California Treasurer Advances Green Bonds

Palm Springs, California exterior

When California diverges from federal viewpoints and policy on climate change and supports the Paris Agreement’s goals, Alan Gordon, its deputy state treasurer, leverages green bonds to yield results. California is one of the world’s six largest economies. The Golden State manages massive amounts of pension assets.

Taking a Stand in a Harsh Federal Climate

After the Trump administration expressed its intention of leaving the Paris Agreement in an official statement on June 1, hundreds of mayors and state officials around the country have continued to work to combat climate change. California’s Governor Jerry Brown went to China to reassert his commitment to the Paris Agreement.

“We will continue to go down this path,” Gordon said. “We think it will be better for California, for Californians’ economic future, and for our grandchildren. Not only will we not retreat, we will litigate. Our Attorney General has made it very clear that in every place that the Trump administration looks to supersede California's environmental laws, we will litigate all the way.”

Why is this resistance to environmental sustainability occurring? According to Gordon, “There is a belief that environmental laws and regulations are detrimental to the economy. That is one of the reasons Trump is rolling back environmental regulations across the board. However, all the peer-reviewed evidence indicates that in jurisdictions with stronger environmental laws and regulations, long-term growth is higher. If you do have better environmental controls, long-term risks and liabilities decrease. Therefore, you have steadier long-term growth.”

In other words, while environmental controls can make businesses and municipalities shut down factories, leading to layoffs and market malaise in the short term, that is not the end result. An overhaul of our energy system would be a massive, Keynesian-style capital investment that would lead to explosive industry and job growth while decreasing reliance on extracting expensive, toxic, and climate--compromising fossil fuels.

To meet the Paris Agreement’s goal of limiting global temperature rise to below 2°C, replacing infrastructure powered by fossil fuels with low-carbon alternatives is estimated to cost $93 trillion, including $8 trillion in the United States.

Without leadership from the federal government, California is joining forces with other municipalities to address climate change. Along with the states of Oregon, Washington and New York, California formed the United States Climate Alliance to implement new programs to reduce carbon emissions. This undertaking demands the full range of financing tools.

“We are currently working on a program here in the Treasury that will provide financing for energy-efficient upgrades in the commercial building sphere,” Gordon said. “After transportation, commercial buildings are the biggest users of energy on the grid… We are looking to standardize financial products that will help malls and buildings and all the commercial building stock out there.” One such financial product that municipalities and businesses are using in growing numbers is green bonds.

Financing Commercial Energy Upgrades

Green bonds were created to fund projects that have positive environmental and climate benefits. Unlike investors purchasing vanilla bonds, investors buying these bonds require verification and follow-up metrics on promised projects with quantified impact. This helps prevent greenwashing – pro-environmental marketing without any results. 

Gordon said he sees a booming industry. “We now have various entities that provide third-party verification and follow-up reporting ranging from the Climate Bonds Initiative (CBI) - an NGO instrumental in drafting the green bond principles -  as well as such major corporate or traditional financial players such as PWC, Moody's, and Standard and Poor's. Each of the rating agencies is developing its own metrics. This is clearly an evolving area of expertise that will continue to change over time.”

Green bonds are still a tiny portion of the overall bond market, but the goals of the Paris Agreement show a clear need for financing. Data from CBI show that recent American green bonds issuers include the New York MTA, Southern Power Company, and Apple. The proceeds from these issues are financing such diverse projects as residential solar systems and municipal wind-power facilities. According to Gordon, “Under the cap-and-trade program [that is rolling out with our commitments under the Paris Agreement], companies are going to have to lower their emissions, which is going to mean that they are going to look for conservation and renewable energy. This will lead to additional supply in the green bond market.”

Although these trailblazing issuers and investors are setting the stage, the market is still nascent. Finance teaches us that bond prices and yield go in opposite directions. Imagine you are an investor considering the purchase of two bonds entitling you to the same future payments. If the bonds have different upfront costs, then the cheaper bond will have a higher yield (or return). Currently, green bonds trade on the curve, the same as their vanilla counterparts, although there is some evidence that green bonds have a slightly higher demand and carry a yield premium on secondary markets. On the primary market, however, there is still no premium, so bond issuers must pay investors the same as for vanilla bonds while also paying rating agencies for verification.

If investors become more knowledgeable and confident in the green bond market, the increased demand will result in lower prices and higher yields. When that happens, investor demand will increase like a chain reaction.

“All fund managers across investment industry look at is yield,” Gordon said. “And at some level, they're justified in doing so. Their primary responsibility as fiduciaries is to get the best price they can.”

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Investing in to Assist their Growth

Our capitalist economy allows us to speak through dollars. While everyone’s situation is different, you can consider how green bonds can fit into your overall portfolio.

Gordon said, “The most important decisions you make are the financial ones. You are making a value judgment right there. And it may be that your value is that…  the economic security of your family is more important than anything else. And if Exxon and Shell are making the highest returns, you want to hold those stocks. But that is a choice. It may be one that you don't consciously think about. But if you consciously think about these things, then there are socially responsible investments out there where you invest your values and don’t give up. Invest in companies that will be consistent with your values.”

For example, the VanEck Vectors Green Bond ETF (GRNB), started in March 2017, invests only in bonds certified by Climate Bonds Initiative.

Voting for a Review of Tax Exemption to Support Green Investment

Our democratic system of government allows us to express our conscience through civic engagement, including electing and holding our representatives accountable.

Tax exemption currently constrains demand for municipal green bonds in the United States. Bonds issued by tax-exempt organizations pay investors lower yields, as investors do not have to pay taxes on the payments they earn. This makes sense for high-net-worth United States-based investors, but destroys incentives for investors that do not receive these tax benefits, such as municipal pension funds and international investors.

 “CALPERS, which is the largest private public pension fund in the United States, cannot buy municipal green bonds [because of] the simple fact that CALPERS itself is tax exempt. So, if they were to purchase a tax-exempt security, they would be violating the fiduciary responsibility to their members,” Gordon said. “As a result, most municipal bonds in the United States are purchased by high-net-worth individuals to decrease their tax liabilities. Under the Obama administration, the Build America Bonds program of the federal government paid the difference between taxable and tax-exempt. That is one thing we are looking at in California.”

If broad tax cuts are implemented, then demand for tax-exempt municipal securities will plummet. There needs to be increased public debate about the benefits of tax-exempt securities and how they can be used to enhance the public good.

Helping to Fund Verification to Strengthen Compliance

Until the demand for green bonds is high enough to drive their price below comparable vanilla bonds, issuers will need to pay verification expenses for compliance without added benefits.

“For an issuer, when does it make sense to issue green bonds with an additional cost?” Gordon said. “If they trade at a premium, then the difference offsets the verification cost. The second possibility is that there would be a third party, such as an NGO, that covers whatever additional cost there might be in post-issuance compliance.”

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