How Do Labeled Green Bonds Measure Up?

Transcription

1 How Do Labeled Green Bonds Measure Up? November 08, 2017 PRIMARY CREDIT ANALYSTS Michael Wilkins London (44) Miroslav Petkov London (44) Noemie de la Gorce London (44) Jessica Williams London (44) RESEARCH CONTRIBUTORS Beth Burks London Snehal Suryawanshi Mumbai Reshma Thomas Mumbai spglobal.com/ratingsdirect

2 Overview The results of our retrospective scoring exercise suggest that self-labeled green bonds meeting the CBI eligibility criteria would be likely to score between 50 and 100 under our Green Evaluation. Close to two-thirds (63%) of the green bonds in our sample got an overall score of E2, the second highest score on our scale. Of those, 42% would have been scored E1 if they had achieved higher governance and transparency scores. The main factor explaining the high average overall score is the type of projects financed by the self-labeled green bonds in our sample, the majority of which were in the green energy, buildings, transport, and water sectors. Our hierarchy adjustment positively affects the overall score of these projects, reflecting the higher contribution of these sectors to systemic decarbonization and water system enhancement. The types of projects financed by self-labeled green bonds also explain the limited number of bonds scoring E3 and the absence of bonds scoring E4. Our sample, based on the CBI eligibility criteria excludes projects with a limited environmental contribution, such as upgrades of fossil-fuel technologies, though these could be evaluated under our Green Evaluation. While providing a useful reference point, these results are not representative of the wider unlabeled green finance universe excluded under the CBI criteria. Although the recipient project s location plays a material role on the overall score of green bonds in our sample, this is typically less significant than the impact of our hierarchy adjustment. There is not one geographical region that scores systematically higher than others in our net benefit ranking. The relative ranking between regions is specific to each project category due to the use of local sector-specific factors in our Green Evaluation for environmental key performance indicators (ekpis). The average governance and transparency scores of respectively 60 and 51 in our sample reflect the comparatively low level of disclosure in the vintage green bond market, as opposed to the bonds that have been evaluated by S&P Global Ratings to date and point to the need for better transparency of the environmental contribution of green bond transactions. View the related CreditMatters TV segment "Applying Our Green Evaluation To The Labeled Green Bond Universe" spglobal.com/ratingsdirect Nov. 08,

3 Green finance is a fast-expanding market. Driven by a global political push and new market dynamics, it is channeling investments into green technologies and infrastructure that support climate and other environmental-related policies. The challenge ahead is huge: The Paris Agreement--signed by 197 countries in December requires an estimated $1 trillion in annual investment to transition to a low-carbon economy. In recent years, green bond issuance has become a bellwether of green finance. These selflabeled green bonds have been issued to finance new projects and refinance existing projects with a positive environmental contribution. The market is growing rapidly, expanding by 127% annually since 2012 and S&P Global Ratings expects 2017 to be the fifth consecutive year of growth, with $130 billion of self-labeled green bond issuance forecast for the full year 1. The universe of potential green bonds is even higher if one includes projects that have a positive environmental impact but are not labeled as green. 127% Annual growth in green bond issuance since 2012 Chart 1 Annual Green Bond Issuance By Issuer Type (Bil. $) To be defined Green loans and other debt instruments Sovereign Bank Corporate ABS Municipalities Development bank YTD YTD--Year to date. Source: Climate Bond Initiative. What Is A Green Evaluation? Our Green Evaluation is a point-in-time assessment of the relative environmental contribution of a financing transaction or portfolio compared to similar technologies globally. This evaluation is based on the quality of a transaction s governance and transparency as well as its quantifiable life-cycle environmental impact. Based on these three components--governance, transparency, and environmental impact--we score the transaction between 0 to 100. The score reflects the transaction s overall environmental contribution as well as its alignment with climate-change mitigation or adaptation goals. The score is expressed as a quartile between E1 and E4, with E4 representing projects with the lowest environmental contribution and E1 the highest. Our Green Evaluation is also applicable to financings of adaptation projects that aim to strengthen the resilience of infrastructure and communities against the risk of extreme weather or changing weather patterns caused by climate change. The score of adaptation projects is expressed as a quartile between R1 and R4, with R4 representing projects with the lowest resilience benefit/cost ratio and R1 the highest (see chart 1). For further details see S&P Global Ratings Green Evaluation Analytical Approach, published April 26, Climate Bond Initiative. spglobal.com/ratingsdirect Nov. 08,

4 Chart 2 S&P Global Ratings Green Evaluation Analytical Approach Framework Weighted aggregate of three: Transparency + Governance + Mitigation or Adaptation = Green Evaluation Transparency Governance Mitigation Adaptation Use of proceeds reporting Reporting comprehensiveness Management of proceeds Impact assessment structure Buildings, industrial efficiencies, energy infrastructure, transport, and water Resilience capex such as flood defenses, asset protection etc. Net benefit ranking Cost benefit ranking ekpis: Carbon emissions, water use, waste creation Resilience benefit ratio: Estimate of reduction in damages if event occurs Hierarchy applied Environmental impact Resilience level Mitigation score Adaptation score Final Green Evaluation (E1- E4 or R1- R4) ekpi--environmental key performance indicator. Since the launch of our Green Evaluation service in April 2017, we have evaluated on request 20 green transactions and published our evaluations of 12 of them. These 12 transactions received an average score of 84, with only one so far scoring less than 75, or E2. In addition, in order to provide further transparency and help calibration in the market, S&P Global Ratings has evaluated the green contribution of 282 green bonds issued between January 2012 and July 2017, the so-called vintage green bond portfolio. We applied this retrospective scoring exercise to a universe of already-issued labeled green bonds meeting the eligibility criteria of the Climate Bond Initiative (CBI) 2. Our analysis covers 30 different categories of green projects implemented across more than 80 countries, ranging from the implementation of an energy recovery system in a South African wastewater treatment plant to the construction of LEEDcertified buildings in Massachusetts. It was based solely on publicly available information disclosed by the issuer. Please refer to Appendix 1 for further information on our methodology. 2 Self-labeled green bonds represent bonds labeled as green by their issuers, which meet the eligibility criteria for bond transactions as defined by the CBI. spglobal.com/ratingsdirect Nov. 08,

5 The majority of green bonds evaluated under the Green Evaluation tool scored E2, with an average score of 70. Our Green Evaluation scored the 282 vintage self-labeled green bonds in our sample based on publicly available information. E1 represents a score of between 75 and 100, E2 between 50 and 74, E3 between 25 and 49, and E4 between 0 and 24. The majority (63%) of the bonds evaluated received a Green Evaluation score of between 50 and 74 (see chart 3). The overall score shown above is the result of three components: The net benefit score, which considers a project s negative and positive environmental impact relative to the regional baseline for relevant environmental key performance indicators (KPIs) compared with peers; The environmental impact score based on S&P Global Ratings opinion on each project s relative contribution to avoiding and coping with climate change. The environmental impact score of each asset is combined to derive the overall mitigation score for the transaction. An evaluation of the transaction s governance and transparency. Chart 3 Breakdown Of Overall Scores By Quartile (%) 2% 35% 63% Source: S&P Global Ratings. Chart 4 Breakdown Of Mitigation Scores By Percentile (%) 5% E1 E2 E The mitigation score is a relatively pure ranking of a green bond transaction compared to its peers and is weighted at 60%. It is complemented by an evaluation of the transaction s governance (weighted at 25%) and transparency (weighted at 15%). Both the governance and transparency scores are capped at the level of the mitigation score 3. The average mitigation score in our sample is 78, with approximately half of the bonds scoring between 80 and 100 and the other half scoring between 60 and 80. Chart 4 shows the distribution of the mitigation score by percentile. 46% Source: S&P Global Ratings. 48% 3 In deriving the final Green Evaluation, we cap both governance and transparency scores at the level of the mitigation or adaptation score. This reflects S&P Global Ratings opinion that the governance and transparency assessment does not enhance the overall environmental impact, assuming the assets function as expected. Please refer to S&P Global Ratings Green Evaluation Analytical Approach for further information. spglobal.com/ratingsdirect Nov. 08,

6 The type of technology financed by historical self-labeled green bonds in our sample is a key factor explaining the relatively high mitigation score. Chart 5 shows the allocation of proceeds of the vintage green bonds covered in our sample 4. Of these proceeds, 47% were used to finance projects in the green energy sector, followed by green buildings (22%) and green transport (15%). Chart 5 Breakdown Of Proceeds By Project Category Green energy 47% Green buildings 22% Water and wastewater 15% Green transport 9% Energy efficiency 8% Source: S&P Global Ratings. Chart 6 provides a similar breakdown of proceeds at the technology level. Chart 6 Breakdown Of Proceeds By Technology (%) (%) Green energy Green buildings Green transport Energy efficiency Waste and wastewater Onshore wind power generation New build commercial Solar power generation Offshore wind power generation Urban rail systems Refurbishment commercial Wastewater treatment no energy recovery Energy efficiency general New build residential Hydroelectric power generation small National rail electric Hydroelectric power generation large Fuel efficient vehicles Energy star products Biomass power generation Refurbishment residential Geothermal power generation National rail diesel Green energy other Water distribution network improvements Wave & tidal power generation Landfill gas power generation Water reuse Water conservation Bus rapid transit diesel Bus rapid transit electric Industrial efficiencies Wastewater treatment with energy recovery Seawater desalination plant construction Source: S&P Global Ratings. 4 The selection process of self-labeled green bonds included in our sample is described in Appendix 1. spglobal.com/ratingsdirect Nov. 08,

7 The main assets financed by the green bonds in our sample are onshore and offshore wind farms (24%), new green buildings (14%), solar assets (8%), urban rail systems (6%), and wastewater treatment plants (5%). The high average mitigation score (78) in our sample reflects the type of technology financed by the universe of self-labeled vintage green bonds. The majority of proceeds issued by selflabeled vintage green bonds have been used to finance or refinance projects with high environmental benefits, including renewable projects, construction of green buildings, urban rail systems, and wastewater treatment projects. Because of their significant environmental contribution, projects financed by the self-labeled vintage green bonds in our sample sit mostly in the first two tiers of our hierarchy. Green energy, green buildings, and green transport without fossil-fuel combustion sit in the first two tiers of our carbon hierarchy assessment, while the wastewater sector sits at the top of our water hierarchy assessment. The green bonds in our sample finance projects that fall in the top two levels of our carbon and water hierarchies Table1 S&P Global Ratings' Carbon Hierarchy Sector Technology Systemic decarbonization Green energy Wind power Solar power Small hydro Large hydro (excluding tropical areas) Energy efficiency Energy management and control Significant decarbonization of key sectors through low-carbon solutions Green transport Green buildings Green transport without fossil fuel combustion Green buildings new build Decarbonization by alleviating emissions in carbon-intensive industries Energy efficiency Green transport Green buildings Energy efficient projects (industrial efficiencies and energy star products) Green transport with fossil fuel combustion Green buildings refurbishment Decarbonization technologies with significant environmental hazards Nuclear power Green energy Nuclear Large hydro in tropical areas Improvement of fossil fuel-based activities environmental efficiency Fossil fuel power plants Coal to natural gas Cleaner fuel production Cleaner use of coal Source: S&P Global Ratings' Green Evaluation Analytical Approach, April 26, 2017 spglobal.com/ratingsdirect Nov. 08,

8 Table 2 S&P Global Ratings' Water Hierarchy Tier 1 System enhancements Recycling wastewater to supply potable municipal water Recycling wastewater to supply non-potable water for agricultural uses Recycling wastewater to supply non-potable water for other industries Wastewater treatment with no energy recovery Wastewater treatment with energy recovery Tier 2 Marginal system enhancements Reducing water losses in the water distribution network Tier 3 System enhancements with significant negative impacts Water desalination to supply potable municipal water Tier 4 Demand-side improvements Conservation measure in residential buildings Conservation measure in commercial buildings Conservation measure in industrial buildings Smart metering in residential buildingsbottom of Form Source: S&P Global Ratings' Green Evaluation Analytical Approach, April 26, 2017 The limited number of bonds scoring E3 and the absence of bonds scoring E4 reflects the exclusion of projects with lower environmental benefits from our sample The average high position in our hierarchy of projects financed by green bonds in our sample positively affects their mitigation score. While the average net benefit ranking in our sample is 46, the average mitigation score increases to 78. The proportion of bonds scoring between 60 and 100 increases from 31% to 94% after the hierarchy adjustment, contributing to the concentration of the scores in the two upper quartiles. This suggests that the positioning of the technology in the hierarchy is as important--if not more so--than the net benefit ranking, which shows the significance the Green Evaluation gives to alignment with climate-policy goals. Within the sample, green bonds issued by U.S. municipalities to finance wastewater treatment plants scored the highest under our Green Evaluation methodology. Other examples of green bonds receiving an excellent score include a geothermal project in the Philippines and a hydroelectric generation project in Ohio. Examples of transactions receiving lower overall scores in our sample include a green bond issued to finance a diesel-fueled railway project in Europe and an asset-backed securitization financing water-conservation measures in the U.S. This reflects our opinion on the negative environmental impact associated with fossil fuel combustion in the transport sector and the limited impact of measures that reduce the demand on potable water supplies. The limited number of bonds scoring E3 and the absence of bonds scoring E4 reflects the high environmental contribution financed by green bonds in our sample. Projects with lower environmental benefits--such as nuclear projects, large hydro projects in tropical areas, or upgrades of existing fossil-fuel technologies--are not represented in our sample. The absence of such projects explains the limited number of bonds scoring below 50. This result is mostly due to the nature of the sample we have analyzed which constitutes a selection of self-labeled green bonds based on a list provided by the CBI. The CBI list excludes those project types. spglobal.com/ratingsdirect Nov. 08,

9 Project location also has a material impact on the sample s Green Evaluation scores. The project s location determines the regional baseline used to calculate the environmental net benefit of a project and is a significant driver of the net benefit scoring. The carbon intensity of the local grid as well as the water stress of a river basin are examples of factors included in our net benefit ranking: the higher the carbon intensity of the regional baseline, the higher the relative environmental benefits associated with a green project. Similarly, the higher the water stress of a city or region, the higher the relative positive impact associated with wastewater and water projects. Chart 7 shows the allocation of proceeds of the vintage green bonds covered in our sample. Of these proceeds, 43% are used to finance projects in Europe, followed by North America (24%), and Asia-Pacific (18%). Chart 7 Breakdown Of Proceeds By Geography (%) - 43% Europe 24% North America 18% Asia-Pacific 8% Global 5% Central and South America 2% Middle East Africa Eurasia 31-50% 21-30% 11-20% 1-10% Below 1% Source: S&P Global Ratings. Chart 8 shows the average net benefit score by region and project category. Chart 8 Breakdown Of Net Benefit Score By Geography And Project Category Net benefit score (0-100) North America Middle East Africa Global Asia and Oceania Central and South America Europe Eurasia 10 0 Green energy Green buildings Energy efficiency Green transport Water and wastewater Note--This chart only includes the net benefit score of pure players in our sample (issuers that allocate 80% or more of their proceeds to one project category). Source: S&P Global Ratings. spglobal.com/ratingsdirect Nov. 08,

10 While the project s location is a key driver of its net benefit ranking, its impact on the bond s final score is more complex. The absence of a systematic scoring pattern at the regional level can be explained by the use of local factors in our Green Evaluation. For example, a water reuse project will receive a higher net benefit score in New York than Chicago because the level of water stress in New York is much higher than in Chicago. However, a renewable project is likely to receive a lower net benefit score in New York than Chicago due to the different carbon intensities of the electricity grids. In the sample, projects located in North America tend to receive a relatively high net benefit score across all sectors in our sample. In particular, wastewater projects in this region get the highest average net benefit score compared to other sectors. The net benefit ranking of projects within the energy sector does not solely reflect the carbon intensity of the grid. This is because the carbon intensity of the grid is only one of the several factors used to determine the net benefit ranking of a green energy project. For example, the net benefit of a renewable project is also affected by the capacity factor of the technology, which depends on meteorological conditions and the degree of sophistication of the technology in the country. Similar to projects in the energy sector, the net benefit ranking of projects within the water sector does not solely reflect the level of local water stress. For example, the net benefit of a project aiming to reduce the losses in the water distribution network will incorporate the current efficiency of the water distribution system in the region as well as the potential water savings associated with the project. The absence of a systematic scoring pattern at the regional level can be explained by the use of local factors in our Green Evaluation Conclusion Our analysis of 282 vintage green bonds suggests that self-labeled green bonds that meet the CBI eligibility criteria are likely to score between 50 and 100 (E1 or E2 on a scale of E1 to E4) under our Green Evaluation. This is mostly due to the project types that have been historically financed by green bonds, such as green energy, green buildings, and wastewater treatment plants. In our view, these sectors contribute significantly to the transition to a low-carbon economy and to the achievement of environmental and climate-related policies. However, we believe that the universe of historical self-labeled green bonds under the CBI criteria only partially reflects the entire universe of future green financings, which includes a broader range of projects and financing types. We will continue to track the environmental quality of transactions as the green finance market expands and plan to further report on the scoring these transactions would receive under our Green Evaluation. spglobal.com/ratingsdirect Nov. 08,

11 Related Research Paris Agreement Climate Pledges: Where Will The Money Come From?, Nov. 6, 2017 Understanding Climate Change Risk And U.S. Municipal Ratings, Oct. 18, 2017 Green America: Renewable Standards, Tax Credits, And What's Next?, Oct. 10, 2017 Green Bonds Are Increasingly Expanding France's Public Sector Investor Base, Sept. 26, 2017 S&P Global Ratings Green Evaluation Approach, April 26, 2017 Appendix 1: Methodology S&P Global Ratings has analyzed the green contribution of self-labeled green bonds issued between January 2012 and July 2017 using its Green Evaluation Analytical Approach. Our initial sample comprised a universe of 368 green bonds based on data from the CBI 5. This universe of vintage green bonds includes the biggest issuance of each green bond issuer involved in the market over that period of time. Out of the entire universe, the Green Evaluation exercise was conducted on a sample of 282 green bonds that met the following criteria: The underlying projects were in scope for the Green Evaluation tool. The underlying projects fell under our mitigation methodology. This resulted in the exclusion of adaptation projects. Green bond-related disclosure was available in English. Sufficient disclosure was available to perform a Green Evaluation. We consider sufficient disclosure to be publicly available information related to the amount of the green bond issuance as well as the types of technologies financed. When the split of proceeds between those technologies was not available, we assumed an equal split. This selection criterion resulted in the exclusion of private placements. Because of the selection criteria listed above, our sample does not capture the entire universe of vintage green bonds. For example, we excluded some green bonds issued by Chinese issuers that had not disclosed any information in English. We also excluded bonds financing projects in the waste, agriculture, and forestry sectors, as these projects are currently out of scope for our Green Evaluation Analytical Approach. Furthermore, for the purpose of this exercise, our sample did not capture the broader universe of unlabeled green bonds, which typically includes: Other types of financings with environmental benefits that are not labeled as green bonds; Bonds labeled green but considered as non-green by the CBI, such as bonds financing nuclear plants and efficient fossil-fuel assets. However, these projects are in scope for our Green Evaluation. We believe our sample provides a fair representation of the historical self-labeled green bond market. Our selection process captures more than 70% of the proceeds in our initial sample and the main project types historically financed by the self-labeled green bond market. However, the scope of our analysis is limited to the self-labeled green bond market and does not aim to represent the potential universe of green transactions issued in the past and likely to be issued in the future. 5 Self-labeled green bonds represent bonds labeled as green by their issuers, which meet the eligibility criteria for bond transactions as defined by the CBI. spglobal.com/ratingsdirect Nov. 08,

12 Appendix 2: The Impact Of The Governance And Transparency Scores On The Green Evaluation Score Of Vintage Self-Labeled Green Bonds The overall score applied to a green bond transaction is the weighted average of its governance score (25%), transparency score (15%) and its mitigation score (60%). The governance score evaluates what steps have been taken to measure and manage the environmental impact of the proceeds of the financing. The transparency score focuses on the quality of disclosure, reporting, and management of bond proceeds. The mitigation score reflects S&P Global Ratings opinion on the environmental benefits of the project relative to peers. Therefore, the difference between the overall Green Evaluation score and the mitigation score of a green bond depends on our assessment of the transaction s governance and transparency. Comparing the distribution of the overall Green Evaluation score (see chart 3) with the distribution of the mitigation score (see chart 4) illustrates the impact of the governance and transparency score on the overall score. In our sample, the proportion of bonds with an overall score of greater than 80 decreases significantly--to 20% from 48%--after evaluating the governance and transparency of the transaction. Furthermore, the majority of green bonds scoring E3 in our sample are affected by poor governance and transparency scores that lower the overall score. Breakdown Of Governance And Transparency Scores By Percentile Number of bonds Total Governance Total Transparency Note--The governance and transparency scores are expressed on a scale from zero to 100. Source: S&P Global Ratings. This result reflects two important elements: The Green Evaluation conducted on the universe of vintage green bonds was based solely on publicly available information disclosed by the issuer. The low level of public reporting from issuers on their management of proceeds and environmental impacts limits governance and transparency scores for the majority of the green bond issuers. The average governance and transparency scores were 66 and 51, respectively, resulting in an average governance and transparency performance of 60 in our sample. However, this average score does not necessarily reflect the level of disclosure S&P Global Ratings would have access to during a standard Green Evaluation process due to the engagement phase with the issuer. This result suggests that there has been historically a lack of disclosure from issuers on the use of proceeds and environmental impacts of green bonds. While this level of transparency has spglobal.com/ratingsdirect Nov. 08,

13 increased significantly over the last two years, we believe this can be further improved. Improving the level of disclosure from issuers is likely to be a key factor to ensure the future environmental integrity of green bonds and other financings claiming positive environmental impacts and the scale-up of the green finance market. Appendix 3: Green Evaluations Scores Published By S&P Global Ratings Since April 2017 Transaction Date Transparency score (0-100) Governance score (0-100) Mitigation score (0-100) Overall score (0-100) Overall score E1-E4 Hannon Armstrong Sustainable Yield Bonds /10/ E1 Brookfield Power New York Finance LP's $305 Million Senior Secured Notes 04/10/ E1 Province of La Rioja s $200 Million Notes Due /09/ E1 TenneT Holding B.V. Green Bonds 25/08/ E1 Greater Orlando Airport Authority Priority Subordinated Airport Facilities Revenue Bonds, Series 2017A Capital Region Water Series 2017 Sewer System Revenue Bonds 23/08/ E1 26/07/ E1 Mexico City Airport Trust 21/07/ E1 Three Gorges Finance II (Cayman Islands) Limited 10/07/ E1 Brookfield White Pine Hydro Senior Secured Notes 10/07/ E1 D.C. Water & Sewer Authority Series 2017 A Senior Lien Revenue Bonds 20/06/ E1 City of Gothenburg 19/06/ E2 Cross-Sound Cable LLC 02/05/ E1 Only a rating committee may determine a rating action and this report does not constitute a rating action. spglobal.com/ratingsdirect Nov. 08,

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