(This is the third of the 3 part series on Net Zero and includes “What is Net Zero”(Part 1), How to set Net Zero targets(Part 2) and financing emission reduction and Net Zero targets(Part 3))
When setting Net-Zero and Corporate Decarbonization targets, every corporate should be aware of the various financial instruments that can help achieve these targets. In this article, some of the debt instruments that can enable financing emission reduction targets are highlighted.
Bonds Vs Loans
Broadly, there are two types of debt instruments available – bonds and loans. Both the instruments have some key differences, which is explained in detail in this article. In the context of financing emission reduction projects, there are Green Bonds and Green Loans, in addition to Sustainability Bonds(SBs), Sustainability-Linked Bonds (SLBs) and Sustainability-Linked Loans (SLLs). There are also Social Bonds and Loans, which are quite similar to the Green Bonds, but enable social projects. The table below provides a summary of the different types of debt instruments in the market.
Table 1: Classification of Sustainability related debt instruments
| Category | Bonds | Loans |
| Green |
X |
X |
| Social |
X |
X |
| Sustainability |
X |
– |
| Sustainability-Linked |
X |
X |
| Transition |
X |
– |
| SDG |
X |
– |
| Environmental Impact |
X |
– |
| Social Impact |
X |
– |
Principles and Guidelines related to Sustainability themed Bonds (including Green and Social) are developed and published by International Capital Market Association (ICMA) and those related to Sustainability themed Loans (including Green and Social) are developed and published jointly by Loan Market Association (LMA), Asia Pacific Loan Market Association (APLMA), Loan Syndications & Trading Association (LSTA).
Bonds
1. Green Bonds
The Green Bond Principles (GBP), developed by the ICMA, provides a standardised process and disclosure guidance for issuers that help the investors, banks, underwriters, arrangers, placement agents and others understand the characteristics of any given Green Bond.
According to the GBP, “Green Bonds are any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects and which are aligned with the four core components of the GBP”.
There are four core components for alignment with the GBP, which are Use of Proceeds, Process for Project Evaluation and Selection, Management of Proceeds and Reporting. The eligible Green Projects categories under the GBP include Renewable energy, Energy efficiency and clean transportation, among others. There are four types of green bonds – Standard Green Use of Proceeds Bond, Green Revenue Bond, Green Project Bond and Secured Green Bond. The German energy company e.on is one of the top issuers of Green Bonds and is a good example of using this instrument for financing emission reduction projects.
Social bond has a definition similar to a Green bond, except that the use of proceeds will be for financing social projects. Sustainability Bonds are also identical, and a combination of both Green and Social Projects are eligible for Sustainability Bonds.
2. Sustainability Linked Bonds (SLBs)
Unlike Green or Sustainability Bonds which ringfence funds for use in green or sustainable projects, SLBs links financing to sustainability targets. This is accomplished by linking the coupon paid by the issuer to its achievement of pre-agreed sustainability targets, often called Key Performance Indicators(KPIs).
The SLB has five core components.
- Selection of Key Performance Indicators (KPIs)
- Calibration of Sustainability Performance Targets (SPTs)
- Bond characteristics
- Reporting
- Verification
The SLB Principles state that the KPIs should be:
- relevant, core and material to the issuer’s overall business
- measurable or quantifiable on a consistent methodological basis
- externally verifiable
- able to be benchmarked
The Principles and Guidelines related to Green, Social, Sustainability and Sustainability-Linked Bonds(SLBs) can be accessed here.
Loans
1. Green Loans
The Green Loan Principles (GLP) provides guidelines that help market participants asses the characteristics of a Green Loan and are based on the Green Bond Principles (GBP). The GLP defines Green loans as “any type of loan instrument made available exclusively to finance or re-finance, in whole or in part, new and/or existing eligible Green Projects”.
GLP also has four core components similar to the GBP, which are Use of Proceeds, Process for Project Evaluation and Selection, Management of Proceeds and Reporting. In addition, the Categories of Eligibility for Green Projects are similar to those for Green Bonds.
Social Loans are very similar to the Green Loans except for the type of projects eligible for financing.
2. Sustainability-Linked Loans (SLLs)
According to the GLP, Sustainability-linked loans(SLLs) are “any types of loan instruments and/or contingent facilities (which incentivise the borrower’s achievement of ambitious, predetermined sustainability performance objectives”. SLLs also have the same five core components that SLBs have, and includes KPIs.
The Principles related to Green, Social and Sustainability-Linked Loans (SLLs) can be accessed here.
3. Transition Bonds
Transition bonds are a relatively new class of bonds, and the use of proceeds are intended to fund a firm’s transition towards reduction of negative environmental impact or reduction of carbon emissions. The framework is similar to Green Bond issues and has the same four components as Green Bonds. In short, while Transition Bonds are relatively new, they are useful instruments in financing emission reduction projects. More details on Transition Bonds can be found here.
SDG Bonds are mainly country specific Sovereign Bonds meant for financing SDG-oriented projects. Environmental Impact Bonds (EIBs) have also been issued in the past along with Social Impact Bonds(SIBs) with the aim of financing environmental and social impact projects. More details on EIBs and SIBs can be accessed here and here.
Conclusion
There are several options for financing green projects that enable achievement of emission reduction targets. For a firm serious about its Net-zero or emission reduction targets, financing emission reduction commitments and decarbonisation targets will be relatively easy.
(Note : Parts 1 and 2 of this blog series can be accessed here and here)
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