The Financial Express

SDG bonds to accelerate a green recovery from the pandemic

SDG bonds to accelerate a green recovery from the pandemic

The pandemic has had a devastating impact on Southeast Asia's achievement of the Sustainable Development Goals (SDGs), the international effort to improve the lives of people around the world, with various studies especially identifying the millions being pushed back into joblessness and poverty.

One way to help get the SDGs back on track is for the greater issuance by governments and government entities of SDG bonds to bring a focus on one or more of the SDGs and also raise funds from the private sector, much needed to bridge the rising financing gap for achievement of country SDG targets.

The good news is that the global appetite still exists for SDG bonds. Thailand's sustainability bonds of late 2020 - one of the first sustainability bonds since the pandemic broke out - and supported by Asian Development Bank (ADB)'s technical assistance, raised almost US $1 billion and was three times oversubscribed.

The not-so-good news is that despite being at a record high, issuances of SDG bonds in many developing regions such as Southeast Asia are still only a fraction of both the global total and of what is needed. This is a result of the perceived effort of developing such bonds by potential issuing entities as well as the perception of risk by the global investing community on many of these prospective SDG bonds stemming from issues such as capacity of first-time issuers, weak subproject pipelines, financial risks, and legal complications. These perceptions constrain the up scaling of such bonds.

A possible solution to this problem is the SDG Accelerator Bond, a new, de-risked way of issuing SDG bonds.

How do these bonds work? Imagine you are the mayor of Sea City, a medium-sized Southeast Asian city of 2 million people. Sea City is slowly recovering from the worst impacts of the Covid-19 pandemic, but your unemployment rates sky-rocketed during the crisis, tax revenues are still falling, and your plans for improving the city's infrastructure have been put on hold.

Before the pandemic hit, your national government made some ambitious goals to fulfill its commitments to the Paris Agreement and the UN SDGs, to strengthen its profile as a green and sustainable country. As the mayor of a major city, you are committed to supporting your country in its global sustainability commitments, and you firmly believe in the importance of the SDGs to combat poverty, inequality, environmental degradation, health and justice.

To boost employment, improve the city's reputation, strengthen the city's infrastructure, and contribute to mitigating climate change, the Sea City municipal council has decided to undertake three infrastructure projects that target a number of SDGs: (a) A light rail system to alleviate traffic congestion and provide safe, clean, and comfortable transportation for hundreds of thousands of Sea City citizens; (b) A sustainable solid waste management facility with composting and advanced sorting capabilities; (c) Five parks and recreational areas at various locations in the city which will contribute to the livability of Sea City and improve the health and wellbeing of the citizens.

Despite being at a record high, issuances of SDG bonds in many developing regions such as Southeast Asia are still only a fraction of both the global total and of what is needed.

How much will it cost? The total bill for these projects is $850 million. Sea City does not have $850 million, so you have decided to fund these projects through a combination of schemes: Sea City itself will contribute $250 million, and you will take a $500 million sovereign loan from a development bank such as ADB. The remaining $100 million will be raised through an SDG Accelerator Bond.

Sea City seeks to mobilise $100 million from two primary groups of investors: one is domestic impact investors including foundations and philanthropists, the other is offshore investors who live up to a predetermined set of eligibility criteria.

But why would they choose to invest in infrastructure in a medium-sized Southeast Asian city like yours with an unproven track record and limited funds? What's the attraction for overseas investors?

The SDG Accelerator Bonds would help mitigate these risks for investors with a structure that includes a backing in the form of an exit guarantee or loss protection on investment by a national guarantee fund, itself supported by one or more multilateral or bilateral development agencies. However, such backing would not be open ended but for meeting the perceived risks of a bond for a limited time period, perhaps the time for getting underlying subprojects off the ground, and thus gradually reducing the liability of the guarantee fund.

The bond structure would also similarly offer financial incentives to the bond issuer in the period of the guarantee, such as deferral of initial payments. 

Hence, in the case of Sea City, the possible guarantee fund could be called upon if Sea City was unable to pay back the investors at any of the fixed exit intervals for instance, where an investor may want to pull out.

Having such a structured guarantee makes the SDG Accelerator Bond seem much less risky to investors. At the same time, Sea City benefits from a bond structured to make payments after the initial construction years when usage is increasing and rising payments are aligned with tax revenues and project revenues from light rail ticket sales, advertising on trains and platforms, rent from vendors in the parks, among others.

As your projects finish, Sea City will monitor and measure their impact according to your country's national Sustainable Financing Framework, globally accepted impact metrics, and any additional impact monitoring tools. Following the successful SDG Accelerator Bond, your municipal council now decides to regularly issue further such bonds to reach about $500 million by 2023.

At this point, the SDG Accelerator Bond concept is only that, a concept, albeit one that is based on global best practices for project financing. It would need to be fine-tuned and piloted before making its proper entrance into the mainstream toolbox of green infrastructure financing.

We'll need many innovative solutions and new ways of thinking to bridge the financing gap for fulfillment of the SDGs after the pandemic. SDG Accelerator Bonds could be a good start for this toolbox.

The piece is excerpted from Asian Development Blog (www.blogs.adb.org)

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