Investing in the future
In the past few years a new financial concept has been created called a green bond ( the World Bank recently issued its first green bonds to Japanese investors).

Recently, a new concept for these types of bonds, called a Climate Bond was created by the Climate Bonds Initiative (CBI), which was launched in December 2009 by the Network for Sustainable Financial Markets. Climate bonds were the brainchild of Yvo de Boer, executive secretary of the UN Framework Convention on Climate Change back in 2008. The CBI propose a new strategy for funding large-scale climate saving projects using climate bonds. They are an extension of the green bonds idea, but go further in their scope. Although still at a conceptual level, many governments, especially in Western developed nations are talking about ways to implement climate bonds. The idea could have vast implications for the way that governments and multinational organisations do business in the future.

To start off, what is a bond you may ask?

A bond is a loan made by investors to a company or government to finance a large project that needs vast sums of start up capital. You can think of a bond as an IOU given by a company, parastatal or government borrowing the money (the issuer) to a lender (the investor). In the case of bonds there is not a single investor but thousands of public or private investors.

The money is payed back by the government or company who issued the bond to the bond holder (investor) with interest, at fixed points in time. The points in time and the interest rate are known upfront. In the case of Climate Bonds it is proposed that the interest rate will be around 5% or 6%. Bonds are usually long term investments, of between five and twenty-five years. The date on which the issuer has to repay the amount borrowed (known as face value) is called the maturity date.

Unlike the stock market investor, the bond holder does not have a stake in the ownership of a company of its future profits, but rather a loan that pays interest on fixed dates and is repayable on a certain date.

So what is a climate bond then?
"The idea of a climate bond is an extension of the green bond concept. Green bonds are issued by a government or corporate entity in order to raise the finance for an environmental project. The issuing entity guarantees to repay the bond over a certain period of time, plus either a fixed or variable rate of return. Government usually provide stability in these investments as they get the money to return the investment through taxes. Climate bonds would be issued by governments (or others) to raise finance for investments in emission reduction or climate change adaption” said Craig Mackenzie in his report on Investor leadership in climate change.

The idea is that after the initial capital investment, the renewable energy source should pay for itself through savings created by not having to buy carbon based products such as coal. This will provide the money that will be used to pay back the bonds. Bonds are considered to be a safe investment and are not as risky as investing in the stock market. Other ideas include, having governments sign whole areas up to the agreement with an opt-out scheme. Those who are on the scheme will end up paying less in rates and taxes. Governments could also collect money from private investors who would then be payed out a modest rate of return.

Why are climate bonds so important now?
We are currently heading for a threshold whereby if we do not reduce carbon emissions sufficiently by around 2015, we will not be able to reverse the effects of climate change. To do this governments need to make decisive legal and regulatory changes. Governments however, have to allocate funds to many different sectors and so do not have enough funds to put towards incentives for environmental initiatives.

There is an urgent need to move from a high carbon based society to a low carbon based society over the next five years. This will involve US $10 trillion a year. This is unsupportable when most governments garner funding through taxes. Yet Private capital worldwide is estimated to be about US $120 trillion. It makes sense to therefore delve into this private capital. Climate bonds could therefore be a means to raise sufficient capital to implement large scale energy efficiency.

Many energy efficiency projects involves large initial capital investment, but will pay for themselves in energy and cost saving in the future. The bonds would be issued by creditable corporations and governments and would be good pension investments.

Bonds appear to provide real hope in the prospect of raising enough funds to be able to fund climate change.

Climate bonds in a nutshell

1. We need to avoid the catastrophic impacts of climate change that will be arrived at if we continue with a "business as usual" attitude.
2. Governments must take decisive legal and regulatory changes
3. But governments with all their obligations can only make relatively small investments and incentives.
4. The transformation of the world economy, in the window of opportunity available, could involve as much as $10 trillion investments per annum. This can never be funded by taxes alone, whether private or company taxes.
5. Private capital worldwide is estimated to be $120trillion.
6. Bonds are long term investments with a guaranteed payback of a certain time. They are less risky than venture capital.
7. Climate Bonds are a vehicle well suited to raise the finance necessary
8. Energy efficiency and renewable energy are characterized by large upfront costs but ever growing savings in the future. Building a solar power station or windfarm is expensive up front. But with little to no fuel costs there will be massive savings compared with business as usual.
9. Bonds can be constructed so as to follow the pattern of the life costs of the plant with low or no interests in the beginning and attractive interest or other payback in the future that reflect the savings obtained by the power station asset.
10. To issue the climate bonds the institution must be credible. Generally the bonds can be issued by governments or private corporations or public/private partnerships. The funds will be provided by corporations and the public. Climate Bonds are an ideal vehicle for pension funds.
11. In the case of energy efficiency many small contracts will need to be aggregated which bonds can finance.
12. Whole classes of efficiency can be handled as a unit like all schools, hospitals, hotels, chemical factories and residences. There can be bonds for classes of renewable energy like wind power, Concentrated Solar Power (CSP) and Photovoltaic (PV) power stations. These can be linked to feed-in tariffs.
13. These climate bonds provide a workable solution to finance climate change mitigation. As the costs come down due to learning and economies of scale the investment will become more and more attractive.

With thanks to John Joslin of Smart Green Prosperity