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Setting the Standards for Investing in the Solutions to Climate Change

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The news around climate change grows more ominous every day, with reports of rising sea levels, droughts, severe weather, and mounting scientific evidence that the Earth’s temperature could well rise between 2 and 7 degrees in the coming century due to rising levels of atmospheric carbon. The International Energy Agency estimates that US$1 trillion investment in climate change combating projects per year will be required over the next four decades to address these catastrophic risks to the planet and global economy.

It has become more and more obvious that the challenge of climate change must be met not merely through punitive, regulatory measures. Big tent solutions that focus on the opportunities in investing in a low carbon economy are expected to be far more effective. The Climate Bonds Initiative—a not-for-profit collaboration among investors, policymakers, academics, and environmental NGOs seeking to support the development of a transparent global market for bonds issued to raise funding for climate-change mitigation and adaptation—is one such ambitious, solutions-oriented project.

Last month we spoke to Nick Robins, Director of HSBC’s Climate Change Center for Excellence, about his participation as an advisor to the Initiative. This month Sean Kidney, Chair and Co-founder of the Initiative, talks about its standard setting activities and why they are critical for the development of the market.

[FPP:] How will the standards for certifying Climate Bonds encourage more institutional investors to participate in this emerging market?

[Kidney:] Most of the demand for climate change solution–related investment opportunities is coming from public sector funds, and that demand is considerable—19 of the top 20 pension funds are public sector funds. These investors recognize the macro risk of climate change but right now it is difficult for them to translate that into portfolio management practices.

For example, last year California State Teachers’ Retirement System (CalSTRS) issued an instruction to all its fund managers, both equity and fixed income, to look for climate change solutions in their portfolios. They got push back from the managers who said they did not have the expertise to do that. CalSTRS has joined the Climate Bonds Standards Board because it recognizes the need for a set of standards that can be used by its fixed income fund managers to carry out their mandate.

It is pretty obvious that any kind of thematic market like climate change, which depends on a view about the relative efficacy in non-credit terms of a particular investment, is going to be helped by a standard for that efficacy. [The Climate Bonds Initiative is not setting a credit standard—it will certify a bond based on its contribution to climate adaptation or mitigation, whether it is a junk bond or a triple A bond.] In the absence of a standard, the lowest common denominator of greenwashing corrupts the whole market and the result is reputation destruction for the market as a whole.

The standard becomes a useful screening tool for investors over time. We think that if we give those who care about the macro risk of climate change the opportunity to choose green over brown with the same risk/reward profile they will choose green. As the universe of certified Climate Bonds grows, the liquidity benefits will be obvious.

The standard should also be a tool for governments when they are looking to provide tax credits or other incentives to encourage climate change–related investments. The standard will be designed to give originators an easy means to decide whether they qualify for certification or not and to minimize the reporting they have to do to determine if they qualify.

[FPP:] What types of projects will you certify?

[Kidney:] We are unpacking what the low carbon economy will look like and planning over the next two years to release in an incremental way the criteria for a variety of low carbon economy investments.

Our first certifications will be bonds linked to wind energy but we are working on solar, grid infrastructure, and energy efficiency investments. We expect the latter to be about 40 percent of the US$1 trillion a year in investment we believe is needed for climate change adaptation and mitigation. We are also working on certifying bioenergy investments. It is a dynamic process and over time we may refine criteria and add others.

[FPP:] You note that some of the projects you certify may at present have a high level of “embedded” carbon. Can you explain what you mean and how they will qualify?

[Kidney:] Current levels of embedded carbon in a given project are not necessarily a big issue for us. We have to think long term and build everything in parallel. You can argue there is a lot of embedded carbon in solar, for example, but that is because the grid is still largely coal-fired. If we switch the grid to clean energy then the emitted carbon issue is dissipated. If you build a high-speed railway now it is only 15 percent less polluting than a plane if it is run on a coal-fired power-station-based grid. But we need to be building a high-speed railway line now, assuming the grid will eventually go green and that the railway line will therefore run on clean energy. So we plan to certify high-speed rail in the very near future because it is an essential infrastructure for a low carbon economy.

We are also considering certifying broadband infrastructure for the low carbon economy, because they will facilitate teleconferencing, smart grid applications, and load balancing across grids.

[FPP:] Are you looking at other ESG issues when you certify a Climate Bond?

[Kidney:] We are deliberately not tackling supply chain or ESG issues. As part of the application process we ask the originators to disclose how they are rated according to other types of standards but we do not mandate it. We cannot be all things to all people in disclosure. Our focus is clearly on the investments that need to be built to save the planet from climate change. That said, we would not support an investment that ends up having huge collateral damage like chopping down rainforests.

[FPP:] How do you see the Climate Bond Initiative aiding oil companies in their transition to becoming clean energy companies?

[Kidney:] Some institutional investors who want to mitigate their climate change risks are asking, “Is disengagement from oil companies going to make a difference and is it the right thing to do?” One can make the argument that the oil companies are in transition moving into cleaner forms of generation, and that helps climate change. So is disengagement the right thing?

One of our objectives is to get the petro fuel companies sideways into clean energy. It will only work if we can get conventional energy companies to retool. So one of our objectives is to make it easier for an Exxon to raise money for wind energy projects than it is for oil projects. It is a wild dream but it is one of the things we would like to change. Exxon is just a group of engineers and finance people and imagine if we could make it worth their while to build up clean energy rather than oil. If the money were cheaper to access for a clean energy project they would do it. That is what we hope the Climate Bonds Initiative will help accomplish.

Next month we will talk with Sean Kidney about the types of Climate Bonds that are likely to be issued into the market in the near future, and how they may be structured to attract investors.

–Susan Arterian Chang

Susan Arterian Chang is a contributing writer to The Finance Professionals’ Post and the Director of the Field Guide to Investing in a Resilient Economy Project of Capital Institute.

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