Green Shoots in the U.S. Bond Market – But Still a Sapling

U.S. Cities Lead Sharp Increase in Issuing Green Bonds

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Michael Ferguson is Director of Infrastructure at S&P Global Ratings.

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Posted: Wednesday, January 17, 2018 12:00 pm

As market interest continues to mount in renewable energy, energy efficiency, and water conservation measures, U.S. cities and states are witnessing substantial reductions in their environmental footprints, as well as an ongoing mass transformation of the generating grid.

In order to finance this green transition, many municipalities across the country are taking advantage of the green bond as a form of financing.

While significant progress has been made in the U.S. green bond market, the country’s share of global issuance remained relatively small through the end of 2017 – and the lack of near-term clarity on regulatory policy may offer a possible explanation. That said, favorable trends could signal further growth in the long term.

State Support

In recent years, environmental and climate change news has been dominated by developments at the federal level – where regularity policy has been uncertain and marked by political partisanship in the U.S. But at the state and municipal levels, more cohesive policies have coalesced, and the green energy transition continues to make headway.

Individual states have been implementing Renewable Portfolio Standards (RPS) – a legally binding policy that requires utilities to procure or generate a specified percentage or amount of renewable electricity, from wind, solar, biomass or geothermal sources. Since Iowa led the way in 1983, 29 states have now passed an RPS. Hawaii and Vermont have the highest standards, with 100 percent and 75 percent respectively of utility-sold energy necessarily being renewable; even several states without binding standards have established formal goals for renewable installations.

Other progressive states – Massachusetts, California and New York, in particular – have sought to forge ahead in mitigating climate change, both by cutting down on their own greenhouse gas emissions with the use of cleaner generation and by developing those industries that support mitigation efforts elsewhere (including battery storage technology, offshore wind, and energy efficiency technology). Politically, this offers benefits, too: aside from reducing emissions, this can be a major job creator for savvy states. Even states long dominated by fossil fuel industries, such as Texas, have seen considerable growth in their wind and solar industries.

However, cities in these states require a means of financing new, green projects. And they must do so at a time when municipal budgets are already straining to cover the high costs of maintaining, repairing and replacing the country’s aging infrastructure.

Municipal Green Issuers

This is where green bonds enter the picture. These debt instruments, constructed precisely to bring capital to sustainable projects – whether that is renewable power, battery storage or climate change adaptation projects – can provide an alternative means for cities to invest in the infrastructure they need to remain economically competitive in a manner that is both environmentally and ecologically sound.

Not only can green bonds help municipal debt issuers to obtain crucial funds, they also afford municipalities an opportunity to show their "green" credentials. In an environment where "being seen to be green" increasingly matters – and where competition for attracting large-scale, institutional capital is becoming progressively fierce – this may be a differentiating factor for some investors. This is especially the case for long term, investment grade financings, for which investors may require some protection from climate risk. A green financing can, therefore, provide some validation.

Even for those municipalities without an immediate, acute focus on climate change, green bonds are seen as a viable financing option. Because green bond investors are spread around the world but the primary beneficiaries of green financings are more concentrated by region (or even by country), some municipalities could appeal to a broader base of investors by issuing green bonds. What’s more, issuers and investors alike could stand to benefit from certain municipal bond tax-exemptions.

In this respect, cities have been well-represented in America's green bond market. In the first half of 2017, U.S. municipalities accounted for both 70 percent of U.S. bonds issued and a majority of the global 101 green bonds issued worldwide by municipalities, cities and states. New York City, for instance, has committed to an 80 percent reduction in carbon emissions by the middle of the century, and has recently issued green-labeled debt to fund large-scale infrastructure projects that will be necessary to meet this target. And with California’s State Treasury Department having identified a $359 billion funding gap in public infrastructure over the next decade, we will likely also see California's cities using green bonds (or alternative green financing tools) as essential means of closing it.

The municipal experience with green bonds has already been a promising one. In the first half of 2017 alone, American municipalities had together issued some $18 billion worth of green bonds. This number represents a sharp increase on previous years, and essentially matched the amount issued by US-based companies in the same period. The final 2017 tally is anticipated to be even higher.

America's Market Position

In the grand scheme of things, however, the U.S. still boasts only a relatively small share of the global green bond market. Lacking a cohesive set of principles for carbon mitigation and adaption – itself a casualty of the political partisanship belying scientific consensus on climate change at the federal level – America's stake in the global green bond market is still dwarfed by those of Europe and China. Thanks to a transparent and enduring carbon reduction framework, Europe enjoys the longest history of a deep green bond market, while China has seen green issuance skyrocket in recent years, with expectations that it will continue to increase sharply as it did in 2017. Domestically, meanwhile, green-labeled bonds are still far outweighed by the wider universe of American debt issuance.

It is important to note, however, that a less developed U.S. green bond market to date is not necessarily indicative of diminished interest in sustainable investments. While the renewable energy market in the U.S. may have grown at a slower rate than in other economically comparable countries, it has still done so dramatically – even amid continued discord over climate change and renewable tax credits.

In years to come, the U.S. green bond market is expected to flourish. Much of the country’s new energy generation capacity brought online over the next four years is expected to be renewable. And, despite the federal rollback of environmental policy, since 2016 there has been a groundswell of support for more proactiveness on carbon mitigation from cities and states. As the chart above shows, in fact, renewable-favorable regulation from state-level authorities makes a noticeable difference when it comes to growing the municipal green bond market.

So, with a stricter federal policy on climate change unlikely to materialize any time soon, it will be down to states, cities and corporations to drive future green bond growth – with much of the investment for green projects coming from investor-owned and public utilities to meet new standards.

While the U.S. green bond market has come a long way in a short time, it is still playing catch up with Europe and China. And with the impetus behind the American energy transition coming not from the federal level, but from the local level, it may be falling to municipal issuers to establish green leadership.

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