Investors, get your checkbooks ready.
What started as a marketing ploy in Japan has spawned a multibillion-dollar industry, and now green bonds could make their debut in this country as early as next month.
A group of young, ambitious bond salesmen in Japan came together in the early 2000s to create a new sales pitch that by the end of last year had bloomed into a US$53.2 billion market. The rebranding of the Uridashi bond focused on an environmental theme that struck a chord among the older Japanese population.
These generations remembered the devastation from the Second World War when the first and only warfare atomic bomb was dropped by the US at Hiroshima and Nagasaki. Older Japanese recalled the water and air pollution that in the late — 1950s created new strains of disease such as Minamata that resulted in fatalities in as little as a month. It was later discovered that this was a result of heavy-metal poisoning.
So when these salesmen began to search for new ideas to market bonds, the environment seemed to be a natural selection. And the idea of a “green bond” was developed. Green bonds are a financial instrument designed to help to propel clean energy projects. The capital raised by the bond is used to provide loans for green projects such as refitting old buildings with energy efficient light bulbs.
A bond is similar to a fundraiser such as a Girl Scout selling biscuits for her local troop; the money from sales goes toward projects such as camping weekends. To make it green, the project would need to have certain environmental qualifications, such as the Girl Scouts Forever Green programme.
Unlike a traditional fundraiser, conventional bonds require that all financial contributors receive a payback with interest.
For Japan, this idea grew into an even larger market with the green Uridashi bond expanding into the car sector last year. Toyota issued a $1.75b green asset-backed bond — backed by car leases and loans that are earmarked for future green vehicles (electric or hybrid cars, for example).
It did not stop there.
The Development Bank of Japan (DJB) issued its first €250 million green bond in the European market in October. The proceeds will be used to finance loans given by the bank for green building certifications such as having a certain percentage of energy efficient measure installed in a building.
Strong demand for the bond came from various investors with an interest in supporting green projects. In fact, the demand for this reached more than €750 million (Dh2.95bn). Tokyo-based Daiwa Securities Group, an underwriter for the DJB green bond, says it was the first green bond in the European market issued by a Japanese issuer. “[The DJB green bond] is an enviable success story, and a fine example for others to follow,” adds Christopher Brown, the head of investment banking at Daiwa Capital Markets Europe.
Yet, despite the green bond issuance market increasing more than threefold to US$36bn last year on 2013, according to the Climate Bond Initiative (CBI), the UAE is still uncharted territory. However, the race is on to release the world's first green sukuk, or Sharia-compliant environmental bond, and this country is looking like a strong contender for the first issuer of a green sakk (the singular of sukuk).
Green sukuk, as with traditional sukuk, differ from non-Islamic bonds in that they do not pay interest but instead grant the investor a share of an asset, along with the commensurate cash flows and risk.
Andy Cairns, the National Bank of Abu Dhabi (NBAD) managing director of debt origination and distribution, believes the UAE will see its first green sukuk issuance this year. “We’re talking to a number of issuers in the region, particularly around opportunities in green sukuk,” he says.
Mr Cairns adds that green sukuk appeal to a more versatile group of investors. Instead of hitting the conventional bond buyers, a green sukuk can attract conventional bond investors to those diversifying their portfolios.
Some western firms have made recent announcements allocating a portion of company investment to go toward energy efficient schemes. The UK financier Barclays said it would invest at least £1bn (Dh5.53bn) in green bonds from issuers by November.
Switzerland’s Zurich Insurance announced that it would invest $1b in green bonds that provide a market return. The company’s chief investment officer Cecilia Reyes says it is a win-win situation. “These bonds let investors finance environmentally-sustainable projects that help communities mitigate and adapt to climate change,” she says.
“They allow us to invest for sustainable impact at a return fully compensating for the risk.”
Nicholas Pfaff, the director of regulatory policy at the International Capital Market Association, says: “The idea is that there is obviously a very large amount of money being raised on the asset management side as well as through public entities to invest in green project.
“That money is looking for a home.”
According to CBI, the amount could total $100bn by the end of the year. Sean Kidney, the chief executive of CBI, says market drivers for this type of bond are based on three points.
The first is investor diversification or, basically, bringing new investors into the market. It is similar to what the Japanese bond sellers did when they created their new market pitch to tap environmentally conscious buyers.
Second is the “stickiness” factor, meaning a deeper engagement with investors that are interested in green projects. Creating a financial tool that an investor feels a deep connection with, such as a solar project in a village in Africa, will keep that investor engaged and loyal. “People will stick with you through thick and thin even if they don’t [understand the bond market],” says Mr Kidney.
And last is that this is a buy and hold market, meaning that investors buy up the bonds and hang on to them. These types of instruments are not traded like normal bonds. Mr Kidney says this is because investors prefer the “extra green liquidity” because there simply is not that much on the markets.
He says these bonds are often over-subscribed four to five times. “As a result, we have investment banks around the world trying to get onboard,” he adds. “We will definitely see $50bn of issuance by the end of this year, but we have a reasonable shot of seeing $100bn.”
The strong market demand for green bonds is why CBI was officially launched, five years ago, and resulted in a group that sought to establish a set of guidelines for the new financial mechanism. CBI, comprised of various financiers, set out to foster the long-term debt to fund low-carbon projects. The group came up with a set of guidelines that include various sectors of the green bond sector, from issuers to underwriters to project qualifications.
“Green bonds allow you to acquire a new source of leverage,” says Mr Pfaff. “Even if you can convert a small portion of the fixed-income market to green bonds, you’re talking about a very substantial amount of money.”
But what will it require for the market to really take off in this country or the wider GCC?
Ammar Shams, HSBC’s regional head for corporate sustainability, says that in fixed income markets, such as the UAE, green sukuk are a “natural choice”.
He says there needs to be a clearly identifiable and measurable business case to support a clean-energy project. For private businesses, as opposed to government entities, the issue is that it is a long-term commitment. “Most of these projects run on a 15 to 20 year power purchase agreement.
“The numbers may change, but the principle remains the same. We want clarity on the exposure and risk and as long as there is clarity, the project is bankable and we’re interested,” Mr Shams says.
Mr Kidney adds that all it would take is one issuer to come out in the region to show the demand. He says CBI has had a green sukuk working group based in Dubai for a couple of years. “Many issuers have been talking about it, but we just need some demonstration issuance out there to show the way.”
lgraves@thenational.ae
Follow The National's Business section on Twitter
