By Apricum Vice President Corentin de Ricaud
While Green Bonds have commanded headlines, we observe a more interesting development in green finance. Compared to last year, the issuance of new Green Bonds has fallen by nearly 35%, to just USD 83 billion in Q1 of 2022. Rising interest rates, inflationary pressures and fallout from the Ukrainian conflict have reduced issuance of many global bonds – green ones included.
Before general issuance slowed, Green Bonds were growing fast as a distinct liquid financing tool. New issuance peaked in 2021 reaching a record level of USD 474 billion, up from USD 296 billion in 2020, according to data by the Climate Bonds Initiative. Europe remains a key market for Green Bonds, hosting 50% of 2021 global issuance.
WHAT IS A GREEN BOND?
A Green Bond is debt or fixed-income security whose proceeds specifically finance climate and environmental projects according with the Green Bond Principles (GBP), guidelines issued by the International Capital Market Association.
Green Bonds have been issued by sovereign entities, financial institutions and corporates. According to S&P, utilities were the most active corporate issuers in 2020, making up over 50% of non-financial corporate issuers. They have been recently joined by more carbon-intense entities in the oil and gas, chemical, or mining industries, keen to combine diversity of funding sources with visible commitments to the energy transition.
They are used to finance large-scale sustainability projects requiring high up-front investments such as wind and solar development, as well as other climate mitigation/adaptation ventures such as water treatment facilities, or electric vehicles.
THE EMERGENCE OF DEVELOPMENT GREEN BONDS
An interesting recent sub-trend is the growth of development facilities including much smaller Green Bonds, which have at times been highly oversubscribed (Greencells 2021). Apricum is witness to an increasing number of new players entering this space, and larger funds being raised. Their proceeds fund the development costs of renewable energy projects. Security is provided to creditors as a pledge on the rights or SPVs of the projects under development.
Security value corresponds to the intrinsic value of the collateralized projects that the developer accepts to pledge. The debt principal is then determined as a percentage of the security value as agreed together with the bond holders. This sizing generally includes a buffer to cover for any material variations in projects’ value during the term of the Green Bond/loan.
The collateralized pipeline needs to be fairly advanced in order to be assigned a certain value and incorporated in the security basket. A developer working on a 300MW mid-advanced development pipeline can raise close to EUR 15M. This will cover most of the development costs leading to pipeline’s ready-to-build status but could also cover beyond.
A Development Green Bond could therefore be a good fit for sub-investment grade and early developers with restricted balance sheet capacity and limited cash flow generation, but sizeable development pipeline that they either develop for themselves or for others. Decent amounts of capital can be raised at rather attractive terms, meaning single digit fixed interest rate, due to the limited size of the bond and the quality of the underlying security.
A step further for more advanced developers looking for capital to fund the construction period without raising additional equity is also to resort to such Green Bonds/loan. The latter will then be secured against the developers’ rights into assets that are at more mature stage and therefore higher value. Proceeds can be then allocated at the asset level as quasi-equity or even mezzanine-liked funding instruments.
Hence the more the pipeline grows in volume and reaches a higher level of maturity, the more bond amount can be raised at a significantly higher volume, supporting the corporate growth of a developer and possibly its gradual transition to a more asset-holder player.
The emergence of new funding sources for developers is welcomed and is helping to drive down the call on equity as they grow and reduce their weighted cost of capital. The appeal of generic Green Bonds, however, is less clear.
THE MURKY MERITS OF GREEN BONDS
What are the distinct advantages of Green Bonds, especially as opposed to a more conventional bond or facilities?
In the past, strong investor demand for quality green instruments led to favorable coupons for EUR-denominated ESG corporate bonds compared to benchmark conventional bonds of similar maturity (i.e. the so-called “greenium”), reaching nine basis points in 2020. However the gap has recently narrowed to just one basis point, according to Association for Financial Markets in Europe (AFME) data. Parity is not wrong: the credit risk is the same. The advantage is not, therefore, the cost of capital.
Green Bonds diversify companies’ funding sources which can boost liquidity, and climate-minded investors are more likely to “hold-to-maturity”, creating greater price stability. But these are marginal benefits.
Perhaps more importantly, Green Bond financing attracts positive attention. They enhance the issuer’s reputation and send virtuous signals to capital markets. It is not just signal: issuers also disclose more information about their sustainable operations, as investors require greater transparency about the environmental projects being financed. Independent auditors typically evaluate bond compliance against the GBP and certify the investments’ genuine environmental impact. This limits greenwashing claims, but adds additional cost, which we do not believe is compensated elsewhere.
Demand for Green Bonds remains strong (e.g., Acciona Energy’s recent over-subscribed 10-year USD 500 million bond). But for pure renewables companies, they do not reduce credit cost, yet have higher compliance costs. So a green bond carrying a 1bp advantage has little specific benefit to the greenest of renewable energy companies. It is only interesting to issuers keen to fund and manifest newer commitments to the energy transition.
A BETTER ALTERNATIVE
However, the extension of green finance products to renewable energy project development is an undeniable benefit: tangibly reducing the industry’s equity call and cost of capital. We recommend solar and wind developers examine these because of their impact, allowing them to:
- reduce their overall cost of capital
- reduce equity dilution
- hold projects for longer
- continue pipeline growth
- diversify funding sources and establish new lending relationships
While Green Bonds are of only passing interest to pure renewable energy companies, the expansion of development green loans will stay, and Apricum will connect new investors in the space with development borrowers.
Please contact Apricum Vice President Corentin de Ricaud if you would like to learn more about Green Bonds or financing for renewable energy developments.