Climate bonds ‘are the ideal financial tool to tackle climate change’August 2012
Bond investors are not comfortable with the risks of developing projects. But once schemes are up and running, they are happy to provide refinancing, Sean Kidney, co-founder and chair of the Climate Bonds Initiative, tells Mike Scott
There has been a lot of focus on climate change and sustainability from an equities perspective, but the world of bonds receives little attention.
Sean Kidney, co-founder and chair of the Climate Bonds Initiative, is trying to change that. An Australian serial social entrepreneur who switched his focus to finance, Kidney believes that the financial force of institutional investors is ideally suited to financing climate change-related investments.
Most other investors, he says, are trapped in a culture of short-termism, but pension funds and insurance companies have a long-term perspective built into their charters.
While too many institutions still act in a short-term manner, at the same time being extremely passive with most of their investments, the way they exercise their holdings is changing, he believes, citing the example of Canadian pension funds, which have in recent years started to invest in infrastructure.
The Climate Bonds Initiative emerged out of the Network for Sustainable Financial Markets and Kidney says that bond markets are the ideal tool to tackle climate issues. “I was talking to a scientist about the cost curve of renewable energy and how it will come down over the next five to 20 years while fossil fuels will increase in price. Taken over 40 years, the average cost of renewable energy will be cheaper than fossil fuels but it’s more expensive now,” he says.
“The scientist also pointed out that if you build lots of renewable capacity up-front, then the costs will come down even more quickly. You are no longer talking about an area of investment that is a cost centre, you are talking about one that provides returns. Bond financing is the ideal solution,” he adds. “Yet there is not a lot of bond issuance in the climate change arena.”
However, because climate change is, in economic terms, an externality (in other words, the actions of some create costs that they do not pay for, such as emitting greenhouse gases), public sector involvement is needed to de-risk climate bonds. This is happening to a certain extent with carbon prices and feed-in tariffs, which can help to give investors certainty that they will get a return on their investment.
There is a misunderstanding about the role of bonds, with many people pressing for them to be used for project finance, Kidney says. “But they’re not great for projects – what they are great for is as a refinancing tool.”
Bond investors are not comfortable with developing projects because of the risks involved in the initial stages, but once schemes such as wind farms are up and running, much of the risk has been dealt with and the projects offer safe, stable, long-term returns.
Banks that have financed projects through to the commissioning stage need to be able to sell those projects on, in the form of bonds, so they can reinvest the money into new projects.
“I see the market as being like a giant wave,” Kidney says. “At the front of the wave, you have the banks, project developers and maybe governments creating the institutions of a low-carbon future. As these things are created, they flip them behind the wave into the calmer seas of the institutional investment market, where investors don’t want the excitement of project development.”
The Climate Bonds Initiative lets investors know which bonds are climate-friendly. Areas of investment could include railway infrastructure, energy and water efficiency and clean energy. “If you have a choice of two similar bonds but you know one is green, why wouldn’t you choose that one?” Kidney asks.
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