What you need to know about green bonds: from definition to principles

15 min approx | 10 November 2020

Remco Bleijs: 

Welcome everyone to this podcast. My name is Remco Bleijs, Head of Sustainable Finance Netherlands, and in this podcast, I will talk about green bonds. Green bonds were introduced to the world more than a decade ago, and have increased tremendously in number and in value over the years. Especially in the most recent years, the issuance of green bonds has been skyrocketing as a great variety of companies, including some of the world’s largest banks and consumer goods companies, issued their own green bonds. Green bonds are an example of sustainability bonds. Sustainability bonds are debt instruments, the proceeds of which are used to finance all kinds of sustainable assets and operations, relating to environmental, social and corporate governance (ESG) factors. It’s a type of sustainability bond, just as, for example, social impact bonds are. This podcast discusses the concept of green bonds.

First, I’d like to give a brief definition of what a green bond is.
A Green bond is a debt instrument by which investors finance sustainable assets or operations within a company, with a direct focus on reducing the environmental impact or improving the positive influences a company has on the environment. The issuer of such a financial instrument reports on the operations that have been established by using the funds (which have been received through the green bond). A third party, such as the EY organization, often provides assurance to verify whether the funds are truly used for environmental purposes, and that the report includes transparent information on these operations. Also, assurance on the impact of the bonds is provided.

But why use green bond reporting assurance? Why do we think it is important to provide assurance on this new type of investment?
The Financial Times posted an article on “The dark side of green bonds”, which raised several good questions on the believability of green bonds. Some of them were: Is the green bond just another case of “greenwashing”? Are the increased funds really used for environmental purposes? And the most interesting one is: Are the proceeds of green bonds channeled to new environmental investments, or would they finance projects that would have been funded anyway, releasing a budget for other purposes. Assurance can be an answer to such concerns.

As the green bond market grows, it is becoming increasingly important for the issuer to provide their report with an external assurance statement. This bolsters investors’ confidence on the use of the bond proceeds, as well as the management of the funds, and enhances the trust that investors place in the company’s sustainable assets or operations. This is like, for example, an assurance statement to a company’s annual report.

In addition, the enhanced quality of the reporting obtained through the assurance throughout the green bond cycle will not only provide reliable information to the stakeholders but will also provide early insight in potential risks regarding misuse of the proceeds and funds, and hence will prevent greenwashing risks.

The balanced assurance on the bonds’ quantitative and qualitative performance indicator disclosures also provides in-depth information for the issuer and other stakeholders. This information will play a critical role in making informed decisions. A key concept of assurance is the aspect of the internal control environment of the information that is being assured. Assurance providers offer feedback to the issuer on their own internal control, over the processes in place, to gather the data relevant for green bond reporting.

An important factor that I’d like to mention here is the upcoming “EU action plan on sustainable finance (Sustainable Finance Action Plan)”, including the EU Taxonomy. The taxonomy regulation will require financial market participants offering products with sustainability or ESG objectives in the EU to disclose the product’s percentage of taxonomy-alignment, and elaborate on which of the six environmental objectives of the taxonomy it plans to pursue. Having the green bonds assured against standards such as the EU Green Bonds Standard (GBS) will benefit the issuers, while attracting investors (since the EU GBS would be aligned with the EU Taxonomy).

Let me take you through a typical life cycle of a green bond.

Broadly, the issuance of a green bond can be separated into four stages:
1) Defining the green criteria
2) Issuing the green bond
3) Monitoring performance
4) Reporting performance

In the first stage (defining the green criteria), the issuer of a green bond determines what standard and associated guidelines to use in reporting on green bonds. The most commonly used set of standards are the Green Bond Principles (GBP), the Climate Bond Certified (CBC) and the EU GBS, all of which provide criteria to which a green bond must adhere. Organizations often develop their own criteria based on these frameworks. I will talk more about the different frameworks later in this podcast.

In defining the green criteria, the common practice is to use a second party to express an opinion on the Green Bond Framework that has been adopted. As organizations often develop their own framework on the basis of the frameworks that I mentioned before, this can be quite helpful. A second party can also express and give opinions on whether the chosen operations are in fact “green,” by measuring the assets or operations against certain criteria.

During the second stage, issuing the green bond, the issuer determines the characteristics of the instrument, including tenure, issue size, prepayment and penalty clause. This information is drafted into a prospectus. In this prospectus, the Green Bond Framework is also stated, as well as the performance indicators that measure the outcome and impact of the operations. These figures are especially important when evaluating whether the green bond investment actually leads to environmental improvements.
We have come to the third stage, monitoring performance. Here, the proceeds of the investors have been flowing into the company and the firm can use these proceeds to start working on sustainable operations. After all, the green bond has been issued for the purpose of environmental investments, and not just as a normal cash infusion. At the same time, a company must measure their performance on these operations and projects in order to provide the investors with the necessary information. Information has to be gathered, and reviewed and reports have to be drafted against the criteria that have been mentioned before.

In the last stage, reporting performance, the performances of the company are reported to the investors that have invested into the green bond. Transparency is key here. Investors have invested into a green bond that holds the promise of a sustainable purpose. In return, they expect transparency on what operations and projects their funds have been used for. An important factor to consider here, and is included in the green bond frameworks, is to not only report on the use of the funds, but also on the impact on the environment by using KPIs. For example, a company might have purchased zero-emission vehicles with the proceeds, resulting in an impact of avoided CO2 emissions. This impact should also be mentioned.

At EY, we can help issuers of green bonds that are going through these stages.

Our services can be separated into three types:
1) Pre-issuance verification
2) Post-issuance verification
3) Capacity- building sessions

We conduct pre-issuance verification, which is done before the issuance of the green bonds. Therefore, pre-issuance services are applicable to stages 1 and 2 of the green bond life cycle. The services consist of reviewing the green bond framework to firstly assess the overall presentation,
structure and content of the sustainability information, and secondly to review the prospectus of the green bonds to be issued. By doing this, we obtain an understanding of the key assumptions, presented framework and the eligibility of nominated assets for inclusion in the proposed bond against the use of proceeds criteria, within the selected guidelines or standards and the framework.

After the issuance of the bonds, EY teams conducts post-issuance verification on reporting associated with guidelines or standards compliance. This is applicable to stages 3 and 4 of the green bond life cycle. This includes review of policies and procedures on the use of proceeds, and management of proceeds raised in accordance with “green” criteria to assure, on behalf of the issuer, that the proceeds of the bonds are used for intended projects and managed as promised throughout the life cycle of the bond. In addition, EY teams conducts post-issuance verification on quantitative and qualitative reporting associated with the impacts of projected “green” attributes on a periodic basis.

The above services are all under the assumption that the involved persons at the issuer are up to speed on the developments in the world of green bonds. The EY organization also offers tailored capacity-building sessions to equip the involved persons with relevant knowledge and confidence throughout the journey of issuing green bonds.

We have supported many clients already in their green bonds journey. One example is that we supported a top five Dutch bank in enhancing its green bond allocation reporting framework and provided assurance on it. As a next step, EY client will enhance its impact report which will be reviewed and assured by EY. The client benefitted from our work since the framework(s) improved and due to EY assessment, the outcome became more reliable for all stakeholders. We did something comparable for one of the leading global companies in healthcare products, which was more complex given the type of underlying collateral in the green bond, also including research and development disbursements which required more in-depth eligibility assessments.

I promised some moments ago that I would talk a bit about the different green bond frameworks.

Let’s start with the Green Bond Principles (GBPs). The GBPs are a set of suggested guiding principles that can be applied to climate change and other environment-related projects. As they are guidelines, they offer more freedom in the application of the framework. For example, issuers may seek a second-party opinion, but are not obliged to do so by the GBPs. In addition, the reporting is voluntary and there are no penalties when there is a violation of the GBPs.

Secondly, the Climate Bond Initiative provides certification for green bonds. The criteria for a Climate Bond Certified (CBC) stamp applies to climate change mitigation and adaption projects, and the criteria of the framework has less of a voluntary character than the GBPs. Reporting is mandatory under CBC as well as third-party assurance on the report. When there is a violation of one of the CBC criteria, a company risks losing the certification of the Climate Bond Initiative, thereby losing the credibility of the green bond. The Climate Bond Initiative estimated that by the end of 2020, a dazzling USD $350 billion would be invested in climate bond-certified green bonds. Just imagine what impact that would have on our environment.

Last but not least, is the EU Green Bonds Standard (EU GBS). The EU GBS will be formally in use by the end of 2021 and proposes voluntary standards that apply to investments that are in line with the upcoming EU Taxonomy. Just as under the CBC, reporting and third-party assurance is mandatory under the GBS.

This concludes our green bonds podcast. We hope you liked this podcast and in case you have any queries, please reach out to me or your local EY contact for further support.