Can bonds help Asia achieve renewable energy goals?
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Can bonds help Asia achieve renewable energy goals?
A recent study examines the causes behind the financing gap in Asia’s renewable energy sector and proposes bonds as a potential solution.
Thiam Hee Ng, Jacqueline Yujia Tao, "Bond financing for renewable energy in Asia," Energy Policy, Volume 95, August 2016, Pages 509-517, ISSN 0301-4215, DOI: 10.1016/j.enpol.2016.03.015
By 2035, Asia will consume more than half of the world’s energy. But as concerns about anthropogenic climate change push countries towards a cleaner, more sustainable energy future, many Asian economies are beginning to embrace more renewables in their energy mix. Some have established supportive policies such as setting up ambitious renewable energy goals. Yet, a significant investment gap exists between the reality and these stated goals. The United Nation’s Sustainable Energy for All initiative shows that in order for 50 percent of the world’s energy generation to be supplied by renewable energy, the global economy needs $167 billion per year. So countries will require significant investments in their renewable energy sector to bridge the financing gap.
A recent study by Thiam Hee Ng from the Asian Development Bank and Jacqueline Tao from the National University of Singapore examines the causes of the financing gap in Asia and suggests bonds, a fixed income financial instrument, as a potential solution. The research paper specifically explores three types of bonds: local currency corporate bonds, asset-backed project bonds, and green bonds. The authors published their results in Energy Policy.
Financial systems in Asia are largely dominated by banks. Most members of the Association of Southeast Asian Nations (ASEAN) still heavily rely on the banking sector, with minimal involvement of the capital markets. The lack of diversity in the financial system may imply insufficient financial mediators to match renewable energy (RE) projects to suitable investors. This reduces RE developers’ access to finance and increases the cost of capital — the required returns on investments. Ng and Tao suggested bonds as the solution to the investment deficit faced by the renewable energy sector in Asia due to three main reasons.
First, bonds attract investors with both high- and low-risk appetites, expanding the potential investment pool. Investors with a higher risk appetite may invest in high-risk, high yield bonds issued by companies with poor credit ratings, whereas more risk-averse ones may purchase lower risk investment grade bonds.
Second, bonds act as a magnet that attracts investors that already have an interest in RE projects. Institutional investors such as insurance funds, asset managers, and pension funds have a growing interest in RE investments. These investors take long-term risk into account as they are likely to favor investments that reduce carbon and climate risk.
Third, bonds reduce the cost of capital by lowering risk and expanding the period of cost recovery. Bonds are cheaper than bank loans because they share ownership across a group of investors. Shared ownership means shared risk. With a lower risk, the financial cost is reduced. Also, bond tenures usually span between 7 and 15 years, similar to the length of the payback period of a RE project. This allows a RE project to recover its capital cost over the payback period.
Ng and Tao’s research paper explores three different types bonds suitable for the RE industry. The first is the local currency corporate bond — bonds issued by renewable energy corporations. Asia has led the usage of bonds recently, though most originate from China. The authors suggest that Asian countries with strong domestic local currency corporate market can emulate China’s successful model. They also pointed out how local currency bonds target regional and local investors, whose knowledge of local conditions may well inform their investment decisions.
The second type of bonds proposed is the asset-backed project bonds. These bonds are paid back only by cash flows from the specific RE project. A project bond is viable only if the project can generate enough cash flow to cover the bond repayment and required returns for the investors in the form of coupon payments. Such bonds fill an investment gap particularly as stricter bank regulations limit the amount of long term debt that banks can undertake.
The third is the green bonds. These bonds’ proceeds are specifically invested in environmentally friendly products. Green bonds can increase a RE company’s corporate image and facilitate their access to finance. A critical characteristic of green bonds is that they enjoy a large degree of flexibility as any organization can issue them. Yet, such flexibility can raise questions about the environmental credibility of these bonds. These issues may be addressed by certifications and monitoring of green bonds, though this may impose additional costs on companies.
In the end, Ng and Tao proposed three principal recommendations to bridge the financing gap in Asia. First, Asian governments should level the playing field for RE companies by bridging the information gap between investors and RE projects, increasing tax or credit incentives for the RE sector, and punishing polluters. Second, governments should develop a large pool of long-term investors for the bonds along with a supportive regulatory infrastructure. Third, governments should create national standards to protect the credential of green bond labels.
The financing gap between Asia’s renewable energy goals and current investments reflects the problems and complexities in the region’s financial landscape. Different countries will need to elect different financial solutions to suit their needs. For now, bonds stand as the solution of choice for Asian countries. China has led the pack in bond investments. Which other nations will follow?
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