2018 - 2019 Edition of Citi Perspectives for the Public Sector

6 On the Future of Sustainability Bonds The likelihood of a trillion- dollar, mainstream and broad- based sustainability bond market is high. Over a decade ago, I gave a speech at Harvard on the Future of Islamic Finance, the thrust of which is particularly relevant here: Once a market develops a critical mass of support, with both large, consistent aggregate demand from the grassroots or retail level and full policymaker commitment to drive the market forward, it is likely to grow in size, globality and sophistication, often times spreading across asset classes, currencies and into structured markets. Because green and theme bonds, which I will now refer to as “Sustainability Bonds,” have each of these powerful dynamics, it is likely that they will continue to grow far beyond what we have seen to date. No, this market does not have to develop with uniform success and may face setbacks, as most innovation naturally does. However, in the end, Sustainability Bonds will likely alter debt market participants’ behavior as materially as shareholder activists have changed the face of equity and M&A markets. Green bonds began within the domain of the development bank community when the European Investment Bank in 2007 and the World Bank in 2008 launched bonds with proceeds dedicated to the environment. The market was given a major boost in 2013, when Citi and three other banks drafted the Green Bond Principles. These provided standards and practices for disclosure, transparency and monitoring of green bonds. In January 2014, the International Capital Markets Association (ICMA) codified the principles and took over as the Secretariat. The market was further invigorated by the IFC’s 2013 $1.0 billion green bond issuance, which was the first benchmark size green bond. Since then, the issuer base spread first to virtually all development banks and then to global corporates, commercial banks, municipalities and most recently to sovereigns. By 2017, 39 countries were home to issuers of green or theme paper. Standards acceptable to investors led to more and larger-value issues. While initially primarily a U.S. dollar market, the market now supports multi-currency issuance — both G10 and EM currencies — and institutionalized, local markets have developed, as we have seen in China, India and Japan. Apart from the currency and issuer continuum, a new type of ESG-focused bond emerged, which has been called a “theme bond.” Again, with successful Development Finance Institution leadership, the concept emerged that capital markets would accept developmental themes beyond green goals. In 2014, the Inter- American Development Bank issued an “EYE” Bond targeting spending for education, youth and employment. The theme bond market was further bolstered by the historical 2015 meeting in Addis Ababa, Ethiopia, at which global leaders discussed funding strategies for the SDGs, and the spotlight was placed on the size and potential of the global bond market. In particular, President Jim Yong Kim of the World Bank developed a powerful mantra of “billions to trillions,” explaining how the SDGs required trillions of dollars and could not be funded without the help of the private sector. 2 Following ICMA’s leadership and applying principles of disclosure, transparency and monitoring, the Social Bond Principles and Sustainability Guidelines were painstakingly developed to address the broader sustainability ecosystem, making it theoretically possible to issue a theme bond against virtually any one of the SDG goals. Bonds have now been issued to address many of the SDGs, from employment and youth to women and poverty. In fact, under the “social” and “sustainable” rubrics, issuers have begun to print paper referencing groups of SDGs. For example, in March 2018 the German state of North Rhine-Westphalia issued a EUR 2.0 billion bond linked to eight different SDGs. 3 The Sustainability Bond market is also at an early stage of impacting the infrastructure finance market. We have already seen that infrastructure project bond investors have incremental appetite for project bonds designated as “green.” The best and an early example of this was the Mexico City Airport financing, for which Citi acted as a lead underwriter. Not only did this transaction set tremendous precedent from a duration and size perspective, but by making the project bonds green, the issuance demonstrated the possibility to make the “green” designation not just an ancillary benefit but a core feature. 2 Kim, Jim Y. (2015) “ Billions to trillions: Ideas to actions, ” World Bank Group http://documents.worldbank.org/curated/ en/144851468190446079/Billions-to-trillions-Ideas-to-actions-by-Jim-Yong-Kim-President-Addis-Ababa-Ethiopia 3 “ Sustainability Bond #4 of the State of North Rhine-Westphalia, ” https://www.nachhaltigkeit.nrw.de/projekte/ nachhaltigkeitsanleihe/sustainability-bond-4/