Making houses in Spain more energy efficient or installing solar panels in Wales are both worthy green bond projects. But they don't generate as much benefit as some projects that are more difficult to invest in.
Don’t get me wrong, I love Wales. Its beauty, friendliness, history, passion and sense of humour more than make up for the fact that it is constantly bloody raining there. I do wonder though at the wisdom of installing solar farms. At a Euromoney conference recently a solar panel operator from Mexico was discussing his problems getting finance. No such problems for a Welsh project that I was reading about recently. I’m no expert but I’m guessing that Acapulco gets a bit more sun in a typical year than Aberystwyth.
At another event I was discussing energy efficiency with a representative of a city in another emerging market. Like most cities in the region heat is provided in the winter by vast, soviet style municipal heating units and piped to people’s houses. The system was ludicrously inefficient when it was installed thirty years ago, since then it has got worse. The carbon based fuels that are wasted every winter by the inefficiency of the system is utterly staggering and probably dwarfs the carbon savings from all of the Teslas in the world combined.
The problem, of course, is that some of the highest potential benefits from green bonds are in the higher risk emerging markets. The projects themselves have a massive pay-back in economic, let alone environmental terms. They are totally bankable projects in themselves. The dual problems that they face are the sovereign risk premium of being in an emerging market and that green investors in the bond market are surprisingly risk averse. What could be done?
In the previous article I discussed the disclosure that would help green investors optimise their portfolio in terms of a trade-off between quantifiable benefit and yield foregone. There is a parallel analysis to optimise quantifiable benefit against risk. Fortunately, the market being what it is, there is a highly transparent ‘exchange rate’ between risk and return – however you chose to measure it you can see its value, real time, on that Bloomberg screen on your desk.
It wouldn’t be difficult, for example, to compare the carbon emissions avoided per basis point for an IFC green bond and an investment in upgrading a city’s heating system hedged with a credit default swap on the sovereign bond (as a liquid proxy for the countries riskiness). Take it to the next level, would you invest in a fund that does two things: invests in emerging market green projects (only those with substantial and quantifiable benefits) and goes short an index of emerging market risk?
I’m far too lazy to construct the model but I’m pretty certain that this would be a much better investment in terms of risk, return and environmental benefit than investing in a bond financing solar panels in a rainy country.
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