Green bonds can help Bangladesh fulfil NDC commitments

Scaling up environment-friendly investment and divesting from carbon-intensive activities is the key to limiting global warming to within 1.5 – 2° Celsius above pre-industrial levels. 

Being a signatory of the Paris Climate Agreement, Bangladesh submitted its updated Nationally Determined Contributions (NDC) last year, offering a 6.73% (27.56 MtCO2e) emission reduction in the unconditional scenario from the business as usual level by 2030 from the sectors of energy, industrial processes and product use, agriculture, forestry, other land use and waste. 

The emission reduction target will mostly be achieved in the energy sector. The energy sector will alone cut 26.3 MtCO₂e (95.4%) by 2030 followed by agriculture (2.3%) and waste (2.2%). 

International Finance Corporation (IFC) estimated that, in order to meet the ambitious NDC commitment of Bangladesh, approximately $172 billion investment needs to be mobilised within the timeline of 2018 to 2030. 

Green projects require long-term financing. The banking industry is still the major source of green finance in Bangladesh even though long-term financing has always been a challenge for the banking industry. This sector alone cannot channel this large amount of funds. Thus a major change in investment pattern is required to meet the huge green investment gap. 

A vibrant green bond market can be instrumental here. 

Bonds are debt securities, which means that an investor lends money to a bond issuer for a period of time. In return, the investor receives interest income. 

Then what makes green bonds different from ordinary bonds? International Capital Market Association (ICMA) defines green bonds as "any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or refinance, in part or in full, new and/or existing eligible green projects provided by transparent green credentials". 

Principally, green bonds are used to finance projects that bring environmental benefits such as pollution prevention, renewable energy, energy efficiency, environment-friendly transport, climate change mitigation, green buildings etc. 

The World Bank issued a green bond worth 2.325 billion Swedish Krona (SEK) for the first time in 2008 to support climate mitigation-based projects. Since then, the green bond market is the fastest-growing financial instrument in the global debt securities market, growing at a rate of 120% each year. 

The government of Bangladesh needs to implement 911.8 MW (Grid connected 581 MW Solar, Wind 149 MW, Hydro 100 MW and others) renewable energy-based projects by 2030 to fulfil its NDC commitment. However, renewable energy-based projects have multiple challenges to address. Among them, the financial barrier is the main one, particularly for emerging markets and developing economies like Bangladesh.

The unfavourable project scale of renewable-based projects represent another concern. The absence of equity funding from the private sector is a fundamental challenge for the growth of large-scale renewable energy-based projects. Since private equity funding is unavailable, renewable energy-based projects are starved of investment and have to depend on bank credit. 

Now, even if bank credit is available, the limited length of loan tenure is making the situation unfavourable for this sector. Here green bonds can take the lead and be a solution. It can finance renewables and energy efficiency projects at a lower cost for a long tenure. 

Funds raised through green bonds usually have fewer restricting covenants, compared to bank loans, and are therefore an attractive source of green finance.

China Three Gorges Corporation has issued $2.98 billion green exchangeable bonds to finance its large hydropower projects. Toyota already issued six green bonds totaling $7.6 billion to support the sale of environment-friendly Toyota vehicles. 

Our local electric vehicle manufacturer can follow the same model to finance its project cost. Beximco and other private commercial institutions finance their green initiatives by issuing green bonds. 

Green bonds also have the potential to become an interesting and unconventional source of financing for government-supported entities like the local governments of Bangladesh. Most of the municipal authorities of Bangladesh fail to provide basic infrastructural facilities to its citizens because of their financial incapacity. 

Their infrastructural development depends on the central government's allocation, which is limited and that leads to poor urban services. On the other hand, the conventional banking system does not support them. In absence of funding sources, the municipal authorities can use the untapped potential of green bonds. Municipalities can issue green bonds to finance their water supply, waste management, and sanitation-related projects like other developed countries. 

Despite Bangladesh Bank's requirement of 5% Green Finance disbursement by bank/FI on the basis of term loan disbursement (excluding staff loan), green finance as a whole is still at an early stage. The green bond market in Bangladesh is at its debut. Green bonds are governed by the Bangladesh Securities and Exchange Commission (BSEC). 

Recently the central bank circulated its guideline on green bonds for banks and financial Institutions. Still, there are a significant number of barriers to its growth. Those barriers exist for both the issuer and the investor. 

A limited number of commercially viable green projects, like renewable energy, are the main challenge of issuing a green bond. Government support like non-commercial financing is required to make those green projects bankable. 

Globally, bonds are an easy way of raising finance for bigger entities. However, small and medium-sized enterprises have limited access to the process of issuing green bonds due to their size and limited credit absorption ability. Bangladesh is not an exception. Policymakers and regulators need to formulate the policy in such a way that the SME segment, the driving force of Bangladesh's economy, can take part and expand the overall green bonds market. 

On the other hand, considering the comfort and perspective of potential investors, the challenges are even bigger. Building trust among investors is pivotal. In a country where depositors even don't get their money back from the conventional and highly regulated financial industry, building trust in a new and specialised financial instrument will be a massive challenge. 

Then, the use of the proceeds of the green bond is another concern. Third-party assurance providers, such as specialised research agencies, should be responsible for verifying the "green bond" status and monitoring the use of bond proceeds by issuers. Then again, potential issuers may not be fully aware of how to complete the third-party review process. The third-party opinion will incur a cost. Particularly, for small-size issuers, it will be another challenge. Regulators in this aspect can establish grants to cover the costs of external review. 

In order to foster green investments, a vibrant green bonds market is paramount for the economy of Bangladesh. Though several challenges exist to soliciting green investments in Bangladesh, green bonds offer a distinctive opportunity to support low-carbon environment-friendly projects such as renewable energy, energy efficiency, environment-friendly transportation, waste management and others. 

At this phase of inception, regulators of green bonds need to attract and encourage both the private and public sectors by enabling the environment, introducing coherent policies and capacity development. Besides, building the business confidence of the issuers and investors is another area where special attention is required. 

Karimul Tuhin is a Banker and Green Finance professional. Email: [email protected] 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.