Bretton Woods Committee | Mon, Dec 12, 2022
by Bianca Taylor
Earlier in the month, Boris Johnson stated the UK does not have resources to pay climate reparations to low-income countries. While this may be true, ignoring the problem will be increasingly difficult. This year researchers at Dartmouth College published scientific evidence for climate liability, citing the top five emitters have caused $6 trillion in damages between 1990 and 2014. The flood in Pakistan this year that affected 15% of its population has been called a climate disaster of biblical proportions – and things are projected to worsen, causing further domino effects to our already strained global supply chain.
The last time the COP made promises to vulnerable countries was in Copenhagen in 2015 with a pledge of $100 billion per year to be provided by rich countries to the developing world. Unfortunately, the figure has fallen short year after year, and money that was promised was funneled via multilateral development banks in the form of loans. For the vulnerable and already heavily indebted countries, this pledge was more of nothing.
Whether it's the loss and damage fund, or the $100 billion pledge, the financial markets could serve both as enforcers of COP agreements, and more equitably distribute the promised resources.
Tweaks to already existing financial instruments, called sustainability-linked bonds (SLB), would be all that is necessary.
Sustainability-linked bonds contain clauses that provide for interest rate penalties or bonuses based on whether the issuer attained pre-established goals. This loss and damage fund could for instance pay the interest on debt for countries who issue these types of bonds and achieve their stated target.
This year Chile made headlines when it was the first country to issue bonds tied to their Paris Agreement, called the National Determined Contributions (NDCs). In October, Uruguay followed suit and issued its first bond linked to the country’s NDC.
Not all sustainability-linked bonds are ambitious. The first SLB, issued in 2019 by the Italian energy company ENEL, set a low bar. The then novel $1.5 billion bond set a target of a 55% renewable portfolio, which was a long-standing, stale goal. The meager enforcement of ¼ percent interest rate penalty was equally disappointing.
A year later, Mexico tried dubbing a generic bond “SLB” simply by listing the UN Sustainable Goals in the prospectus, and assuring investors that they would pursue these. No single goal was listed, and no interest rate incentives were enumerated. It was not an SLB, just plain-vanilla greenwashing.
Since then, the market has significantly changed.
According to data from Environmental Finance, there have been $154 billion SLBs issued – mostly by companies – representing 5% of the $2.6 trillion total outstanding sustainable bonds which includes green, social, sustainability, SLB, and transition bonds. The market growth has spawned 26 categories, of which GHG emissions goals represent about 50%.
Deploying SLBs properly means first, the stated goal should be meaningful, transparent and easily verifiable. Government bonds issued targeting NDCs meet all of these criteria. These NDCs are public, and easily followed using non-profit organizations such as Climate Tracker. And there is nothing more important than delivering on the NDCs, which is the basis for keeping temperatures from rising more than 1.5 degrees Celsius.
There should also be a good balance of incentives to both encourage achieving the stated goal and punish the issuer that does not meet the goal. On this the market could use significant improvement. According to Environmental Finance, a ¼ percent step-up and step-down has emerged as a market consensus, rendering SLBs inconsequential. Uruguay chose to stay close to market rate with a 30 bps penalty. Here again, Chile’s SLB raises the bar.
Chile’s SLB was hailed as ambitious because the penalty of 2% they chose is significant. The bonus, however, could be more ambitious – especially for countries determined to be recipients of climate damages.
With the loss and damage fund details still in play, policy makers should consider directing those funds to service the debts of countries making good on meaningful climate commitments. Those who fail, would service the debts on their own.
Developed countries should also issue SLBs – but with an incentive structure focused on steep penalties for failing to meet their NDCs.
It is a no-brainer that countries who are signatories to the agreements made at the Conference of the Parties (COP) should issue sustainability-linked bonds linked to their promises. And the market should demand strong incentives. Putting some teeth to the COP agreements will accelerate progress that is woefully short of meeting the 1.5 degree goal, which is important for the planet, and our global economic system.
Bianca Taylor runs a consulting firm at the nexus of climate, policy and finance. She is also a Public Voices Fellow with the OpEd Project and the Yale Program on Climate Change Communication and a member of the Bretton Woods Committee.