What’s the process for gaining certification as a Climate Bond?
The process is as follows:
- Originator/bank commisions independent verifier (DNV, KPMG or Bureau Veritas) to review offering. The verifier is basically ensuring the bond meets the criteria spelt out in the Standard (see http://standards.climatebonds.net), including type of investment (wind or solar energy at the moment, but energy efficiency will be added for buildings mid-year).
- Costs vary depending on the type of bond: asset-backed or project bonds will be less cost than a corporate asset-linked bond like the World Bank’s Green Bond. A verification recently completed for the latter cost roughly £30,000. A project bond would be considerably less.
- The verification report then goes for final sign-off to the Climate Bond Standards Board. There is a nominal 1/10th of a basis point charge here.
- The originator then has rights to use the “Certified Climate Bond” kitemark and the Climate Bonds Initiative also brings the bond to the attention of our broad investor stakeholder community.
Do Certified Climate Bonds have to be secured (asset-linked)? – or, could you change the use of proceeds language in an existing set of MTN documentation to say that proceeds will be used to finance a particular project?
Does a Certified Climate Bond have to be secured against the assets / cashflows?
Basically, we’re looking at corporates issuing large (c.£500m) benchmark debt in public markets in the simplest way possible (i.e. using existing documentation (with slight amendment for use of proceeds), unsecured, etc) – these company’s have large green investment plans across a variety of projects, if we could change the use of proceeds language to include the financing of a series of projects would that be enough for the verifiers?
The fees are negligible really in the scale these corporates are looking at, but they wont go for it if its excessively more complicated than a regular new issue.
I think that should be fine – all we’re looking for is a clear and traceable (but not necessarily legally constituted) relationship between the funds and the assets to which they are linked.
The first iteration of the Standard is in fact meant to support exactly the style of bond you’re describing.
How open are the Verifiers to dialog about nominated projects? If we have a book of potential projects over the next 12 months, can we work with the verifiers to identify the best projects to assign the funds too?
The question will be whether they fit our stated eligibility criteria; the verifier’s job is to check that whatever you want to have as nominated projects comply with the published criteria; they otherwise won’t mind what you have or out.
For wind and solar it’s pretty straightforward; for energy efficiency and bioenergy it’ll be a little more complicated. Main issue will; be that we have’t finished the process of publishing criteria in some areas; for those we’re happy to talk through what would and wouldn’t be OK based on where the process is up to.
Does the currency the Climate Bond is raised in have to be the same as where the project is?
I.e. Could a company issue a CBI certified bond in Dollars but use the proceeds to fund a green project in southern Europe in Euros?
The currency of the Climate Bond does NOT have to be the same as that for the projects. So, yes, you could issue a Climate Bond in Dollars while the projects are in Euros. What’s important is that there is a transparent link between the proceeds of the bond and the projects.