Huge investment needs temper Green bond hype

* Survey estimates USD6trn needed for Green projects by 2020

* Supras underplay growth potential in Green bond programmes

* Bankers say niche sector can thrive with standardisation

By John Geddie

LONDON, Oct (KOSDAQ: 039200.KQ - news) 2 (IFR) - Despite major advances in 2013, Green bonds look set to remain a niche product, unlikely to make a meaningful contribution towards the estimated USD6trn needed to support low-carbon energy projects by 2020.

Since the financial crisis destroyed most of the monoline bond insurers, and tougher capital and liquidity rules forced banks out of risky long-term finance, public sector and supranational organisations have had to fund a growing share of Green infrastructure projects.

The first ever USD1bn benchmark Green bond from the International Finance Corporation back in February was heralded as a milestone in allowing ethically-minded investors to invest in size towards these projects, and issuers like NRW.Bank are joining the trend and setting up new programmes.

However, the uptick in supply from these developmental organisations is still a drop in the ocean compared to the USD10trn estimated by HSBC (LSE: HSBA.L - news) as the scale of investment needed in the sector, of which around USD6trn is expected to be serviced by debt markets.

"The requirements for Green financing are significantly higher than can be provided by supranational institutions," said Isabelle Laurent, head of funding at the European Bank for Reconstruction and Development, which issued a USD250m Green bond earlier this month.

"In order to properly grow this sector insurance and pension funds will need to take on some of this long-term project risk. This, however, will depend on the impact of future regulatory frameworks CRD IV and Solvency II."

Other capital markets solutions such as project bonds are still very much in their infancy, and for now investors are looking for the safest possible Green investments.

"To date, investor exposure to the climate-themed bond universe has been limited to the thematic funds populated by supranational issuance," wrote HSBC in its latest report, Bonds and Climate Change: The State of the Market in 2013.

While supranationals and agencies can fund Green projects through their normal funding programmes, they view it as part of their developmental mission to try to encourage ethical investment.

Furthermore, it allows them access to stringently Green-focused investors that would not normally buy their regular bond issuance.

As well as the IFC and EBRD deals this year, the World Bank has issued a new USD550m Green bond and the EIB has launched a EUR650m Climate Awareness Bond (and a subsequent EUR250m tap), while the pipeline for issuance is growing with the likes of the African Development Bank and NRW.Bank readying deals.

"We expect to issue our first themed bond some time during November (Xetra: A0Z24E - news) to the middle of December this year," said Klaus Rupprath, head of capital markets at NRW.Bank. "The sector is definitely gaining momentum."

Bankers are confident that interest will continue to flourish.

"The track record for Green investments is much more established in equities, but now some of these investors are starting to pay attention to debt instruments as well," said Andrew Salvoni, vice-president of SSA syndicate at Morgan Stanley.

STANDARDS NEEDED?

A lack of standardisation across Green products, however, is holding growth back, say bankers.

Calculations of the size of the market illustrate this problem. In its July report, HSBC concluded that the universe of climate-themed bonds outstanding totalled USD346bn-equivalent, a significant expansion on the 2012 estimate of USD174bn.

That figure, however, includes a wide range of bonds and not just dedicated Green labelled products. For example, it includes China's Ministry of Railways bonds which account for over one third - or USD117bn-equivalent - of its total climate-themed bond universe.

By comparison, at the end of last year the OECD calculated that the global Green bond market was just USD16bn, tiny compared to the overall bond market of USD95trn.

"It is smaller than a necessary market size of USD200 to USD300bn required to create a sufficiently liquid asset class for institutional investors to access," the OECD report concluded.

The disparity in these calculations emphasises that it is a market consisting of tailored and bespoke products, and puts a dampener on plans to further develop liquid Green indices and ultimately create a "use of proceeds" exchange-traded fund.

In November, the World Bank - which was the first entity to issue a Green bond in 2008 - is holding a conference to try to address the problem of standardisation.

"We need this meeting to see how far away we are from a common ground agreed to by both issuers and investors, and how difficult the requirements will be for issuers," said George Richardson, head of capital markets at the World Bank.

"It will enable new Green or SRI bond issuers coming into the market to have some basic set of guidelines or framework."

However, others are not convinced these discussions will help to advance the market given wide-ranging requirements of Green investors.

"I don't think standardisation is the answer; the important aspect is transparency," said EBRD's Laurent.

"The number of ethically-minded investors is certainly growing, but what is increasingly apparent is that it is not one homogenous investor base."