Is the time for landscape bonds now? Experience shows some barriers remain

Bonds are well known financial instruments for corporations to access large sums of finance. ‘Green bonds’ are a variation designed to finance environmentally focused projects. Ultimately, these instruments could channel the billions of dollars needed to reduce deforestation and encourage sustainable land use. However, our experience at Global Canopy Programme (GCP) shows that there are still some barriers to making this happen.

In 2013, GCP started the Unlocking Forest Finance (UFF) project, with the financial support of the German Government’s International Climate Fund. It aimed to build innovative financial mechanisms which would channel finance towards more sustainable land use. The initial idea was to bundle a portfolio of investments into a green bond, in order to raise the capital needed to implement these landscape-level investment packages.

GCP’s experience suggests necessary steps to make green bonds work for landscapes:

• Focus on securitizing concrete investments. Proceeds from bonds are usually used to securitize a portfolio of existing projects in order to minimize risk on investment for the bond issuer and subsequent buyers. This means bonds are often used for projects that are already running and raising additional capital, but are not suitable for projects at proof of concept or early investment stages. Sustainable landscape investments are too new in many cases – though if this type of investment became mainstream, it would change.
• Bundle large landscape projects. Bonds are best suited to a portfolio with a small number of large projects. This is because bond issuers want to minimize risk and guarantee returns to investors. However, financing a larger number of projects means higher risk as it requires concerted, coordinated efforts to achieve results. In the UFF project for example, to reach a suitable portfolio size for bond issuance, each of the three UFF initiatives would have to include thousands of smallholders and farmers.
• Aggregate smaller projects into sizable portfolios. Many landscape projects may be too small to issue a bond. Bonds are intended to mobilize large sums of money, almost always above US$50 million and often over $1 billion. This is the flip side to the previous point.
• Reconsider returns on investment for green bonds. ‘Green bonds’ currently have the same return as regular corporate bonds, and the same credit-worthiness requirements despite the additional environmental benefits generated. In addition, green bonds incur the additional cost of certification making them actually more expensive to issue. (This added cost may be one reason that many ‘climate aligned’ projects have raised funds by issuing regular bonds – by mid-2016 there were almost USD 700 billion of climate aligned bonds, of which only USD 118 billion were labelled green bonds). Several potential bond issuers seem to be waiting for a market signal that it is possible to issue a green bond offering a lower return on investment.

Given these constraints, green bonds for land use are still very rare, making up just 3% of green bonds issued,  according to one estimate. As robust portfolios of landscape investments are built, such as those being developed by GCP in Latin America, we may see green bonds used more often in this sector. Nonetheless, the UFF project is looking for the more traditional instruments to raise capital for land use projects to build up the portfolio: equity and debt, combined with guarantees and insurance.

Other projects seem to be arriving at similar conclusions about how to pave the way for green bonds to happen: first build a sizable, robust portfolio then issue bonds to securitize it. However, different projects are investigating different routes to reach this goal. These include the Tropical Landscape Finance Facility with BNP Paribas and ADM Capital in Indonesia, which offers lending facilities and grant funds that may lead to bonds eventually.

Other interesting models are starting to emerge. In Madagascar, the EIB, Althelia and Conservation International have partnered with the Green Climate Fund to fund technical assistance and loans while preparing a green bond. And last November, the first ‘forest bond’ was issued by IFC  on the London Stock Exchange.

If the barriers described above can be overcome, green bonds may offer increasing opportunities for agriculture, forests and people.