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Financial Markets and Climate Change > Week 4 > Flashcards

Week 4 Flashcards

1
Q

what is the main source of funding for companies?

A

debt - not stocks and equity

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2
Q

Why is equity still important to consider in terms of funding?

A

credit markets provide the bulk of finacing for companies but equity is important as there is the requirement for an equity cussion to allow for borrowing without issues of excess leverage and financing viability

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3
Q

What are the downsides of being a bond holder in terms of engagement?

A

limited engagement - not voting power

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4
Q

Why is equity better to look at in terms of transition risk?

A

equity markets are the primarly lens to view transition risk manifested - primarily place for negative shocks of climate change

equity is the first loss tranche on the liability side of a company - equity is a junior claim to debt

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5
Q

Why is debt still an interesting place to look in terms of transition risk?

A

debt is required to finance the funding for the energy transition - turn to debt markets first for renewable energy and sustainable energy projects

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6
Q

what are green bonds?

A

used to finance environmentally friendly projects such as renewable energy, energy efficiency, water conservation and climate change adaption

for investors they are part of the sustainably themed approaches

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7
Q

What are the three main labelling schemes for green bonds?

A

ICMA green bond principles

climate bonds standards

european green bonds proposed legsilation 2022

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8
Q

Who determines whether a bond is green?

A

not really any regulation on green bonds - apart from China where there is ban on green bonds for energy companies

mainly labelling authorities - ICMA green bond principles and some regulation

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9
Q

What are the ICMA green bond principles?

A
  1. use of proceeds
    - the issuer must communicate the environmentally sustainability objectives of the eligible green projects
    - the net proceeds should be credited to sub-accounts
  2. process for project evaluation and selection
  3. management of proceeds
  4. reporting - the annual report should include a list of the projects to which green bonds proceeds have been allocated, a brief description of the projects the amounts allocated, and their expected impact
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10
Q

What is the point of a sub-account?

A

not used for soverign bonds

idea of the fungability of money at least formally we are saying that we are putting the money aside to break this fungibility of money issue

easier to monitor how the money gets spent - there is a record for investors to be able to verify how it is spent

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11
Q

What is the Luxembourg green exchange?

A

2007 listed the first green bond to enter the market

the European banks; climate awareness bond

entry is restricted to issuers and asset managers that provide full disclosure and fulfil their reporting obligations

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12
Q

What are sustainability linked bonds?

A

unlike green bonds they dont have use of proceeds instruments - they are can be used to finance any corporate activity

the issuer commits to reaching ambitious, science-based and measurable sustainability performance targets (SPTs) around predetermined KPIs and to having these reviewed by an external party

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13
Q

what happens if you dont meet the targets associated with the sustainability linked bonds>

A

coupon payments go up

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14
Q

Who has the biggest bond market and the biggest green bond issuance market?

A

The US has the biggest bond market

the europe has the largest issuance of green bonds - Europe are leading the way to transition to net zero

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15
Q

Who is the main issuers of green bonds?

A

soverign green bonds are gorwing

however the largest issuer is finance corporate

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16
Q

What is the most common use of proceeds reason?

A

Energy 52%
only 3% for adaption

most of ht money raised through green bonds goes to mitigation only a little bit goes to adaption

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17
Q

Why is there more issuance of bonds for mitigation rather than adaption?

A

Difficulty with financings adaption - not tied to a cash flow stream

most mitigation problems generate a cash flow stream - solar powered plants will sell electricity and generate cash flow streams - easier to finance

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18
Q

Are green bonds a flawed concept?

A

money is fungible - even if funds raised through a green bond issue go to a sustainable investment, other funds are freed that could fund brown operations
–> most funding is internally sourced therefore you are not preventing the funding of potentially brown or environmentally degrading projects

credit risk is embodied in the issuers balance sheet

the fact that a bond is green and other debt is not does not provide any special privilege or seniority per see in bankruptcy
- the green bond couldn’t lower the credit risk associated with the bond

there may be no risk mitigation involved in the issuance of green bonds

19
Q

how do you work out the credit risk?

A

probability of bankruptcy given default
x
loss given default

20
Q

why do companies issue green bonds?

A

signalling
- advertising that they are doing the right thing

greenwashing
- fungability of money is an issue
- greenwashing doesn’t change a companies emissions doesn’t matter if they issue a gb or not

investor clientele
- ESG funds pitch that they are ESG funds but have to prove it by buying ESG assets - easy way of saying you are an ESG fund

21
Q

What did Flammer (2019) find about US Corporate Green Bonds?

A

sampled 217 bonds issued by public companies

issuers tend to be a larger companies, in industries with high environmental materiality

issuers tend to be leaders in ESG performance

RESULTS
- positive cumulative abnormal return announcement effect of a green bond issue
- effect is stronger for issuers in industries with high environmental materiality

emissions reduction of 21.6 tones of Co2 per $1m of assets

REDUCTION OF 27.7%

no greenwashing

22
Q

How are the green bonds emerging in emerging markets?

A

regulation and official guidelines - china

liting requirements - south Africa

private institutions - Brazil

23
Q

How is the IFC involved in green bons?

A

IFC provides public money and due to its investment in the fund it brings in private sector institutional investors

  • reduces the risk for private investors because the public money that goes in is the junior tranche
  • private money is the senior tranche

idea of blended finance

estimates a 30 trillion dollar potential market for blended finance

24
Q

What are the potential benefits for investors for green bonds in emerging markets?

A
  • long term maturities with stable and predictable returns - with given risk exposure
  • provide environmental benefits
  • satisfy ESG requirements for sustainable investment mandates eg. IFC Performance standards
  • Enable direct investment in the greening of brown sectors and social impact activities
  • provide increased transparency and accountability on the use and management of proceeds
25
Q

What are the potential benefits for issuers for green bonds in emerging markets?

A
  • provide an additional source of green financing
  • match maturity with project life - in the case of green project bonds
  • improve investor diversification and attract buy and hold investors
  • enhance issuer reputation
  • attract strong investor demand, which can lead to high oversubscription and pricing benefits
  • support issuers with environmental risks management
26
Q

What did Davivienda do?

A

third largest bank in Colombia

issued £150 million green bond, the largest green-bond issue by a private FI in latin America

uses funds to finance construction of green buildings

27
Q

Why is there a difficulty in getting green bonds to smaller countries?

A

difficult to attract private investment if there is no structured market

IFC good here, as it provides a network and helps place a green bond where there is no bond market in the country

28
Q

What is the green cornerstone bond program?

A

a partnership between the IFC and Amundi Asset Management

the goal is to develop expertise in green investments in EMEs and to channel global institutional investments towards these investments

EGO - Emerging Green one completed in 2018

29
Q

What are the conduits for green bonds in emerging markets?

A

a network of accredited EME banks

a green cornerstone bond - set up by the IMF and Amundi

  • on the asset side there are EME banks’ green bonds
  • the liability side is divided into three tranches
    > senior tranche for institutional investors
    > mezzanine tranch for IFIs - international financial institutions
    > junior tranche for IFC
30
Q

Can you give me some information about Amundi’s Emerging Green One bond?

A

launched 28th feb 2018 having raised $1.4bn making it the largest fund by a factor of 4

aim = buy labelled green bonds issued in emerging market banks

initially invested in unlabelled EM bonds but switch entirely to green bonds over the funds 7yr life

once yr in it switched to 15.81% green bonds

invested in 14 green bonds

  • investors get yield with impact
  • a combination of top-down and bottom-up approaches
  • a green standards-setting initiatives
  • creation of new asset class - EM green bonds
31
Q

What are some of the elements of the IFC technical assistance program?

A

Training

Information dissemination

enahcned issuer reporting

knowledge sharing

32
Q

Can you name any other investment bank structures for green bonds?

A

Green Credit Continuum Program - july 2019

Asia climate bonds - sept 2019

33
Q

What did ENEl do?

A

first introduced a sustainability-linked bond
- an early issuer of green bonds

ENEL business model is fully sustainable - no need to signal this to the market

  • in 2019 ENEl issued the first sustainability-linked bond - a bond with financial incentives to meet sustainability performance targets (SPTs) within a pre-determined timeline

SDG- linked bonds marked the beginning of the sustainability linked bond markets

if you meet the target then you have a lower cost of cap, lower coupon payments

if not met then higher cost of cap and higher coupon payments - can start high and then lower if objective is met

34
Q

What is a key motivation for green soverign green bonds?

A

signalling - support growth of a local green bond market

35
Q

Where does a greenium come about?

A

more releavant for EME issuers eg, egypt

greenium is associated with greater climate vulnerability

36
Q

What makes a soverign bond green?

A

the green bond promise little or nothing that would be legally enforcable

key is the use of proceeds - that it is being channeled for a particular purpose - there is no obligation for this under the soverign green bonds

37
Q

What are two examples of loose green bonds?

A

Fiji
- to be enforcable the contract must be specific, concrete and verifiable - the project is to be determined by the issuer thus not something you can enforce

Egypt
- no market consensus on what attributes are required to be green or sustainable - therefore no assurance that investor expectation will be satisfied \

38
Q

What is the issue with the soveriegn debt sustainability and the transition to net zero?

A

how do you overcome national debt sustainability constraints to finance climate change mitigation and adaption

there is a fiscal capacity and constraint - need to understand how easy it is for countries to borrow and meet debt obligations

39
Q

What are nature-based carbon sinks?

A

concentrated in a few countries and some of these countries have debt sustainability issues

debt for nature swaps and carbon credit markets

but this is an issue as previous sinks such as the amazon rainforest previously were sinks and now they are sources

40
Q

What did the geneva report recommend as being some solutions to this debt and natural capital issue?

A
  1. fiscal transfers to overindebted countries to directly fund mitigation and adaption –> green climate fund (GCF)
  2. debt relief –> debt for climate swaps
  3. green finance –> green bonds and carbon credits
41
Q

How would a two-way pricing system work?

A

high price if you dont achieve the target and a low price if you achieve the target

the price is paid to the investors

42
Q

What is the issue currently with existing public carbon sinks and how they are valued?

A

countries with the largest carbon sinks are currently not being compensated adequately for the public good they provide the world in maintaining or building these natural resources

  • global demand for voluntary carbon credits reached 100bn tonnes of Co2 in 2020 and it is likely to grow 100x on the 1.5oc pathways
43
Q

What are some of the problems with the current carbon credit and carbon sink markets?

A

currently the market is too fragmented

demand for carbon credits is too low because carbon credits are purchased mostly on a voluntary basis

carbon credit supply based on the preservation of nature-based carbon sinks should be standardised

carbon credits based on avoided emissions should also be allowed to incentivise decarbonisation
eg. closing a coal fired plant and replacing it with wind

has to be done correctly otherwise it is greenwashing

Financial Markets and Climate Change (5 decks)

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