By Emma Copenhaver, Project Analyst, UNC Environmental Finance Center
Because debt financing is an important way utilities fund water and wastewater projects, finding the right funding source can be an important part of capital planning for utilities. Sifting through each type of debt financing to find the right fit can be a daunting and time-consuming task, especially since each financing strategy ultimately targets certain types of projects and issuers.
What is a green bond?
One relatively new financing strategy is green bonds. Green bonds are designed for projects with significant environmental benefits, as outlined in the Green Bond Principals (GBPs). These project categories include energy efficiency, renewable energy, pollution prevention and control, sustainable water and wastewater management, and climate resiliency. While following these practices outlined in the GBPs is voluntary, projects that follow them may find certain benefits associated with the bond.
To show that projects meet GBPs, issuers must follow the four core components for alignment: use of proceeds, process for project evaluation and selection, management of proceeds, and reporting. The first core component, the use of proceeds, ensures the chosen project meets the environmental standards of the bond. Project evaluation and selection allow issuers to communicate their project goals with investors and double-check that the project meets environmental standards. Management of proceeds allows issuers to choose how they will manage the bond. Reporting ensures the project is consistent with the project’s initial environmental standards.
It’s important to note that, besides following GBPs, green bonds operate very similarly to traditional revenue bonds. Utilities must undergo the same credit rating, underwriting, and posting processes as revenue bonds. Additionally, utilities will secure these types of bonds with revenues generated from user fees. The timelines, procedures, and basic financing strategies are the same; the only major difference is the additional requirements that must be met, providing a sense of continuity in the financing process.
Why would a utility want to issue a green bond?
A utility may want to issue a green bond for a few reasons. First, it can help a utility align its values with its actions. The green bond title can help signal to customers, partners, and other investors that the utility is intentionally engaging in environmentally sustainable practices. Intentionally seeking out innovative and sustainable practices could positively impact stakeholders’ perception of the system and draw in more support, whether customers are more understanding of rate increases that may come with an expensive bond or investors looking to fund green projects. Because environmentally sustainable practices are inherent to Green Bonds, they have drawn a diverse pool of investors, which brings more cash flow into the market and allows investors to put their money towards projects that align with their values.
In addition to positive reception from customers and investors, green bonds may also enjoy a lower interest rate than their traditional counterparts. This reduced premium is often referred to as a “greenium.” Many issuers find a small but noticeable decrease in interest rates for a specific project if it is marketed as a Green Bond. This could be due to various inherent benefits that come with green infrastructure, including longer useful life and customer buy-in to environmentally friendly practices.
What are some potential drawbacks of green bonds?
On the flip side, this market is relatively new, which means some established issuers and investors are skeptical of its credibility. Whereas the traditional bond market has existed since 1812, the green bond market did not gain traction until 2007. Because of its explosive growth and diverse investor pool, some issuers and investors have been slow to enter the market because they are wary of how sound their investments may be. However, that has not stopped $190 billion from being issued in green bonds in 2023.
Green infrastructure holds several potential benefits for utilities, but pursuing a bond may not make sense for small and mid-sized utilities. Revenue bond ratings often favor larger utilities that enjoy economies of scale. This can mean smaller and mid-sized utilities are assigned lower ratings, which translates to higher interest rates. Bonds also require a lot of additional work, like a lengthy underwriting process and fund management. In contrast, subsidized funding options and other innovative financing mechanisms may have more streamlined procurement processes, which means less administrative burden for utilities. For utilities that may not want to access funding on the private market, subsidized options may be available that offer significantly reduced interest rates and fund management, such as the Clean Water State Revolving Fund (CWSRF) Green Project Reserve.
With green infrastructure being the way to go for more and more utilities, understanding different financing options is imperative to choosing the best payback terms for important infrastructure projects. Green bonds could be a smart choice for utilities looking to implement innovative, environmentally friendly infrastructure in their utilities. For more information on green bonds, utilities can visit EPA’s website.
Need technical assistance? The UNC Environmental Finance Center is here to help!
The Environmental Finance Center at UNC-CH offers free one-on-one technical assistance for small water systems. If you are interested in our support, fill out our Technical Assistance Request Form or contact us at efc@sog.unc.edu.