The issuance of sovereign green bonds by France – announced in the run up to the G20 summit in early September 2016 – sends a political signal to the market stakeholders and other countries that environmental issues are becoming a top national priority.
From an economic standpoint, this could be seen as a purely symbolic act. Nevertheless, the issuance of sovereign green bonds may help France increase its climate policy ambition, assure the investors in its commitments to climate action and provide an impetus to other countries to follow suit and use this type of instrument to finance low-carbon infrastructure projects. In the long run, sovereign green bonds may become one of the possible ‘commitment devices’ that could underpin ratcheting up the ambition of Nationally Determined Contributions (NDCs) – countries’ decarbonization strategies under the Paris Climate Agreement – for both industrialized and emerging economies.
The French State joins the green finance movement
Green bonds are fixed-income securities whose proceeds are earmarked to finance or re-finance environmentally sound projects. They can therefore be viewed as ‘thematic’ bonds – similar in principle to railway bonds issued by the US companies in the 19th century – but this time dedicated to the low-carbon and climate resilient transition or other environmental objectives. Green bonds are a new asset class that has received increasing attention over the past few years as a potential tool to address the low-carbon investment challenge at scale.
The initial issuers of green bonds were international financial institutions, notably the European Investment Bank (EIB) and the World Bank, who issued their inaugural green bonds in 2007 and 2008 respectively. The market started to boom in 2013 with multibillion-worth green bonds issued by the International Finance Corporation (IFC), the French electric utility EDF, private corporations such as Toyota and Unilever among others – most of them heavily oversubscribed. In the past few years the market has thus seen a diversification of issuers – from development banks to private corporations and municipalities – as well as the diversification of underlying investments – from renewables and energy efficiency to transport infrastructure, buildings and waste.
While States represent more than 40% of general debt securities, national governments have abstained from the green bond market – until recently. On September 2 – in the run up to the G20 summit – the French government announced that France would be the first national State to issue sovereign green bonds in the amount of EUR3 billion per year for a total of EUR9 billion over the period of 2017-2019. Given the total overall issuance of green bonds of USD42 billion in 2015, the entry of the French State in this market is not negligible – especially if it is followed by other countries. Moreover, if successful, the French experience may pave the way for emerging countries to issue green bonds to lock-in financing for sustainable infrastructure. This may be particularly important for countries where only national governments are in a position to issue bonds – given lack of credit ratings and restricted access of the private sector to capital markets.
The issuance of sovereign green bonds: a strong political signal
The impact of a large issuance of sovereign green bonds by France is threefold.
First, the French government sends a political signal to the market and other countries that it considers environmental issues as a top priority. Indeed, in order to make proper investment decisions, the industry and investors alike require long-term certainty regarding national climate policies. In this light, the issuance of sovereign green bonds may be one of the means to cement commitment to climate action – particularly after COP21, the adoption of the French Energy Transition Law and the launch of the ‘Transition Energétique et Ecologique pour le Climat’ (TEEC) green label developed by public authorities. Moreover, the issuance of sovereign green bonds by France may give impetus to other States including emerging countries to do the same. This snowball effect could become an element of ratcheting up the ambition of Nationally Determined Contributions (NDCs) – countries’ climate strategies under the Paris Agreement.
Second, France sends a financial signal to project developers by committing to allocate funds raised by the issuance of green bonds to environmental projects. Indeed, should the government precise specific types of projects or sub-sectors that would be eligible for support – e.g. efficiency in buildings or small-scale renewables – market actors would receive a signal of where public support priorities are. The allocation of funds may hypothetically take various forms, such as subsidies for renewable energy projects, support for clean technology research and development or providing a contribution to the Green Climate Fund. As a concrete example, France could use the proceeds from green bonds to support the increase in the installed renewable power generation capacity to 71-78 GW by 2023 – a target presented in the draft “Pluri-annual energy planning” in May 2016. The actual ‘use of proceeds’ will have to be defined prior to the issuance. The French government will therefore be making a commitment vis-à-vis investors in sovereign green bonds and project developers. The funds raised through these green bonds will be ‘ring-fenced’ for environmental policies and/or projects irrespectively of the potential future changes in the French government.
Finally, the issuance of sovereign green bonds will help boost the expansion of the market itself. Indeed, despite its rapid growth, the green bond market still accounts for a tiny fraction of the total annual bond issuance that amounts to USD19 trillion. In order to create a ‘pulling effect’ on the investors and have a tangible environmental impact, the market will need to reach a critical mass – probably in the order of hundreds of billion USD in yearly issuance. The entry of sovereign States into the market may significantly contribute to the buildup of this critical mass and increase its attractiveness for mainstream institutional investors.
Sovereign green bonds need to be coupled with ambitious climate policies
Generally speaking, the green bond market unlocks a number of benefits by increasing the transparency of information available to investors on underlying assets. Notably, green bonds can help investors implement their long-term climate strategies and enable responsible investors to have alternatives to broaden their portfolios. In turn, green bonds can help bond issuers communicate their sustainability strategies, expand and improve relationships with debt providers and create internal synergies between financial and sustainability departments of companies or potentially between environmental and financial ministries of countries. Finally, they can support the implementation of national climate policies – as in the case of the issuance of sovereign green bonds by France.
While these benefits of green bonds may justify the existence of the market, its tangible contribution to the low-carbon transition should not be overestimated. Most notably, there is no strong evidence that green bonds directly stimulate a net increase in green investments through a lower cost of capital. Instead, green bonds help match the existing supply and demand for green investments, foster refinancing and act as a tool to ‘reduce friction’. The demand for green investments is however mainly driven by other factors – such as, for example, declining costs of renewables or climate policies in the form of direct regulations, carbon pricing or subsidies. If used properly sovereign green bonds can therefore complement climate policies and smoothen the redirection of investment flows towards the green economy.
To have a tangible impact, sovereign green bonds need to be coupled with ambitious climate policies, thus becoming a ‘commitment device’. Indeed, from the purely economic point view the issuance of green bonds does not make any difference, since France already has access to capital markets on attractive terms thanks to its credit rating. Similar to corporate green bonds issued by companies that do not have trouble accessing the capital at a low cost, the ‘financial additionally’ of sovereign green bonds may be questioned. Consequently, the risk of green bonds being demeaned as ‘greenwashing’, allowing the issuer – be it a private corporation or a national State – to continue its business-as-usual operations, needs to be addressed. To mitigate this risk, the issuance of sovereign green bonds must be coupled with increased ambition of the underlying climate policy. In the long run, sovereign green bonds could thus become a ‘commitment device’ that would be linked with tangible policies and reporting on the use of proceeds boosting the credibility of countries’ climate objectives.
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