Landscape GreenBonds: An emerging new asset class?
Publication date 09/09/2017
The green bond market is growing fast but remains a small component of the bonds universe. According to the Climate Bonds Initiative 2016 Report, 'labelled' green bonds accounted for US$118 Bn of the market which is in turn a subset of the 'climate - aligned' green bond market of US$694 Bn. Most issuances are linked to energy but an emerging new opportunity is in 'Landscape Green Bonds'. Today these are rare and make up just 3% of green bonds issued. In the next decade, this market could expand offering exposure to a US$200bn a year business opportunity in climate-smart tropical agriculture.
Bonds are commonly used financial instruments in capital markets to enable corporations and governments to access large sums of finance. ‘Green bonds’ are a variation designed to produce an environmental benefit, such as reducing carbon emissions. Already, such instruments are channeling billions of dollars into climate mitigating industries such as renewable energy and transport.
A huge emerging opportunity exists in transforming tropical landscapes, where most of the world's food will come from in the future, to become climate smart and deforestation free. Some scientists believe that up to 50% of what is needed to keep earth's atmosphere below a 2 degree rise in temperature could come from action to halt deforestation and reform agricultural production. That's where capital markets come in because that job is far too big for governments to finance on their own.
So how would you design a Landscape Green Bond? In 2013, Global Canopy, the 'think tank' I founded in Oxford, set out to answer this question, with the financial backing of the German Government’s International Climate Fund. We initiated this work following a challenge from an investor who said to me one day: "What could you do with a billion dollars?". The problem he identified was that there were no products around in this sector sufficiently large enough for capital markets to get their teeth into.
Over the last four years I have been involved in building a portfolio of investable projects for future landscape finance mechanisms in Acre and Mato Grosso in Brasil, with AgroBanco in Peru and also in Indonesia, during a collaboration with ADM Capital and BNP Paribas and the Indonesian government. In all cases what has emerged is a pioneering but broadly similar financial mechanism that could channel finance at scale towards more sustainable land use. The first transactions are about to get underway. What's clear is that several stages are need to access this kind of finance. The first is to design an aggregated pipeline of projects and initially an innovative 5 -10 year lending mechanism to fund them. Secondly it's necessary to aggregate a number of portfolios in different regions into a 'warehouse' to achieve scale, that could later have a bond wrapper put around it. Thirdly, blending climate finance from governments is a crucial way to help de-risk these investments, to attract large scale private investment in. Here are six ingredients I feel are needed for large scale finance mechanisms that deliver more productive landscapes, reduce deforestation and deliver sustainable livelihoods:
1. Banks need to be incentivised to invest for the long term as payback periods are often longer than 4 years. The lack of long dated, low interest capital is a major barrier for smallholder farmers. Replacing old palm oil trees with new ones, leaves smallholder farmers facing a 5 year “Valley of Death” without an income stream, so decade long loans need to be available to them at a price they can afford.
2. Donors need to be willing to use Climate Finance to de-risk deals and increase the scale of investment. There is a significant amount of climate-linked finance potentially coming on stream, such as through the Green Climate Fund. By offering floor prices, insurance and guarantees, public sector funding can be leveraged within blended public-private finance mechanisms.
3. Finance has to adapt to requirements on the ground, as ‘bundling’ sectors brings its own challenges. An initial lending mechanism needs to finance not just one supply chain but possibly 5 or 6 commodities together, coupled with say weather insurance and other de-risking incentives.
4. Technical Assistance is essential to build capacity, not only among farmers, but also provincial governments that may not be familiar with novel finance mechanisms, such as bonds. Private sector investors rarely finance such activities, so their funds need matching grants or concessional finance from donors to oil these wheels.
5. Aggregating portfolios can help to reach the scale capital markets need. That means finance mechanisms themselves and their pipelines, may need to be aggregated, possibly across a country, region or even globally. Projects and larger portfolios can be ‘warehoused’ as they come on-stream, until the required scale is achieved. Then a bond ‘wrapper’ can be put around them and taken it to market increasing liquidity.
6. Mixing and matching with more mature sectors, can reduce the perception of risk for investors. So for example, including off-grid renewable energy for smallholders, alongside sustainable agriculture, helps to diversify the portfolio and can make a landscape green bond more attractive to investors and also to governments, keen to meet their Sustainable Development Goals. The World Bank's 'AgriFin' Conference taking place 12th-13th September in London will provide a fertile testing ground for such ideas to take root.
Image: c. Henry Neufeldt, World Agroforestry Centre