Updated Proposal for a Green Bond Evaluation

S&P Global Ratings
Written By: Michael Wilkins, Miroslav Petkov and Jessica Williams
S&P Global Ratings
Written By: Michael Wilkins, Miroslav Petkov and Jessica Williams

On Sept. 2, 2016, S&P Global Ratings proposed a Green Bond Evaluation Tool that would provide a second opinion(1), plus a relative green impact score on capital market instruments targeted at financing environmentally beneficial projects. The Green Bond Evaluation is not a credit rating. The proposed framework evaluates the governance and transparency of the bond and provides an analysis of the environmental impact of the projects financed by the bond's proceeds over their lifetime, relative to a local baseline. When evaluating environmental impact, the approach would consider both climate change mitigation and adaptation projects.

Mitigation projects aim to bring environmental benefits and target areas of concern, such as natural resources depletion, loss of biodiversity, pollution control, and climate change. Adaptation projects aim to take practical steps toward reducing the exposure to and managing the impacts of natural catastrophes, such as building the resilience of communities and critical infrastructure against an increased risk of extreme weather events due to climate change.

The output of the Green Bond Evaluation would include at least three scores (a transparency score, a governance score and a mitigation and/or adaptation score, as relevant,) which combine into an overall final score as follows:

  • The transparency score would focus on the quality of disclosure, reporting, and management of bond proceeds.
  • The governance score would assess what steps have been taken to measure and manage environmental impact of the use of proceeds of the bond, including certification, impact assessment, risk monitoring, and risk management.
  • The mitigation score would consider the key environmental impacts of the use of bond proceeds, taking into account environmental impacts beyond reductions in greenhouse gas emissions and water use. It is proposed to be based on a consideration of key variables determining the level of environmental impact in each category (such as technology and location), supporting a quantitative assessment of sustainability.
  • The calculation considers a range of quantifiable environmental impacts, termed environmental key performance indicators or eKPIs, such as carbon dioxide, water, and waste.
  • The impact calculation would be done on a net benefit basis, meaning both negative and positive environmental impacts of the project are considered relative to the appropriate local baseline (for example, a new renewable energy project compared to the conventional grid) for each eKPI.
  • The net benefit for each individual eKPI would be compared against a range of modeled net benefit outcomes derived from a universe of relevant countries in order to derive a relative score. For example, green energy generation projects are compared against a range of net benefit calculations for every green energy generation type (wind, solar, hydroelectricity etc.) in 61 countries that produce over 95% of global generation capacity(2).
  • The resulting score is proposed to be a weighted average across eKPIs, and is labelled the unadjusted green impact score, a best-in-class assessment of the bond's green impact.
  • The adaptation score would reflect the estimated reductions in the costs of expected damages achieved by the initiatives financed. To determine the environmental resilience benefit that may be achieved through the use of bond proceeds, we propose to analyze and assess the benefit studies prepared for the project.

In addition to the unadjusted green impact score for mitigation projects, a hierarchy of sector positions relative to one another would be overlaid in order to transform the score from a best-in-class approach to a sector-relative approach. The adjusted green impact score will place the bond's mitigation activities within the broader context of different sectors and indicate its relative contribution to the ongoing effort to avoid and cope with climate change.

This relative hierarchy would imply that projects that are financing climate change solutions, such as renewable energy, for example, would have a higher adjusted environmental benefit than projects looking to improve conditions within conventional technologies (such as coal-to-gas). The resulting mitigation score would provide a flexible and user-friendly assessment of the relative importance of net benefit impacts and broader sector-level considerations. For example, if a bond were financing coal-to-gas switching, the mitigation score would reflect how the bond compared to best-in-class bonds within this project type, while also providing information on the difference between these and more advanced renewable projects.

The proposed approach would evaluate the bond's financing against each category, with the resulting scores weighted and amalgamated into an overall final Green Bond Evaluation.

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