The Need for Green Covenants. Regulating the Green Bond Market

Master's Thesis, 2015

36 Pages, Grade: B




1 Introduction

2 Green Bonds - a Novel Instrument to address Climate Change
2.1 Connecting Finance and the Environment
2.2 Operation of a Green Bond
2.2.1 World Bank Green Bonds
2.2.2 Clean Renewable Energy Bonds
2.2.3 Transport for London
2.2.4 NRG Yield, Inc

3 Introducing Green Covenants
3.1 Determining the Shade of Green
3.2 The Need for Green Covenants
3.3 Simple Enforceability ofGreen Covenants
3.4 Why are Green Covenants Necessary?

4 Operation of Green Covenants in Comparison with Common Law Instruments
4.1 FiduciaryDuties
4.2 Fraudulent Misrepresentation and Securities Fraud
4.3 Quistclose Trusts
4.4 Green Covenants as a Superior Solution


Online Sources

Litigation and Proceedings



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1 Introduction

Green Bonds are a novel form of long term debt financing instruments ena­bling continued and sustainable economic growth in a finite physical world. The market for green bonds or Climate Bonds[1] comprises of debt instruments, the proceeds of which are Earmarked[2] for use in environmentally friendly pro­jects. Introduced by the European Investment Bank (EIB) in 2007, the market for green bonds has been growing rapidly, reaching the record volume of USD 36.6 billion in 2014.[3]

Rapidly growing markets offer a myriad of opportunities for investors, but those opportunities come with certain risks attached. The risk addressed by this paper is a twofold one.

Firstly, there is a risk to the environment if the proceeds of earmarked bonds are used for projects that do not actually benefit the environment. Secondly, there is a legal and financial risk to bondholders that arises when issuers of green bonds use funds for purposes other than those set out in the bond in­denture.

There are two steps that need to be taken in order to address these risks at the same time. First, a uniform standard of what defines a green bond or a specified range of Shades of Green[4] has to be found and implemented. Se­cond, a green bond needs to state explicitly, in its indenture, what purposes the funds will be used for and of what shade of green those purposes are, in order to empower bondholders to take legal action if covenants are broken. These clauses will be referred to as Green Covenants[5].

This paper will start by briefly setting out the threat posed by climate change before continuing to introduce green bonds, explaining how they operate and why they will become part of the solution to climate change. Four varieties of green bonds, issued by four very different entities, will then be examined and it will be shown that there are certain shortcomings they all have in common.

This paper goes on by suggesting that these shortcomings can be addressed by introducing stricter and, most importantly, legally enforceable covenants that determine what proceeds of green bonds can be used for. This will be proven by comparing instruments of English Law and United States (US) Federal Law that are currently available to bondholders, with powers a stronger set of covenants will make available to bondholders in the future.

2 Green Bonds - a Novel Instrument to address Climate Change

Capitalism is arguably one of the most transformative cultural and economic phenomena found in the world today. It nurtured political liberty, enabled the industrial revolution and created unprecedented growth and wealth. At the same time, the spirit of capitalism is based on rational calculations instead of moral or ethical values and inherently expansive, acquisitive and insatiable.[6]

The scientific evidence that industrial, expansive, capitalism is outgrowing our planet and destroying its own resource base while harming our biosphere is now compelling.[7] Various scholars have thus called for a transformation of the capitalist concept to emphasize intensive instead of extensive growth and en­able global capitalism to co-exist with its natural biospheric limits.[8] As Randers[9] put it:

“This debate (over whether it is possible to have unending growth of GDP on a finite earth) has continued till today, in spite of its obvious and simple answer: Economic growth can continue forever, but only if the ecological footprint of that economic activity can be accommodated within the boundaries of the finite physical world. For growth to contin­ue, the ecological footprint per unit of GDP must decrease so fast that the total ecological footprint (at least) remains constant. (...)”[10]

2.1 Connecting Finance and the Environment

Sustainable growth is possible if we find a way to design a new form of Sustainable Industrial Capitalism[11] that enables consumers and producers to keep within natural biospheric limits. Such a redesigned form of capitalism will have to be embraced across the economy. In this paper, I will specifically ad­dress the implementation of sustainable capitalism in the financial industry.

Climate finance in its various forms[12] has been part of international climate change agreements from the outset - the United Nations Framework Conven­tion on Climate Change (UNFCCC) stated that developed countries shall pro­vide “new and additional financial resources” to developing countries to ena­ble them to cope with climate change.[13] At the Copenhagen Conference of the Parties (COP) 15 Conference in December 2009, industrialised countries committed to giving USD 100 billion per year from 2020 onwards. While it re­mains unclear whether this goal will be reached, Copenhagen has demon­strated that there is willingness to raise large sums of money to invest in re­newable and low carbon energy solutions.[14]

Public finance will clearly play an important role, however the potential of pri­vate finance in addressing climate change should not be underestimated. And indeed, there are various potential solutions at hand. While Carbon Taxes or Cap and Trade Schemes[15] tend to work well in developed countries, they cannot be expected to play an equally significant role in developing countries, where low energy prices are a means of development.[16]

I shall argue that, thus, the key to sustainable growth is long term financing through the use of public and private sector debt instruments - so called green bonds or climate bonds[17]. And indeed, the issuance volume of labelled green bonds has been on the rise since 2008, reaching the record volume of USD 36.6 billion[18] in 2014.[19] While this constitutes merely about 1% of global corporate bond issuance in the same timeframe[20], there is a clear trend that can be identified. As can be seen in Figure 1 below, the volume of green bonds issued in 2014 was about three times as high as the volume in 2013. Markets are expected to triple again in 2015.[21] [22]

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Figure 1: Green Bond Issuance to Date, Source: green-bonds-final-report-0 (Accessed July 13, 2015).

To be clear, these numbers only relate to labelled green bonds. As can be seen in Figure 2, the volume of the climate bonds or climate themed bonds market is much larger at over USD 500 billion outstanding in 2014.[23]

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Figure 2: Climate Themed Bonds and Green Bonds, Source: (Accessed July 13, 2015).

2.2 Operation of a Green Bond

In order to fully comprehend the shortcomings of green bonds and the poten­tial negative effects these may have on a framework to permit the use of pri­vate finance in combatting climate change, one has to understand the design and operation ofthese debt instruments.

While the early days of green bonds were dominated by instruments issued by international financial institutions, such as the International Bank for Re­construction and Development (IBRD) or World Bank and the EIB, today’s market is much more diverse. And indeed, after the first three corporate green bonds were issued in November 2013[24], in 2014 combined corporate and municipal issuers (46% of the market) overtook multilateral development banks (44%) for the first time in terms of the volume of green bonds issued as can be seen in Figure 3 below.[25]

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Figure 3: Corporate and Municipal issuance overtook Development banks in 2014, Source: (Accessed July 13, 2015).

Most green bonds are very similar to standard Plain Vanilla[26] bonds - they are debt instruments underwhich an investor loans money to an entity (corpo­rate, governmental or multilateral), which borrows the funds for a defined pe­riod of time, at a fixed (or sometimes variable) interest rate. Bonds are used to raise money and finance a variety of projects and activities - in the case of green bonds, projects that have positive environmental and/or climate impact. The majority of green bonds are Use of Proceeds bonds - proceeds from the issuance of bonds are earmarked for green projects but backed by the issu­er’s entire balance sheet. There are also green use of proceeds revenue bonds, green project bonds and green securitised bonds.[27] Green bonds are standard bonds with the green feature as a bonus - their credit profile, pricing and position in insolvency are similarto plain vanilla bonds.[28]

While most green bonds issued today are very much standard instruments, the market is growing and diversifying rapidly. In order to reflect these devel­opments, I will now analyse the operation of green bonds, referring to four debt instruments issued by four very different entities, namely the World Bank, the United States (US) Treasury, NRG Yield Operating, LLC and Transport for London (TfL).

I will give a brief overview of the general background of each debt instrument, however the main point of this brief analysis is to explore the types of projects considered green or climate friendly and whether investors have any possibil­ity of demanding recourse if earmarked funds are used for non climate friendly projects. I will come to the conclusion that investors are very limited in their actions and that stronger covenants are needed.

2.2.1 World Bank Green Bonds

In 2008, the World Bank joined with the Scandinavian bank SEB (Skandina- viska Enskilda Banken) to issue one of the first green bonds. The first tranche of the bond, which was targeted at institutional investors, was denominated in Swedish Krona (SEK) to a value of SEK 2.325 billion. Interest payable on the bond was 0.25% above current Swedish government bond rates. The inves­tors were largely institutional investors such as two Swedish pension funds. Since 2008, the World Bank has issued a total of USD 8.5 billion in green bonds through 100 transactions in18 currencies.[29]

Green bonds issued by the World Bank are, in their basic structure, very closely modelled to existing infrastructure bonds - they are what would be called plain vanilla. And indeed, while the indenture[30] of the bond states that “an amount equal to the net proceeds of the issue of the notes will be credited to a special account that will support IBRD’s lending for eligible projects”, whereas eligible projects are “all projects funded, in whole or in part, by IBRD that promote the transition to low carbon and climate resilient growth in the recipient country, as determined by IBRD”, the same document holds that “no assurance can be provided that disbursements for projects with these specific characteristics will be made by IBRD during the term of the notes”.[31]

According to the indenture[32], the World Bank green bonds programme is very much a plain vanilla infrastructure bonds programme. While the World Bank may aim to support climate friendly projects, there is no contractual obligation for it to exclusively use funds raised through its green bonds programme for such projects.

2.2.2 Clean Renewable Energy Bonds

As part of its 2009 stimulus package, the US Treasury announced the Ameri­can Recovery and Reinvestment Act (ARRA)[33] [34] which contains the largest single authorisation of tax credit bonds to that date, among them the issuance of USD 2.4 billion worth of green bonds. Under this tax credit bond pro­gramme, in lieu ofa coupon, the US federal government undertakes to grant a tax credit to bondholders.[35]


[1] This paper follows the definitions ofthe Climate Bonds Initiative, underwhich Green Bonds are debt instruments expressly labelled as green by their respective issuer and Climate Bonds are debt instruments that fulfil the requirements to be labelled, but are not (Climate Bonds Initiative, 2015 bonds-initiative (Accessed July 13, 2015)).

[2] E.g. purpose bound - proceeds from green bonds can only be used for environ­mentally friendly projects.

[3] Green Bonds Final Report, 2014 bonds-final-report-0 (Accessed July 13, 2015).

[4] E.g. a way of measuring how climate friendly the projects a bond is issued for are- since there is no absolute standard to measure the shade of green of an investment, this can only be determined in relation to other green bonds or climate bonds.

[5] E.g. the, legally enforceable, promise of an issuer to only use bond proceeds for climate friendly projects - see also at 4.4 below.

[6] Mathews, J.A., Naturalizing Capitalism: The next Great Transformation, Futures, 43(8), pp. 868-879, 2011; Meadows, D.H., The Limits to Growth: A Report for the Club of Rome's Project on the Predicament of Mankind, New American Library, New York, 1972.

[7] Stern, N., The Economics of Climate Change: The Stern Review, Cambridge Uni­versity Press, Cambridge, 2007; Meadows, D.H., op cit..

[8] Hamilton, C., Requiem for a Species: Why we Resist the Truth about Climate Change, Earthscan, London, 2010; Kaletsky, A., Capitalism 4.0: The Birth of a New Economy, Bloomsbury, London, 2010; Newell, P. and Paterson, M., Climate Capital­ism: Global Warming and the Transformation of the Global Economy, Cambridge University Press, Cambridge, 2010.

[9] Randers, J., Global Collapse - Fact or Fiction?, Futures, 40, pp. 853-864, 2008.

[10] lbid..

[11] Mathews, J.A., op cit..

[12] E.g. local, national or transnational financing that may come from public, private and alternative sources of financing. Climate finance is critical to addressing climate change prevention and adaptation (UN Focus: Climate Finance, 2015 -, Accessed July 13, 2015).

[13] Art 4.3, United Nations Framework Convention on Climate Change (UNFCCC), 1771 UNTS 107; S. Treaty Doc No. 102-38; U.N. Doc. A/AC.237/18 (Part II)/Add.1; 31 ILM 849 (1992).

[14] Mathews, J.A. and Kidney, S. and Mallon, K. and Hughes, M., Mobilizing private finance to drive an energy industrial revolution, Energy Policy, 38, pp. 3263-3265, 2010.

[15] For a proposal of a carbon tax see Metcalf and Weisbach, The Design of a Carbon Tax, for an account of current and future carbon trading schemes see Perdan and Azagapic, Carbon Trading: Current Schemes and Future Developments, for a critical view on carbon trading, see Baldwin, Regulation Lite (Metcalf, G.E. and Weisbach, D., The Design of a Carbon Tax, 33 Harvard Envtl. L. Rev. 499, 2009; Perdan, S. and Azagapic, A., Carbon Trading: Current Schemes and Future Developments, En­ergy Policy, Vol. 39, Iss. 10, pp. 6040 - 6054, 2011; Baldwin, R., Regulation Lite: The Rise of Emissions Trading, LSE Legal Studies Working Paper No. 3, 2008).

[16] Mathews, J.A. and Kidney, S. and Mallon, K. and Hughes, M., op cit..

[17] See supra note 1.

[18] This figure rises to approx. USD 39 billion if unlabelled bonds are considered (see supra note 1) (Green Bonds Final Report, 2014. (Accessed July 13, 2015)).

[19] Green Bonds Final Report, 2014. (Accessed July 13, 2015).

[20] Global Debt Capital Markets Review, 2014 - _Review.pdf (Accessed July 13, 2015).

[21] Frey, F. and Shilling, H. and Altamura, R. and Heller, L., Environmental Risks and Developments: Green Bonds Start to Bloom, Moody’s Investors Service, 2015.

[22] It remains unclear if this can be achieved since issuance is currently not at the USD 8.3 billion per month required to reach USD 100 billion by the end of the year 2015 (Ibid.).

[23] Frey, F. and Shilling, H. and Altamura, R. and Heller, L., op cit.; Green Bonds Final Report, 2014. (Accessed July 13, 2015).

[24] By Électricité de France, S.A., Bank of America and Vasakronan.

[25] Frey, F. and Shilling, H. and Altamura, R. and Heller, L., op cit..

[26] E.g. the most basic or standard version of a financial instrument as opposed to an exotic instrument which alters the components of a plain vanilla instrument.

[27] Green use of proceeds bonds are also referred to as asset linked bonds. Proceeds from these bonds are earmarked for green projects but are backed by the issuer’s entire balance sheet. Green use of proceeds revenue bonds, are only secured by the revenue stream of the project they are used for, green project bonds are only se­cured by the assets of the project they are used for, green securitised bonds are used for and secured by the assets of a group of projects.

[28] Mathews, J.A., op cit..

[29] World Bank Green Bond Issuance to Date - (Accessed July 13, 2015); Mathews, J.A. and Kidney, S., Financing climate friendly energy de­velopment through bonds, Development Southern Africa Vol. 29, No. 2, June 2012.

[32] World Bank Green Bond Final Terms - VBIKGrm6PEo3IOtUHzWRdEmGh/PTOT0NB2wGOnG7JaBqGbvDzXeanLuTM5itH b2TxYVW8Mw5aZPENJ6NdbsoNslrsG5u01 +JgjpKxwluq/1 +H1NCo6Mjpa0J2atRvK 7FGmWSBoW+ZZzUlBvy+CuLKGNi5J (Accessed July 13, 2015).

[33] American Recoveryand ReinvestmentAct (ARRA) of2009, Pub. L. No. 111-5, 123 Stat. 115,516 (2009).

[34] The ARRA provided funding for a range of other renewable energy and energy conservation projects (e.g. tax credits, loan guarantees, grants, energy conservation bonds).

[35] CREBs were originally issued as tax credit bonds and later changed to direct sub­sidy bonds - direct subsidy bonds provide a subsidy of 35% of the interest, paid to the issuer, while tax credit bonds provide a refundable tax credit directly to the bond­holder (Internal Revenue Service, Notice 2009-26, Part III, (US) 2009.).

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The Need for Green Covenants. Regulating the Green Bond Market
London School of Economics  (Department of Law)
Environmental Law
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Markus Hoffmann (Author), 2015, The Need for Green Covenants. Regulating the Green Bond Market, Munich, GRIN Verlag,


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