What are ESG Bonds and Green Bonds and Should You Consider Issuing Them? JD SupraWhat are ESG Bonds and Green Bonds and Should You Consider Issuing Them? JD SupraWhat are ESG Bonds and Green Bonds and Should You Consider Issuing Them? JD Supra
Impact Investing Forum 2022
London. April 28-29, 2022.
An investment banker will market the bonds of your municipality, authority, or school district to investors. The more investors that are interested in purchasing your bonds, then the lower your interest rate.
This is the case for “bank qualified bonds,” where issuers that issue less than $10,000,000 principal amount of tax-exempt debt per calendar year get lower interest rates due to banks being able to buy the bonds. Your municipality, authority, or school district may be eligible to borrow money at lower interest rates to supplement federal funds.
A new trend in the debt market could lead to lower interest rates for issuers due to increased demand: ESG and Green bonds.
Investors are increasingly attracted to ESG bonds and Green bond because the practice and concept of socially responsible investing has been recognized as a valuable asset in the bond market. These socially responsible bonds make up only 2% of the municipal bond markets at the moment, but investors are increasingly interested in them. The demand for ESG and Green bonds has increased significantly over the past decade.
ESG bonds is an acronym for Environmental, Social and Governance bonds. These bonds are a type or debt instrument where the issuer has identified certain environmental and social criteria that will be used to generate bond proceeds. In general, municipalities, authorities, and school districts have been providing environmentally-friendly and socially-responsible projects, so the ability to borrow at a lower interest rate to continue to provide these services is a big benefit.
These ESG bonds can be issued by your municipality, authority, or school district for a variety of projects. This type of offering is appreciated by many issuers. ESG bonds can be used to finance projects in municipalities, schools districts, and authorities. These include smart infrastructure, clean transportation, and renewable energy. These types of projects can be partially funded by federal funds that are pledged to sustainable infrastructure, while the rest may be funded from ESG bonds.
ESG bond financings can also be used to finance governance or social projects. Social projects could include the plan of a municipality, authority or school district for safety management, workplace diversity initiatives, health and safety of employees, citizens, or students. Recent bond issues for housing projects have been designated social bonds by the Pennsylvania Housing Finance Agency. Governance projects can be used to manage the day-to-day operations of a municipality, authority or school district. They also help ensure financial transparency and establish internal policies and procedures.
Green bonds are a type of debt instrument that is used to support climate- and environmental-focused projects. Green bonds can be used to raise funds in order to fund specific climate and environmental projects, such as those in energy (projects like wind or solar) or buildings (projects like efficient buildings and low-carbon materials).
ESG bonds and Green bonds can only be issued by the issuer’s and underwriter’s lawyers. They will work together with ESG specialists to establish and draft the criteria that the issuer will use to make this designation. The counsel will collaborate to assess the request for general funding or project-specific financing and then decide which type of bonds is best suited to the funding request. The ESG specialist may also be involved in the evaluation of the request for general funding or project-specific funding.
The International Capital Market Association (ICMA), in response to questions about the qualifications for either an ESG or Green bond, published “Social Bond Principles and “Green Bond Principles” (www.icmagroup.org). This guidance provides guidelines to issuers on the criteria for these issuances. The Securities and Exchange Commission (SEC), is currently considering the establishment of a standard set principles for ESG bonds and Green bond issuances. However, there are no other standards than the voluntary guidelines in the Social Bond Principles and Green Bond Principles. These guidelines are voluntary and issuers don’t have to follow them. They are accepted by most bond issuers as a framework for evaluating the socially responsible principles of these bonds.
The “Social Bond Principles”, and “Green Bond Principles”, guidance are based on four main components. They are (1) use of proceeds; (2) selection process; (3) management of proceeds; (4) reporting. The Green Bond Principles are focused on climate-related projects, including investments in clean energy or pollution reduction. The Social Bond Principles are focused on projects that “address or mitigate a special socio-economic issue and/or seek positive social outcomes.” Governance is the third qualification for ESG bonds. It is generally understood to refer to how an organization’s internal system, rules, policies and procedures is managed.
An issuer will post the framework used by the issuer to determine whether the financing qualifies for either an ESG or Green bond before marketing it. Investors will need to be able to see the reasoning behind these designations. Investors can then examine each component and determine if it meets their specific requirements and guidelines for socially responsible investing.
Depending on the investor and the issuer, there may be an obligation to continue reporting on the ESG bond proceeds’ impact or the Green bond proceeds’ impact. Some issuers may employ a third party to monitor the expenditure of the ESG bonds proceeds or the Green bonds proceeds in order to ensure that the funds produce the desired outcomes. Until there is a standard requirement to either designate ESG bonds or Green bond, disclosure and reporting obligations will be left up to the discretion of the issuer as well as the demands of investors.
The Securities and Exchange Commission has been active in monitoring ESG bonds and Green bond to identify any misconduct. In March 2021, the Climate and ESG Task Force (the “Task Force”) in the SEC’s Division of Enforcement was created in response to the increasing investor interest in these types of bonds (www.sec.gov/news/press-release/2021-42). The Task Force reviews certain concerns about the criteria used to establish these issuer frameworks and identifies any disclosure gaps. The Task Force will also monitor compliance requirements for ESG bonds as well as Green bonds.
This market is growing and issuers are looking for opportunities to invest in socially responsible projects. Investors are also supporting these projects.