Analysis of Green Bond Financing in the Public Transportation Industry (2021)

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7 Definitions Consistent definitions ensure uniform understanding among key stakeholders in a bond issuance. Several interviewees mentioned that the definition of “green bond” is amorphous and interpreted differently by various individuals or organizations; and this uncertainty opens issuers up to negative reactions from the market. Green bonds as a financial instrument are clearly defined—they are traditional bonds with additional voluntary nonfinancial disclosures attached in order to demonstrate alignment with the core components of ICMA’s GBP. How- ever, there is considerable debate surrounding what projects should qualify for green bond financing. Characterizing Green Bonds As identified in Figure 2-1, the three main characteristics of green bonds are their envi- ronmental benefit, the fact that they are identical financial instruments to traditional bonds, and the fact that they have additional disclosures. Put simply, green bonds are bonds issued to support finance initiatives with positive environ- mental impacts. From a credit standpoint, they are identical to traditional bonds. The voluntary nonfinancial disclosures attached to green bonds signal a more attractive long-term risk profile to the market compared to traditional bonds for those investors concerned with long-term envi- ronmental risks. The biggest risk faced by a bond investor is the default of the issuer. For this reason, credit- worthiness of the issuer is the investor’s primary concern. With green bonds, the credit risk of the counterparty remains the same, but the additional nonfinancial disclosures allow investors to more thoroughly evaluate nonfinancial risks. Understanding the Value of Green Bonds Understanding the value of green bonds to investment managers is vitally important to understanding green bond issuance. Green bonds appeal to investors for two primary reasons: 1. As wealth is transferred from older to younger generations, and as society in general becomes more aware of the social and environmental impacts of investment and lifestyle decisions, demand increases for investments that generate positive social and environmental impacts along with financial returns—and the corresponding pressure on investment managers to identify those investments increases as well (Imberg and Shaban 2019). 2. As industry knowledge of environmental, social, and governance (ESG) risk evolves, insti- tutional investors have an increased appetite for investment with a favorable ESG profile. C H A P T E R 2 What Are Green Bonds?

8 Analysis of Green Bond Financing in the Public Transportation Industry According to RBC Global Asset Management’s 2019 Responsible Investment Survey: An Evolving Landscape, 65 percent of US investors (as well as 97 percent of investors in the UK and 80 percent in Canada) include ESG in investment decisions (2019). Historically, certain costs have not been efficiently priced by financial markets. One of the most prominent is the cost related to GHG emissions born by the environment. As climate science evolves, the indisputable, quantifiable costs of climate change become apparent. For example, California State Treasurer Fiona Ma recently claimed that green bonds would be necessary to raise the billions of dollars required to upgrade California’s infrastructure to deal with increasingly frequent severe weather incidents generated by climate change (California Debt and Investment Advisory Commission 2019). Impact investors with niche interests were first to understand the financial implications of ESG risks. However, as this body of knowledge evolved, ESG risk has been mainstreamed and the narrative has shifted. This was highlighted in 2018 when Larry Fink, CEO of BlackRock (the largest asset manager in the world with over $6 trillion in assets under management), announced in his annual letter to CEOs that BlackRock could no longer invest in companies without a clearly stated social mission, as they ran the risk of losing their license to operate with key stakeholders and failing. In other words, poorly managed ESG risks can negatively affect financial returns. Potential green bond issuers should be aware of the value that these offerings provide for investors. Green bonds fund projects and assets with favorable ESG risk profiles. Green initia- tives are less likely to be affected by future tightening of environmental regulations because they are actively seeking to avoid negative environmental impacts. They are less likely to face opposition from groups of stakeholders concerned with environmental health, so their license to operate is stronger. Organizations that have a strong track record of issuing green bonds signal to capital markets that they are aware of the importance of ESG risk management and are therefore seen as favorable organizations to invest in, with all other things being equal. History Green bonds arose from investor demand. A short timeline of green bond history may be found in Figure 2-2. In 2007, the Intergovernmental Panel on Climate Change published a watershed report that strongly linked human activity to climate change. Prompted by the report, a group of Swedish pension fund managers contacted the World Bank to express a desire to Figure 2-1. Elements that characterize green bonds.

What Are Green Bonds? 9 invest in projects that had a positive impact on climate issues, but they were unsure of how to identify those projects accurately. The World Bank and Norway’s Center for International Climate Research worked with the group, and in 2008 the first official green bond was issued. The first green municipal bond was issued by the Commonwealth of Massachusetts in 2013. In 2014, ICMA published the first edition of Green Bond Principles. What Projects Typically Qualify for Green Bonds? Broadly speaking, any project that an issuer identifies as having a positive environmental impact qualifies for green bond issuance. It is up to the issuer to communicate that opinion to the market. Interview participants were aligned in their belief that transit projects that do not burn fossil fuels automatically qualify for green bond issuance. Interview respondents were also aligned in their belief that green bond issuances to fund station upgrades and other aesthetic or user experience projects would not be received well by the markets. One gray area was replacing older assets with newer, more fuel-efficient assets that still burn fossil fuels but produce a considerable net savings in emissions. There was concern among some interviewees that the market would be hesitant to accept a green bond issuance that primarily funded assets that burn fossil fuels (particularly if there is an available alternative that uses renewable energy). However, others believe the tech- nology should not matter if there is a compelling case for positive environmental impact. If the issuance is poorly received by the market—whether because the case has been poorly made or because the projected environmental impacts are deemed dubious—the issuer runs the risk of damaging its reputation and limiting the viability of green bond issuance in the future. This risk has led to a proliferation of tools designed to provide clarity around what projects qualify as green by setting specific qualification criteria. Some notable examples include: 1. CBI’s Climate Bonds Standards. 2. National or regional sustainability taxonomies, such as the ones produced by the European Commission or China. 3. Independent verification. 4. United Nations’ Sustainable Development Goals (SDG)—not strictly a green bond taxonomy but increasingly popular as a means of identifying appropriate target impacts of use of pro- ceeds debt instruments like green bonds. While these tools are a useful means of benchmarking projects and providing assurance to potential investors, they are not a prerequisite for green bond issuance. Interviews conducted with stakeholders in the transit green bond space returned a variety of opinions on the useful- ness of these tools. Some found them invaluable for signaling commitment to the market, while others found them to be inflexible and excluding projects with a meaningful climate impact. Whether an agency decides to use any of these tools depends on the initiative being funded, along with the priorities and risk appetite of the agency issuing the bond. Figure 2-2. Major developments in green bond history.

10 Analysis of Green Bond Financing in the Public Transportation Industry For a more concrete example of how one of these frameworks views specific transit assets, CBI’s eligibility list for low-carbon transportation is presented in Table 2-1. Green Bond Issuance Green bonds differ from traditional bonds in that they have additional voluntary non- financial disclosures to bring them into alignment with the GBP. These disclosures are outlined in Figure 2-3. In addition, issuers may benefit from identifying metrics that will demonstrate the impact of the project. These disclosures provide investors with important information to evaluate ESG risks associated with financing, but the underlying credit risk of a green bond—and thus most of the issuance process—is identical to a traditional bond. However, the necessary dis- closures do create additional considerations, particularly in the initial issuance when the Automatically Qualified Further Consideration Required Automatically Disqualified Tramways Buses Internal combustion engine vehicles Metro Bus rapid transit Compressed natural gas vehicles Public bikes Commuter rail New public infrastructure Electric vehicles Car-sharing information and communications technology Parking facilities Hydrogen-powered vehicles Hybrid vehicles Filling stations Low-carbon fueling Dedicated freight rail High-speed rail Interurban rail Information and communications technology Source: Climate Bonds Initiative (2016). Table 2-1. CBI eligibility for low-carbon transportation. Source: International Capital Market Association (2018). Figure 2-3. Core components of ICMA’s Green Bond Principles.

What Are Green Bonds? 11 issuer might need to codify the organization’s stance on what constitutes a green project, as well as potentially develop an internal framework for classifying projects and measuring potential benefits. Municipal bonds inherently carry significant monitoring and reporting standards. Inter- viewees largely agreed that the use of proceeds disclosure and tracking requirements for green bond issuance imposes significantly less burden for transit agencies than for other bond issuers that may be accustomed to less rigorous reporting requirements. This issue is discussed in greater detail in Chapter 3.