Minnesota Cities Magazine
More from Jul-Aug 2016 issue

Green Bonds: More Than a Fad but Not Yet Fantastic

By Bruce Kimmel

You may have heard of “green bonds” as a new way to finance capital improvement, acquisition, and construction projects.Hands holding a plant with graph in background, illustrating green bonds A green bond is simply a conventional municipal bond that is labeled “green” by the issuer because its proceeds are used to fund environmentally friendly projects.

The theory behind the green bond designation is that it will attract new, socially conscious investors, resulting in higher demand for the bonds and, thus, reducing borrowing costs for the issuer. However, before your city issues green bonds, it’s important to understand that the true economic benefit is uncertain at this point.

Jury’s still out on benefit of green bonds
According to Thomson Reuters, green bond issuance in the U.S. has soared from $693 million in 2013 to $4.3 billion in 2015. Although it still only represents a little over 1 percent of the $403 billion of municipal bonds issued overall last year, the growth is striking and, in response, several investment firms have launched green bond funds in recent years. Nevertheless, the market has not been able to fully substantiate the theory that green-labeled bonds allow cities to borrow at net lower costs, primarily because interest rates are already low.

Since 2013, when the first green bonds were issued by the Commonwealth of Massachusetts, interest rates have hovered at near-historic lows, and municipal bonds have enjoyed tremendous demand. It is difficult to assess under these market conditions whether the additional demand from socially conscious investors has resulted in materially lower financing costs. If longer-term interest rates increase, the financial benefits of issuing a green bond may become more apparent.

City gives it a try
Even if the financial benefit is not clear, there may be reasons related to civic responsibility for issuing green bonds.

The City of Edina, for example, implemented a program to finance solar installations on private property. The city issued bonds to investors and specially assessed the private business for the cost of the improvement.

“Our program was developed in response to a community desire to reduce dependence on energy sources that contribute to climate change,” says Edina Finance Director Eric Roggeman. “However, the program was not as active as we had hoped because it hasn’t been able to deliver significant financial benefits to either the businesses or the city.”

Bonds were issued for each project and the transaction costs, spread over the two relatively small bond issues, reduced the economic benefit to the businesses.

If your city is considering issuing green bonds, here are some factors to consider:

There is no distinct authority to issue green bonds. So far, the state Legislature has not established distinct authority to issue bonds just because a project is perceived as environmentally beneficial. The issuer must rely on existing statutes authorizing the issuance of debt.

For example, to finance a wastewater treatment plant, a city will need to issue general obligation wastewater revenue bonds under Minnesota Statutes, chapter 444. The city can call the bonds “green” and can market them to investors as green bonds, but will legally issue them as conventional municipal debt.

There is no uniform standard to answer the question of what makes a bond green. Often the answer is, “If the issuer says it is.” As the green bond market matures, we are seeing socially conscious investors become more diligent in determining how their investments are being used.

Due diligence protocols called Green Bond Principles have been developed by the International Capital Markets Association (ICMA) and include requirements such as obtaining independent reports on the environmental benefits of the green bond-funded projects.

The ICMA is also attempting to educate investors about the “green-washing” of supposedly less credible eco-financings. It is expected that ICMA principles or a similar set of disclosure protocols will become the norm over time. This means that deeming your bonds “green” will most likely trigger additional up-front and annual reporting responsibilities.

Is it worth it?
The big question about green bonds, yet to be answered, is whether interest rates for such obligations will offer demonstrable net benefits to the issuer. Green bonds may reduce the cost of borrowing as:

  • The market matures.
  • The definition of what constitutes a green project is standardized.
  • Enhanced reporting and disclosure requirements become the norm, allowing for comfort on the part of investors that their objectives are being achieved.

If your community is considering designating a bond as green, it will be important to assess whether the reputational and/or financial benefits of issuing green bonds will exceed the costs associated with the extra disclosure requirements.

Bruce Kimmel is a senior municipal advisor with Ehlers (www.ehlers-inc.com). Ehlers is a member of the LMC Business Leadership Council (www.lmc.org/sponsors).

Read the July-August 2016 issue of Minnesota Cities magazine

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