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Save the Earth, Buy Green Bonds

Save the Earth, Buy Green Bonds

Bank of America Merrill Lynch has become the first U.S. underwriter to offer the World Bank’s new green bonds to retail investors in $1,000 denominations.

A World Bank green bond is the same as any other World Bank bond, but the proceeds are “ring-fenced” by the World Bank for climate-related projects. The bonds are triple-A rated, secured by the full faith and credit of the World Bank, and not linked to the performance of the projects, so investors do not take any project or country risk, according to the offering documents.

With the uncertainty about the ability of the U.S. to maintain its triple-A rating, World Bank bonds are “another triple-A alternative,” says Suzanne Buchta, a director in the firm’s Debt Capital Markets division.

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BofA Merrill’s first retail offering on May 24th was just $2.1 million. That first issue was structured as a ten-year bond with a fixed rate of 3.5 percent, but only for the first year. It will then convert to a floating rate for the duration, with the rate adjusting every three months based on 3-month LIBOR, with a cap of 4.92 percent. Those bonds were non-callable.

“They’re giving investors a little lollipop at the beginning, so if it’s a year from now, and 3-month LIBOR is still 25 basis points, at least they’ve had the benefit of the 3.5 percent upfront,” says Jordan S. Celkupa, a CFP with Robert J. Oberst, Sr. & Associates in Red Bank, N.J., who has no relationship with BofA Merrill, but has read the offering document. “In this kind of low-rate environment, there’s no way to get one of these floating-rate securities sold without the lollipop.”

The second issue, priced on August 4, was also a 10-year, but with a different and simpler structure. It carries a fixed rate of 2.5 percent for the first five years. At the five-year mark, the World Bank has a one-time opportunity to call the bonds, and if it doesn’t, the coupon is stepped up to a fixed rate of 3.0 percent for the remaining five years.

The fixed deal did better than the flipper, with $7.7 million raised – still small, but
BofA Merrill believes it will be able to do more offerings on some sort of regular basis,
“as more investors become aware of the product,” Buchta says.

The World Bank launched its first green bond issue in 2008, according to its Web site. So far, its green bond program has raised more than $2 billion in 40 issues denominated in 16 currencies. Most were sold in large chunks to big institutional investors, including the California State Teachers’ Retirement System, the California State Treasurer’s Office, and the New York State Common Retirement Fund. Two socially responsible U.S. mutual fund sponsors have also been buyers: Trillium Asset Management, for its Green Century Balanced Fund, and Everence (formerly known as the MMA Praxis Mutual Funds), for its Praxis Intermediate Income Fund.

Japan is the one market where individual investors have been big buyers, with Nikko Asset Management reporting that its “World Bank Green Bond Fund” for Japanese investors is now just over $800 million, according to chief investment officer Stuart Kinnersley in London. This year, the International Finance Corporation (IFC), the World Bank’s private sector subsidiary, also raised $135 million from Japanese retail investors through a series of four Uridashi Green Bonds underwritten by Nomura. (A Uridashi bond is a type of bond sold in Japan to retail investors, where the bond is denominated in a high-yielding currency such as the Australian dollar or the South African rand as an alternative to the yen.)

The World Bank’s program is by far the largest, but the green bond market now includes some of the other supranational development agencies, including the European Investment Bank, the Asian Development Bank, the Nordic Investment Bank, and the African Development Bank. In all, the green bond market – including some private sector bonds – now totals about $12 billion, says Sean Kidney, the chair of the London-based Climate Bonds Initiative, which is about to release its long-awaited final standards for certifying private sector corporate and project development bonds as “green,” much like the LEED (Leadership in Energy and Environmental Design) standard for certifying green buildings. So far, the market for green bonds has been largely the triple-A rated development agencies, but the hope is that once standards are in place, and investors can be assured that green bonds from the private sector really are “green” and not just “green washed,” that part of the market will get a boost.

When investors buy the bonds, they don’t know the specific projects that will be funded with their money, but the World Bank puts the money into a separate account where it is earmarked for projects in two categories: Climate mitigation and climate adaptation.

Climate mitigation is the more obvious category, with the types of projects that are commonly associated with reducing carbon emissions: Building solar and wind farms, rehabilitating power plants and transmission facilities, retrofitting existing buildings, converting biomass to fuel, and improving mass transit. Climate adaptation includes sustainable forest management and re-forestation, along with measures to prevent flooding and improve agricultural methods.

The projects are not in the U.S. or in the other major countries of the developed world, but in what Heiki Reichelt, the head of investor relations and new products at the World Bank in Washington, D.C., describes as “middle-income” countries. For example, she cites Mexico (solar and transportation); Brazil and Columbia (waste management); and Ukraine (energy efficiency).

“Green bonds are the first investment I know of where you can directly participate in pushing the availability of financing to things that reduce the carbon footprint or improve energy efficiency,” says Cheryl Smith, a managing partner at Trillium Asset Management in Boston, which has a $1 million investment in a 2.25 percent World Bank bond due in 2014.

“Usually, you’re investing with an eye towards the environmental characteristics of normal corporate issuers, or issuers with environmental concerns. Green bonds are more targeted,” she says, adding that “Heiki has done a great job of explaining what the World Bank is doing and what its criteria are.”

Benjamin J. Bailey, the fixed income manager at Everence in Goshen, Indiana, notes that most private sector project finance bonds are triple-B’s, “so it’s always nice to have a triple-A, where you can buy larger pieces because it’s more liquid, but with a decent spread, and a really good story.” In 2009, Everence bought $2 million of a 2 percent World Bank green bond due in 2013, he says.

Kinnersley of NikkoAM says it’s “very difficult to know” the extent to which the Japanese are big on green bonds because they want to “go green,” or whether they’re more interested in his fund as a multi-currency vehicle, which holds World Bank green bonds denominated in 16 currencies. It’s structured that way because, if a Japanese investor were to buy bonds denominated in yen, the yield would be negligible, he says. But, at the same time, Japanese investors are getting “this additional feature, and especially, if someone has an environmental philosophy, they feel they can do some good for the world,” he says, adding that NikkoAM also has a newer fund for European investors, which now has about $35 million.

“Any nascent market always starts off small, and has to grow from somewhere. Everything I see points towards green bonds becoming a bigger and bigger asset class in their own right. The World Bank has led the way,” he says.

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