An Overview of Green Bonds

1. Introduction
Green bonds are a financing option for issuers which the proceeds will be used to finance new or existing green projects that deliver environmental benefits (the “Green Bond(s)”), ¹and is the dominant subset of the Environmental, Social and Governance (“ESG”) space where investors seek to align socially responsible interests along with investment returns. Keeping in pace with the rapidly growing global Green Bond market, Hong Kong has introduced certain reforms to enhance its attractiveness as a Green Bond market. Following our discussions on the Hong Kong debt capital market (see our news update here) and the SFC Agenda for Green and Sustainable Finance (see our news update here), we would like to take this opportunity to provide an overview of Green Bonds and sustainability-linked bonds.

2. Characteristics of Green Bonds
Four main types of Green Bonds exist currently as defined by the International Capital Market Association (“ICMA”)² :

I. Standard Green “Use of Proceeds” Bond: standard full-recourse-to-the-issuer unsecured debt obligations where the proceeds are designated for eligible Green Projects.

II. Green Revenue Bond: non-recourse-to-the-issuer debt obligations where the credit exposure is to the pledged cash flows of the revenue streams, and where the proceeds can be used for related or unrelated Green Projects.

III. Green Project Bond: a project-specific bond where proceeds are used to finance the construction of a single asset or a portfolio of projects, and the investor has direct exposure to the risk of the project(s) with or without potential recourse to the issuer.

IV. Secured Green Bond: a secured bond where the net proceeds will be exclusively applied to finance or refinance one or more specific Green Projects.

Green Bonds enjoy the advantage of allowing investors to satisfy their ESG requirements and green investment mandates, as well as diversifying their investment portfolio.

Generally speaking, it is also more resilient to market downturns and has been welcomed by investors during the COVID-19 pandemic with a more favourable risk-return trade-off. For issuers, launching green bonds may allow them to diversify their investor base, enhance the credibility of their environmental strategy, and boost their reputation by contributing to sustainable development.

3. The Hong Kong market for Green Bonds
In 2021, Hong Kong’s labelled green debt market recorded a year-on-year growth of 6.5 times, the highest growth since 2016, reaching a total issuance of US$19 billion. ³) The market is mainly led by the government and corporate issuers who were responsible for approximately 93% of the green debt instruments in 2021.

3.1. Government Issuance
In 2018, the HKSAR Government set up the Government Green Bond Programme (“GGBP”) with aims to demonstrate the Government’s support for sustainable development and determination to combat climate change, set a benchmark for green bond products in the market, provide a good example for other potential green issuers, and promote awareness of and Hong Kong’s international profile in green finance. It has been issuing green bonds regularly since its inaugural deal in 2019. As at 31 July 2022, the HKSAR Government has issued almost US$10 billion worth of green bonds under the GGBP. In May 2022, the inaugural retail green bond launched by the HKSAR Government under the “Government Green Bond Programme” attracted a subscription capital of HK$20 billion.

Moreover, the HKSAR Government launched a three-year programme named the “Green and Sustainable Finance Grant Scheme” (“GSF Grant Scheme”) in May 2021 which aims to subsidize eligible bond issuers and loan borrowers to reduce the financial burden related to the external review and issuance costs. The GSF Grant Scheme has been well received by the industry in Hong Kong. As of April 2022, more than 60 applications have been approved, and HK$70 million has been granted to issuers to aid with their green bond issuances.

3.2. Corporate Issuance
The GSF Grant Scheme has led to more active corporate green bond issuance, with 12 issuers/borrowers participating in the green debt market in 2021. Out of the said 12 issuers/borrowers, there were 9 new issuers including Hongkong Land and China Development Bank (Hong Kong Branch), which issued their inaugural green bonds.

4. Green Bond Principles (“GBPs”)
The ICMA has set out four core components under GBPs, which are internationally recognized voluntary process guidelines that encourage transparency and promote integrity. The GBPs are part of the Hong Kong Green Finance Association’s guide to Green Bonds and are widely used by issuers including the HKSAR Government. Four core components, as shall be discussed below, are at the centre of the GBP.

4.1. Use of Proceeds
This principle concerns the utilization of bond proceeds towards eligible green projects. The designated green projects should provide clear environmental benefits which are feasible, quantifiable and/or assessable which should be disclosed to potential investors. Some green projects categories are expressly recognised as carrying significant environmental objectives:

4.2. Process for Project Evaluation and Selection
Issuers have to communicate clearly to investors about the environmental sustainability objective of the green projects, the process of determining the project category and the identification and management of the associated social and environmental risks. The ICMA suggests that an external review is conducted to supplement the issuer’s project evaluation and selection processes.

4.3. Management of Proceeds
The credit arrangement of the green bond’s net proceeds should be conducted through a sub-account and later moved to a sub-portfolio that attests to the issuer’s lending and investment operations of the project. Issuers are recommended to inform investors about the intended types of temporary placement for the balance of unallocated net proceeds.

4.4. Reporting
Issuers should report up-to-date information on the use of proceeds annually until full allocation. Transparency is a core value in communicating to investors about the expected and/or achieved impacts of projects.

5. External Reviews
To qualify as a green bond, issuers are recommended to appoint external reviewers to ensure the green bond framework is aligned with the GBPs. This mitigates the risk of “green defaults” where funds are not actually applied to green projects, or fail to yield the expected environmental benefits. It should also be noted that a prerequisite for applying for the GSF Grant Scheme is the perusal of pre-issuance external review services by reviewers on the HKMA’s Recognised External Reviewer list.
Some standard external review methods include obtaining a secondary party’s opinion, expertise verification and certification on the alignment to the GBPs or other international standards.

6. Sustainability-linked Bonds
Sustainability-linked bonds (“SLBs”) are bond instruments where the proceeds from issuance are not restricted to specific green projects. Instead, the SLBs are dependent on the achievement of pre-defined sustainability performance targets as measured by the performance of specific key performance indicators (“KPIs”).

Difference between green bonds and sustainability-linked bonds

As it can be seen, SLBs provide lowered thresholds for issuers to engage in the sustainable finance market. Rather than investing in specific green business projects through the funds, potential issuers with overall sustainability or ESG strategies who are unable to afford the high capital cost of green projects could consider issuing SLBs, without requiring them to purchase a significant amount of green assets.

7. Analysis and takeaways
In the past decade, green bonds have continued to dominate among green and sustainable finance markets. Different regulatory updates and subsidies have been enacted in order to promote Hong Kong’s status as a leading Green Bond market. Issuers are advised to refer to GBP standards and guidance on subsidies to ensure their fund-raising process occurs as efficiently as possible. With greater flexibility on offer, SLBs are also an attractive choice for issuers to attain a general performance target.

Please contact our Partner Mr. Rodney Teohfor any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

¹ Hong Kong Monetary Authority. (2020, November). The Green Bond Market in Hong Kong: Developing a Robust Ecosystem for Sustainable Growth. Retrieved from Hong Kong Academy of Finance: https://www.aof.org.hk/docs/default-source/hkimr/applied-research-report/gbrep.pdf
² Capital Markets Association. (2022, June). Green Bond Principles: Voluntary Process Guidelines for Issuing Green Bonds. Retrieved from ICMA: https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles_June-2022-280622.pdf
³ Hong Kong Green and Sustainable Debt Market Briefing. (2022, July). Climate Bonds Initiative. Retrieved from Climate Bonds Initiative: https://www.climatebonds.net/files/reports/cbi_hk_briefing_2021.pdf