Master’sDegreein

ManagementAccountingAndFinance

FinalThesis

GreenBonds:

analternativesourceoffinancingintheEraofClimateChange

SupervisorCh.Prof.GloriaGardenalAssistantsupervisorCh.Prof.FedericoBeltrameGraduandNicolòRossittoMatricolationnumber852523AcademicYear2019/2020

CONTENTS

INTRODUCTION..................................................................................................................................................1

1.CHAPTER:CLIMATECHANGE.................................................................................................................4

1.1RiodeJaneiro1992...............................................................................................................................5

1.2KyotoProtocol........................................................................................................................................6

1.3DevelopmentaftertheKyotoProtocol:TheSternReview..................................................7

1.4TheCopenhagenAgreement.............................................................................................................8

1.5TheCOP21(ParisAgreement)........................................................................................................9

1.5.1TheINDCs.......................................................................................................................................10

1.6SustainableDevelopmentGoals(SDGs).....................................................................................13

1.7MitigationandAdaptation...............................................................................................................15

1.7.1EnergySector................................................................................................................................18

1.7.1.1GSEIncentive........................................................................................................................20

1.8.ClimateChangeandCOVID-19......................................................................................................21

2.CHAPTER:CLIMATEFINANCE..............................................................................................................25

2.1Low-CarbonEconomyTransition.................................................................................................26

2.2ClimateFinanceActors......................................................................................................................30

2.2.1PublicFinanceActors................................................................................................................32

2.2.1.1FinancingSustainableGrowthandTheGreenDeal............................................33

2.2.2PrivateFinanceActors..............................................................................................................37

2.2.3TheimportanceofPublicandPrivaterelationship......................................................38

2.2.3.1BlendedFinance..................................................................................................................39

2.3ClimateFinanceInstruments..........................................................................................................43

2.3.1FinancialInstrumentstoRaiseFunds................................................................................44

2.3.1.1GreenBonds..........................................................................................................................45

2.3.1.2ClimatePolicyPerformanceBonds.............................................................................45

2.3.1.3CatastropheBonds.............................................................................................................47

2.3.1.4DebtforClimateSwaps....................................................................................................49

2.3.2FinancialInstrumentstoDeployFunds............................................................................51

2.3.2.1CapitalInstruments...........................................................................................................51

2.3.2.1.1DebtFinance.................................................................................................................52

2.3.2.1.1EquityFinance.............................................................................................................53

2.3.2.2RiskManagementInstruments.....................................................................................55

2.4SustainableFinanceandCovid-19...............................................................................................56

3.CHAPTER:GREENBONDS.......................................................................................................................59

3.1WhatisaBond......................................................................................................................................59

3.2TheGreenBonds..................................................................................................................................61

3.2.1GreenBondsPrinciplesandClimateBondsStandard................................................63

3.2.2IssuingaGreenBond.................................................................................................................68

3.3GreenBondMarket.............................................................................................................................69

3.3.1Developmentofthelastyears...............................................................................................70

3.4CharacteristicsofGreenBonds......................................................................................................74

3.4.1The“greenium”ofGreenBonds...........................................................................................76

3.5GreenBondMarketinItaly.............................................................................................................79

3.5.1ExampleofGreenBond–EnelS.p.A...................................................................................80

4.CHAPTER:GREENBONDS:ANALTERNATIVESOURCEOFFINANCING?AN

EMPIRICALEVIDENCE...................................................................................................................................84

4.1ProjectFinance.....................................................................................................................................84

4.1.1.ProjectFinanceActors.............................................................................................................87

4.1.2TypicalProjectFinanceTransaction..................................................................................90

4.1.3ProjectValuation.........................................................................................................................92

4.2RenewableEnergysectorinItaly.................................................................................................97

4.3GreenBondsvsProjectFinance:anempiricalevidence.................................................100

4.3.1LiteratureReview....................................................................................................................100

4.3.2EmpiricalAnalysis...................................................................................................................103

4.3.2.1Methodology......................................................................................................................104

4.3.2.2FinancialData....................................................................................................................106

4.3.2.3ResultsandConclusions...............................................................................................113

CONCLUSIONS................................................................................................................................................117

REFERENCES...................................................................................................................................................121

1

INTRODUCTION Attheendof2007agroupofSwedishpensionfundshadtheintuitiontoinvestinclimate

friendlyprojects.Theydidnotknowhowtoinvestingreenprojectsandtheyaskedtothe

WorldBankforsupport.Ayearlater,in2008,theWorldBankissueditsfirstgreenbond,

introducinganewtoolinthemarketthatallowedfinancialinvestorsandprojectstojoin

forcesagainstclimatechange.

Theobjectof this thesis is tostudyandshed lightonan innovative tool:greenbonds.

Climatechangeisthereasonbehindthebirthofthesenewgreenfinancialinstruments,

highlighting the global need of stimulating financial investors towards environmental

sustainability projects, thus avoiding the need to allocate resources on projects that

producehighCO2emissionsandgreenhousegases.

The purpose of green bonds is therefore a kind ofwin-win strategy,where investors

increasetheirprofitsand,atthesametime,individualgovernmentsareabletocomply

with theParisAgreement guidelines. In this context, energy industryplays a key role

againstclimatechange.Infact,theenergytransitionaimstoshiftfromfossilfuel-centered

energytoacarbon-neutralone,basedprimarilyonrenewablesources.Renewableenergy

isplacedatthefoundationofthethesis,highlightinghowtheissuanceofgreenbondscan

facilitatetheenergytransitioninItaly.

After having extensively studied climate change, climate finance and green bonds in

general,theobjectiveofthisthesisistoanalyzewhethertheissuanceofagreenbondin

the renewable energy market can be a viable alternative to conventional sources of

financing used in Italy such as project finance, from a shareholder perspective. In

particular,theanalysisisconductedonthedebtrefinancingofahypotheticalcompany

that has awind farm located in Italy as its core asset. Through the construction of a

financial model, the 10-year financial statements forecast of the company will be

proposed,assumingtwodifferentscenarios:thefirstonewitharefinancingusingproject

financeandthesecondoneissuingagreenbond.Theproposedanalysisdoesnotaimat

statingageneralandunivocalresultbutrathertofosterfurtherfutureresearchonthe

topic.

2

Themotivation behind this thesis is the desire of inspiring the new generations to a

greater sensitivity around climate change, trying to combine both economic and

environmentalinterests.Climatechangeisnowanacknowledgedproblem,asitisthekey

roleplayedbyeconomicsandfinanceinthefutureofourplanet.TheCovid-19pandemic

crisismustbeconsideredasawake-upcall. In fact, ithasshownthathumansarenot

invincibleand,onthecontrary,theyarevulnerablewithoutacommonglobaleffort.Inthe

financial field, green bonds represent the viable way to move from the profit

maximizationparadigmtoamoresustainableandfairerfuture.Thesymbolthatthose

instrumentsrepresent insectorswhereprofitmaximizationhasalwaysbeenthemain

goalisthemainreasonbehindthisresearch.

Thestructureofthisthesisisdesignedtograduallyintroducegreenbonds,starting,as

mentioned above, from its roots in climate change, exploring similar instruments of

climatefinanceandfinallydemonstratingempiricallyhowtheycanbeaviablealternative

toprojectfinanceintherenewableenergymarketinItaly.

Thechapterswillbeorganizedasfollows.

Chapter 1 introduces the climate change issue, highlighting themain global warming

causes. The chapter is focused on howmodern society has dealtwith climate change

throughouthistory,fromthefirstconferenceinRiodeJaneiroin1992,throughtheKyoto

Protocolin1997,theCopenhagenAgreementin2009,andfinallywiththemostimportant

agreement,theParisAgreementin2015.Thefinalpartofthechapterisdedicatedtothe

description of the SDGs (Sustainable Development Goals) and the importance of the

energysectorinthefightagainstclimatechange.Inaddition,afinalparagraphdiscusses

therelationshipbetweenclimatechangeandtheCovid-19pandemic.

Chapter2isdedicatedtothedescriptionofclimatefinance.Inparticular,thefirstpartof

the chapter focuses on the low-carbon transition, highlighting the public and private

actors in climate finance and how the relationship between public and private is

fundamentalintheenergytransition.Thesecondpartofthechapterfocusesonclimate

finance instruments, fromthe instrumentstoraise funds(GreenBonds,ClimatePolicy

PerformanceBonds,CatastropheBondsandDebtforClimateSwaps)totheinstruments

todistributefunds(CapitalInstrumentsandRiskManagementInstruments).Finally,the

finalpartdiscussestheconsequencesofclimatefinanceaftertheCovid-19pandemic.

3

Chapter 3 is entirely focused on describing green bonds, highlighting how these

innovativeinstrumentswork.Inaddition,itoutlinestheGreenBondPrinciplesandthe

GreenBondStandards,whicharethekeyelementsinthegreenbondsclassificationand

categorization.Moreover,thedevelopmentsinrecentyearshaveshowedhowtheiruse

has grown exponentially in the current decade. Finally, the last part of the chapter is

dedicatedtothecharacteristicsofgreenbonds,theso-called"greenium"andafinalfocus

onthegreenbondmarketinItaly,supportedbytheexampleofthegreenbondissuedby

EnelS.p.A.

Chapter4proposesanempiricalanalysisabouttheissuanceofagreenbond.Inparticular,

asdescribedabove,theanalysiscomparesthedebtrefinancingofahypotheticalcompany

operatingintherenewableenergymarketinItalywiththeuseofprojectfinanceandthe

issuanceofagreenbond.Theproposedanalysisisconstructedfromthepointofviewof

the project shareholders/sponsors, obtaining a final NPV (Net Present Value) of the

projectforbothcases.

Theliteratureonthetopichasprovedtobestill fledglingasconfirmedbyCondeetal.

(2020).Theirworkistakenasareferencetodeveloptheanalysisofthisthesis.

Therefore, the chapter is structured by introducing the project finance instrument,

currently the most widely used source of financing in Italy in the renewable energy

market.AfterabriefdescriptionofthecurrentmarketsituationinItaly,withparticular

regardtotheincentivesystem,thelastpartwillbededicatedtotheempiricalanalysis

describedabove.

4

1.CHAPTER:CLIMATECHANGE

ClimateChangesurroundsusandwecannotavoidit.Itisoneofthemajorchallengesof

ourcenturyanditisemergingasoneofthegreatestchallengesofoursociety1.Itiswell

established that climatic variations are themost important threat of themodern age,

consideringthatitseffectsaffectthehumansociety,theeconomiesandthedestinyof

ourplanet.Thecausesof theso-called “GlobalWarming”are relativelyeasy todefine.

Studiesandacademicresearchagreethathumansareconstantlyinfluencingbothclimate

and the temperature of the Earth by burning fossil fuels, this being one of the most

important causes of global warming. The process of burning fossil fuels has the

consequencetoaddenormousamountofgreenhousegasestotheatmosphere,sustaining

andincreasingthegreenhouseeffectandtheglobalwarming.

AccordingtoKaddoandJameelR.(2016),greenhousegasesarethemaincontributorsto

climatechange.Theyareveryefficientintrappingheatintotheatmospheregenerating

thegreenhouseeffect.SolarenergyisabsorbedbytheEarth’ssurfaceandthenreflected

backtotheatmosphereasheat.Astheheatgoesouttospace,greenhousegasesabsorba

partoftheheat.Afterthat,theyradiatetheheatbacktotheearth’ssurface,toanother

greenhousegasmolecule,ortospace.

ThemainconcernforscientistsistheemissionofCO2sinceitisabout75%ofthetotal

globalemissionofgreenhousegases(Burghilaetal.,2015).

The increasing urbanization and industrialization led to the chaotic consumption of

naturalresources,severepollution,naturaldisastersandanirreversibleimbalanceofthe

Earth’s system2.Greenhousegasesare considered themainhuman-induceddriversof

climatechange3.Amongthegasesthatcontributetosustainthegreenhouseeffect(like

carbon dioxide, methane and nitrous oxide), carbon dioxide is certainly the most

dominant causeof thiskindof change, representing the75%ofglobal emissions.The

concentrationofCO2isrisingasaresultoffossilfuelburning4.

1 Burghilaetal.(2015)-ClimateChangeEffects–What’sNext?,AgricultureandAgriculturalScienceProcedia6,405–412 2 Burghilaetal.(2015)-ClimateChangeEffects–What’sNext?,AgricultureandAgriculturalScienceProcedia6,405–412 3 OECD(2008)-AnnualReport2008 4 AmericanMeteorologicalSociety(2008)-WeatherAnalysisandForecastingCommittee2008AnnualReport

5

On a daily basis, the process of climate change is represented as the increase in

temperature that affects populations all over the world, altering social systems,

economiesandtheenvironmentaroundus.Veryhotorcoldwaves,periodsofdrought,

hurricanes,floodsandfiresareputtingfoodsafetyinseriousdangerand,atthesametime,

ourhomesandourcities,ourcompaniesandourhealth.

Inthisparticularscenario,itisinterestingtoreflectonhowthemodernsocietyhasdealt

withtheevidenceofclimatechange,startingfromtherecognitionofthethreatstothe

creationofnewwaysoffundinggreenprojects,pointingoutthatclimatefinancehasa

centralroleonthisbattleagainstclimatechange.

1.1RiodeJaneiro1992

Atthebeginningof1800,thefirststudiesabouttheimportanceoftheatmosphereandits

connectionwiththeclimatewerecarriedout.

Therealbreakthroughwasin1970,whentheWorldMeteorologicalOrganization(WMO)

started to study the connection between human activities, CO2 and the growth of

temperatureontheplanet.TheconnectionswereconfirmedandfinallytheWMOissued

the IPCC (International Panel on Climate Change) in 1988. Its goalwas to summarize

scientificevidenceonclimatechangeandtopartiallyreassessgovernmentalcontrolover

theclimatechangeissue.Afterthefirststudies,theworriesaboutgreenhousegasesand

theirconnectionwiththetemperatureoftheplanetwereconfirmedandtheFramework

ConventiononClimateChange(FCCC)wasestablishedinMay1992inRiodeJaneiro.The

Conventionwasnotanend-pointbutratherthestartofanongoingprocess,thebeginning

oftheguidelinestofighttheglobalwarming.Inparticular,Article2representsthemain

objectiveoftheconference:“Stabilizegreenhousegasemissionsintheatmosphereatalevel

thatwouldpreventdangerousanthropogenicinterferencewiththeclimatesystem”5.

TheconferenceinRiowasalsoimportantbecauseitlaunchedanewwayofinteracting

between developed and developing countries. Indeed, specific commitments for

industrializedcountriesandtheformerEasternBlocweredefined:theyhadto“takethe

lead” in the GHG (greenhouse gases) emission reduction and advanced reporting6.

5 UNFCCC(1992)-Article2,RiodeJaneiro3-14June1992 6UNFCCC(1992)-Article4.2,RiodeJaneiro3-14June1992

6

Moreover,industrializedcountriesexcludingtheformerEasternBlochadtoprovide“new

andadditional”financialresourcesneededtocovercostsofreportingobligationsaswell

asmitigationandadaptationactivitiescostssupportedbydevelopingcountries7.In1994

morethan50statesapprovedtheUNFCCCandit finallyenteredintoforce.TheIPCC’s

secondassessmentreportin1996underlinedthefactthatclimatechangemitigationwas

anecessity8.

1.2KyotoProtocol

During1997inKyoto,Japan,160countriesoftheUFCCC9(UnitedFrameworkConvention

on Climate Change) adopted the Kyoto Protocol, which established legal limits for

industrializedcountriesonemissionsofcarbondioxideandother“greenhousegases”10.

ThecomplexityoftheKyotoProtocolreflectedtheeconomicandsocialissuesraisedby

climatechange11. Inparticular, theprotocolaimedto“reduceemissionsofgreenhouse

gasesindevelopedcountriesandtheglobalemissionstargetwas5,2%belowthe1990

leveltobeachievedoverthe2008-2012”12.

Infact,theart.3par.1oftheprotocolstatesthattheoverallreductionshouldbeatleast

5percent13.

TheKyotoProtocolalsoprovidedapossibilityforcountriestouseasystemof flexible

mechanismsfortheacquisitionofemissioncredits.

Thefirstmechanismwascalled“CleanDevelopmentMechanism”(CDM)anditallowed

industrializedcountriesandeconomiesintransitiontoimplementprojectsindeveloping

countries that produce environmental benefits in terms of reducing greenhouse gas

emissions,inordertoachieveemissioncredits.

7UNFCCC(1992)-Article4.3,RiodeJaneiro3-14June1992 8Bodansky,D(2001)-TheHistoryoftheGlobalClimateChangeRegime,Internationalrelationsandglobalclimatechange 9UnitedFrameworkConventiononClimateChange(1992)-openedforsignatureJune41992,S.Treaty,DOCno.102-38,1992 10ClareBreidenichetal.(1998)-TheAmericanJournalofInternationalLaw,Vol.92,No.2(Apr.,1998),pp.315-331 11ChamberofCommerceandIndustryofWA(1999)-TheKyotoProtocolAndGreenhouseGasEmissions 12WigleyT(2008)-GeophysicalResearchLetters,Vol.25,No.13,Pages2285-2288,July1,199813UNFCCC(1998)-KyotoProtocoltotheUnitedNationsFrameworkonClimateChange

7

The second mechanism, called “Joined Implementation” (JI), allowed industrialized

countries and economies in transition to implement projects for the reduction of

greenhousegasemissions inanothercountryof thesamegroupand touse the linked

creditsjointlywiththehostcountry.

Thethirdandlastmechanismwascalled“EmissionTrading”(ET)anditconsistedinthe

possibility for industrialized countries and economies in transition to “trade” the

emissioncredits. Inotherwords,acountrywhichreduces theemissionofgreenhouse

gasesmore than the objective can exchange that credits to other countrieswhich are

unabletoachievethoseobjectives,maintainingtheoverallbalance.14

ThemostimportantconditionoftheProtocolstatedthat,inorderfortheagreementto

come into force, it had tobe ratifiedbyno less than55 signatory states among those

producing at least 55% of pollutant emissions. This last conditionwas achieved only

during2004,whenRussiasignedtheagreement.

1.3DevelopmentaftertheKyotoProtocol:TheSternReview

After the first meetings organized and studies produced to mitigate the emission of

greenhousegasesand,ingeneral,climatechange,aparticularlyinsightfulresearch(and

thefollowingbook,“Ablueprintforasaferplanet”)wastheSternreview,publishedin

2006byNicolasStern,helpingthecommunitytounderstandtherealrisksoftheclimate

change.

ThegeneralopinionbeforetheSternReviewwasthattheoverallcostsofmitigatingthe

actionsagainsttheclimatechangeweretoohighand,consequently,thecostofclimate

changewasunderestimated.Infact,Stern,afteralifelivedalongsidepoorpeopleinorder

tocombatglobalpoverty,in2006,withthesupportoftheBritaingovernment,showed

withhisreviewthat“costsofclimatechangewouldbehigherthanthecostsofreducing

GHGemissionsand,asaconsequence,strongpoliticalinitiativeswereunavoidableandwere

needed as soon as possible”15. Stern’s approach had little to do with the pessimistic

environmentalismwaytoactthat,tryingtoraiseawarenessthroughshock,alltoooften

leads to resignation. The centralmessagewas simple: the risks are enormous (social,

14 EuropeanCommission(2005)-TheKyotoProtocol 15 SternN.(2007)-Theeconomicsofclimatechange.TheSternreview,CambridgeUniversityPress,Cambridge

8

economic andenvironmental)but it ispossible to contain themsignificantly ifweact

quicklyanddecisively.Thewatchwordisone:investing.

Moreover,inApril2008Sternsaidthattheseverityofhisstudieswereconfirmedbythe

2007 IPCC report. That report showed that thepresenceof greenhouse gases such as

methane,carbondioxideandnitrousoxideintheatmospherehadbeenrisingfrom1800

untiltoday16.TheyadmittedthatintheSternReview"(…)weunderestimatedtherisksand

weunderestimatedthedamageassociatedwiththeriseintemperature.Weunderestimated

the probabilities of temperature increases". In 2008, Stern said also that, since climate

changewasgoingfasterthanexpected,“thecostofreducingcarbonwouldbeevenhigher,

byabout2%ofGDPinsteadof1%intheoriginalreport”.17

1.4TheCopenhagenAgreement

On December 19 2009, the Copenhagen Conference ended with a result far below

expectations.Despitethepresenceofoverahundredheadsofstateandgovernment,the

climate summit did not succeed in creating a global agreement to replace the Kyoto

Protocol,whichwasgoingtoexpiredin2012.Withoutanagreement,the190member

countries of the UNFCCC postponed negotiations to 2010 and, as a conclusion of the

conference,abroadagreementonthetargetsforreducing2020greenhouseeffectwas

achieved: the Copenhagen Agreement. The Copenhagen Agreement was a 5 page

documentthatrecognizedclimatechangeas"oneofthegreatestchallengesofourtimes"

andstressedtheneedtolimittheincreaseinglobaltemperaturebelow2°C.Thetextdid

not containmandatory obligations but invited the industrialized countries to indicate

their reduction targets and developing countries to indicate the actions that were

intendedtobeputintopracticeinordertolimittheexpectedemissionsgrowthinthe

next ten years. On 31 January 2010, the deadline set for joining the agreement, 55

countrieshad formally adhered to thedocument, indicating their plans and reduction

targets.

16SolomonS.etal(2007)-Climatechange2007.ThePhysicalScienceBasis.ContributionofWorkingGroup,totheFourthassessmentreportoftheIntergovernmentalPanelonClimateChange,CambridgeUniversityPress,Cambridge,NewYork 17 Jowit,Juliette;Wintour,Patrick(2008)-Costoftacklingglobalclimatechangehasdoubled,warnsStern,TheGuardian.London.

9

On the other hand, the indications presented were far below what was considered

necessaryby the international scientificcommunityandwouldhavenotpreventedan

increaseintheglobaltemperatureabove3°C.Forthisreason,thatagreementrepresents

only an intermediate stage to be quickly surpassed by far more ambitious goals and

commitments.Until2015,theregulationstocombatclimatechangewerededicatedonly

tofewstates,leavingtheotherswithoutrulesorguidelines.In2015,duringCOP21,anew

fundamentalagreementbetweennationswassigned,aswewillseeinthenextparagraph.

1.5TheCOP21(ParisAgreement)

During2015intheClimateChangeConferenceofPartiesheldinParis,theso-calledCOP21,

197 countries reached a common political agreement: the Paris Agreement. This

agreementhasbeenfundamentalinthefightagainstglobalclimatechangeandagainst

theimpactsgeneratedbyglobalwarming,recognizingthat"climatechangerepresentsan

urgentandpotentiallyirreversiblethreattohumansocietiesandtotheplanet"18.Oneyear

later, on5October2016, the threshold for the entry into force of the agreementwas

achieved.TheParisAgreemententeredintoforceon4November2016,thirtydaysafter

thedateonwhichatleast55PartiestotheConvention(accountingintotalforatleastan

estimated55%ofthetotalglobalgreenhousegasemissions)depositedtheirinstruments

ofratification,acceptance,approvaloraccession19.

Thestatesalreadyinvolvedintheprevioustreatiesacknowledgedthattheeffortofafew

nations was no longer enough and a common commitment was needed to limit the

emissionsofgreenhousegases.Infact,theParisAgreementrepresentedthelargestglobal

effortwiththeaimof involvingallthenationsoftheworldinthefightagainstclimate

change,withparticularattentiontodevelopingcountries,declaringthatclimatechange

wasthegreatestthreattothefutureofourplanet.

Inparticular,thepartiescommittedtotransformtheirdevelopmenttrajectoriessothat

theysettheworldonacoursetowardssustainabledevelopment,aimingatlimitingglobal

warmingto1.5°to2°degreesabovepre-industriallevels.

18 IPCC(2020)-Link:https://www.ipcc.ch/sr15/faq/faq-chapter-1/ 19 UNCC(2015)-ParisAgreement–StatusofRatification,link:https://unfccc.int/process/the-parisagreement/status-of-ratification

10

ThroughtheParisAgreement,thepartiesalsoagreedtoalong-termgoaltoincreasethe

abilitytoadapttotheadverseimpactsofclimatechangeandfosterclimateresilienceand

low greenhouse gas emissions development, in amanner that does not threaten food

production.Additionally,theyagreedtoworktowards“makingfinanceflowsconsistent

with a pathway towards low greenhouse gas emissions and climate-resilient

development”20.

The heads of Governments also understood the need to reach the global peak of

greenhousegasemissionsassoonaspossibleinordertoproceedinthefuturewithrapid

reductions depending on the available technologies, achieving a balance between

emissionsandremovalsbysinksofgreenhousegasesinthesecondhalfofthiscentury.

Infact,asstatedbyUNFCCC,“itisunderstoodthepeakingofemissionswilltakelongerfor

developingcountries,andthatemissionreductionsareundertakenonthebasisofequity,

andinthecontextofsustainabledevelopmentandeffortstoeradicatepoverty,whichare

criticaldevelopmentprioritiesformanydevelopingcountries”.21

Theagreementisdividedintodifferentareas,inordertomeetthesechallenginggoals.In

particular, the areas are adaptation, loss and damage,mitigation, finance, technology,

capacitybuildingandreportingandaccounting.Moreover, theCOP21proposedanew

transparencyframework,fosteringthefinancialandtechnicalinnovationinordertohelp

developingcountriesinmitigatingthedisruptiveconsequencesofclimatechange.

Moreover,itpromotedthefavorableconditionsforatransitionfromfossilfuelstoward

renewableenergysources.

Finally,theagreementstressedtheimportanceofthecommitmentmadein2009during

theCOP15inCopenhagenbydevelopedcountriesto"jointlymobilize$100billionayear

until2020"todevelopingcountriesformitigationandadaptationactions.

1.5.1TheINDCs

Inorder topursue these long-termobjectives,art.4of theagreementstates thateach

country has to prepare, communicate and maintain a list of activities and binding

20UNCC(2017)-NationallyDeterminedContributions(NDCs),link:https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement/nationally-determined-contributions-ndcs#eq-1 21UNCC(2017)-NationallyDeterminedContributions(NDCs)

11

commitments to be implemented post-2020: the so-called Intended Nationally

DeterminedContributions(INDCs),whicharecalledNationallyDeterminedContributions

(NDCs)once theagreementhasbeenapprovedandratified. “Theseplansare the first

instrument throughwhich governments communicate at international level the steps

theyintendtotaketocombatclimatechangeintheirterritories”.22

Sofar,notallthepartiesratifyingtheagreementhavealsodepositedtheirNDCs:only189

outof197nations,whichratifiedtheagreementhavedoneit,whilesomeothercountries

haveonlydepositedtheINDCs.

Moreover,inparagraphs9,11and13itisstatedthat“governmentswillhavetoincrease

their efforts not only to achieve the objective of the agreement and to communicate

supplementary updates every five years, but also operate in the field of transparent

reportingoftheiremissionsandtheprogressofimplementationprocesses”.23

Indeed,theagreementstatesthatactionplansmustbedrawnupinaccordancewiththe

principleofequity,takingintoaccounttheinternalcapacitiesandcircumstancesofeach

nation,thusensuringthateachcountryplaysitspart.Theymustalsobeasambitiousas

possibleindirectingtheprocessofdecarbonizingcarbon-intensivesectors.

As described in art. 14, countries must report on the progress made internally with

respect to theirNDCs and the long-termobjectives of the agreement every five years

startingfrom2023:thisprocedureiscalled"globalstocktake".24

Thekeyquestion iswhether thecommitmentsandobjectiveswithin theNDCswillbe

sufficienttomaintainalevelofglobalwarmingbelow2°Cby2030.

Theanswer, asdescribedbyCAT (ClimateActionTracker), isnegative.Theemissions

reductionstargetsputforwardintheINDCs,iffullyimplemented,areprojectedtoleadto

aglobalwarmingofaround2.7°C(2.2-3.4°C)(or,inprobabilisticterms,arelikelytolimit

warmingtobelow3°C)by2100.25Thisconstitutesanincreaseof0.4°CsinceDecember

2014,beforeanyINDCswereformallysubmitted.

22 UNCC(2015)-link:https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement/nationally-determined-contributions-ndcs 23UNCC(2015)-TheParisAgreement,link:https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement24WorldResearchInstitute(2015)-WhatisanINDC?25 JefferyL.etal.(2015)-ClimateActionTrackerUpdate,link:https://climateactiontracker.org/documents/44/CAT_2015-12-08_2.7degCNotEnough_CATUpdate.pdf

12

Thefigurebelow(seeFigure1) showsthetrendsthat theemissionsshould followin

ordertomaintainthewarmingbelowthe2°C.

Figure1:GHGemissionindifferentscenarios.Source:CAT(2015)

The effortsmadewith the INDCs showa substantial improvement from the scenarios

beforethestartof the INDCprocess.However, the impactof these INDCs isstillmuch

lowerthanthatrequiredtolimitheatingto1,5°Corlessthan2°C.

RegardingtheParisAgreement,arelevantdecisionbytheUShasbeentakenduring2017.

On August 4 (2017), the Trump administration handed the UnitedNations an official

noticethattheUnitedStatesintendedtoterminatefromtheParisAgreementassoonas

itwaslegallyadmissibletodoso.Theformalnoticeofwithdrawalcouldnotbesubmitted

untiltheagreementwasinforcefor3yearsfortheUnitedStates(4November2019).On

4November,theUnitedStatesGovernmentdepositeditsnoticeofwithdrawalwiththe

Secretary-GeneraloftheUnitedNations,thedepositaryoftheagreement.

ThewithdrawaloftheUnitedStates,thesecondmostpollutingcountryintheworld,

fromtheParisAgreementriskstounderminetheinternationaleffortstocombatclimate

change.ThedatapublishedbytheWorldBank,accordingtowhich"theimpactof

extremenaturaldisastersisequivalenttoagloballossof520billiondollarsinannual

consumptionandannuallyforcesabout26millionpeopletopoverty"26,showsthatclimate

26 TheWorldBank(2016)-link:https://www.worldbank.org/en/news/press-release/2016/11/14/natural-disasters-force-26-million-people-into-poverty-and-cost-520bn-in-losses-every-year-new-world-bank-analysis-finds

13

challengesneedamultilateralapproachandcannotfocusonsimplisticandnational

responses.Thenewtechnologiesarereadytodirectthecurrentenergyandproduction

inaverygreendirection.However,suchdimensionscannotbeseparatedfromastrong

politicalleadershipcapableofovercominggeographicalandideologicaldifferences.

WithouttheUnitedStates,thisleadershipgap,evenifitcanbefilled,isboundtobefelt.

Moreover,inFebruary2021thePresidentJoeBidenreenteredtheUnitedStatesinthe

ParisAgreement,fewhoursafterhisinauguration.

However, theParisAgreementhighlights theeconomicand financial field as a central

actorforthefightagainsttheclimatechange.Article2.1coftheAgreementcommitsthe

partiesto"makingfinanceflowsconsistentwithapathtowardslowergreenhousegas

emissionsandaclimate-resilientdevelopment".27

Aswewillseeinthenextchapters,thefundsrequiredtomeetthethresholdof2°Care

large,andtherearemanystudiestoestimatethemshowingdifferentresults.

Theresearchersagreed that thegapbetweenclimate-friendly finance flowsand those

needed to achieve the climate stabilization objective is large but technology and

innovationarereadytolimitit.28

1.6SustainableDevelopmentGoals(SDGs)

InSeptember2015,inNewYork,morethan150internationalleadersmetattheUnited

Nationstocontributetoglobaldevelopment,promotinghumanwell-beingandprotect

theenvironment.TheStatesendorsedtheSustainableDevelopmentAgenda2030,whose

essential elements are the 17 Sustainable Development Goals (SDGs) (see Figure 2)

together with 169 sub-objectives, which aim to end poverty, combat inequality and

supportsocialandeconomicdevelopment.Inaddition,itincludesaspectsoffundamental

importanceforsustainabledevelopmentsuchastheoppositiontoclimatechangeandthe

sustainmentofpeacefulsocietiesbytheyear2030.After2yearsofpublicconsultations

aroundtheworld,the17SustainableDevelopmentGoalscameintoforceon1January

2016. The SDGs replaced theMillenniumDevelopment Goals (MDGs) bymerging the

27 UnitedNations(2015)-TheParisAgreement,link:https://unfccc.int/sites/default/files/english_paris_agreement.pdf#page=5 28 StephenPeake&PaulEkins(2016)-ExploringthefinancialandinvestmentimplicationsoftheParisAgreement,ClimatePolicy

14

agendasofdevelopmentandenvironment29andthedifferencebetweenSDGsandMDGs

is that the latter make no distinction between developed and developing countries,

coveringallstateswithoutdistinction.Inparticular,theobjectives,whichareinterlinked

and indivisible, balance the three dimensions of sustainable development: economic

growth,socialinclusionandenvironmentalprotection,byextendingAgenda2030from

the social dimension of the MDGs to the other two dimensions, economic and

environmental.

Figure2:TheSDGs.Source:UnitedNations

TheSDGsarebasedonthefive“P”s:People,Planet,Prosperity,PeaceandPartnership.In

this particular framework, the focus on finance is crucial. The financial dimension,

comprehensive and consistentwith the achievement of the SDGs,was outlined in the

AddisAbabaActionPlan.SignedinJuly2015bythe193membercountriesoftheUnited

Nationsat theThird InternationalConferenceonFinancing forDevelopment, theplan

identifiesmorethanahundredconcretemeasurestomeeteconomicchallenges,aswell

associalandenvironmentalissuesfacedbytheworld.Thepriorityofactionatnational

levelishighlightedwiththedevelopmentoffavorableandcoherentpolicies,favoringalso

29 MagdalenaBexell&KristinaJonsson(2017)-ResponsibilityandtheUnitedNations’SustainableDevelopmentGoals,ForumforDevelopmentStudies,44:1,13-29

15

the role of the private sector. About this last aspect, the document emphasizes the

importancetoaligntheprivateinvestmentstotheattainmentoftheSDGs.Countriesare

invitedtoputinplaceappropriatemeasurestocombatbothevasionandillicitfinancial

flows. As we will see in the next chapters, the health crisis caused by the COVID-19

pandemichasradicallychangedtheplanofaction.Inparticular,itiscrucialtoanalyzethe

Financing for Sustainable Development Report 2020, edited by the United Nations in

collaboration with 60 agencies of the Inter-Agency Task Force on Financing for

Development, which brings together ONU agencies and international partner

organizations.Thedocument,publishedon4April2020,preparedinthelightofthevery

serious economic, social and health crisis caused by the COVID-19 pandemic, calls

governments toactwithappropriatemeasures to respond to immediateneedsand to

preventaglobaldebtcrisiswithpotentiallydevastatingconsequences.

1.7MitigationandAdaptation

All actions aimed at reducing the amount of greenhouse gases in the atmosphere are

included in theconceptof "mitigation".Acting in thisdirection is crucial,because it is

precisely by emitting an excessive amount of these gases - whose atmospheric

concentration has no precedent in the last 800 thousand years - thatwe are causing

climatechange.Theonlyeffectivewayforreducingtheconcentrationofgreenhousegases

intheatmosphereistoemitless.Inotherwords,to"mitigate"thequantitiesproduced.It

is,however,asolutionthat isassimpleto identifyas it isdifficulttoput intopractice,

becausetheemissionofgreenhousegases,andinparticularCO2,isatthebasisofalmost

allhumanactivities.

Inordertoavoidthemostseriousconsequencesofclimatechange,thecountriesofthe

UnitedNationsFrameworkConventiononClimateChange(UNFCCC)agreedtolimitthe

increaseinoverallaveragesurfacetemperaturecomparedtothepre-industrialperiodto

below2°C.Inordertoachievethisobjective,globalgreenhousegasemissionsmustpeak

asquicklyaspossibleandthereforedecreaserapidly.By2050,globalemissionsmustbe

reducedby50%comparedto1990levels,andbytheendofthecentury,carbonneutrality

mustbeachieved.

Regardingthegreenhousegasemissionsbyeconomicsectors(seeFigure3),theprimary

sources of emissions are the process of burning fossil fuel for electricity and heat

16

generation (25%), followed by industry (21%), transportation (14%), other energy

(10%),buildings(6%).Finally,agriculture,forestry,andotherlandusescontributetothe

24%ofgreenhousegasemissions.

Figure3:Greenhousegasemissionsbyeconomicsectors.Source:Statista

Inthisparticularscenario,theenergysectorrepresentsafundamentalprocesstolimit

GHG(greenhousegases)emissions,followedbyagriculture,forestryandotherlanduse

(AFOLU)30.Asa civil society,wehave twooptions to follow inorder to “mitigate” the

greenhousegasemissionintheenergysector.Ononehand,energyconsumptioncanbe

reducedbyinvestinginenergyefficiency.Ontheotherhand,itiscrucialtoreplacefossil

fuels with "clean" energy sources, in particularwith renewable energy, such as solar

panelsorwind,whichproduceenergyusingthenaturalresourcesoftheEarth(suchas

sunlight, wind, but also the flow of rivers and the motion of waves). Focusing on

renewablesources,currentlyrelegatedtoasecondrole,meansproducingenergywithout

emittinggreenhousegases,andtherefore"mitigating"globalemissions.

30 Smithetal.,(2014)-Agriculture,ForestryandOtherLandUse(AFOLU).In:ClimateChange2014:MitigationofClimateChange.ContributionofWorkingGroupIIItotheFifthAssessmentReportoftheIntergovernmentalPanelonClimateChange,CambridgeUniversityPress,Cambridge,UnitedKingdomandNewYork,NY,USA.

17

Indeed,severalEuropeaninitiativesaimtoreducegreenhousegasemissions.Afterthe

achievementoftheKyotoProtocoltargetsfortheperiodfrom2008to2012,theEUhas

adopted legislation to foster the use of renewable energies, such as wind, solar,

hydroelectric and biomass, and to improve the energy efficiency of a wide range of

appliancesandequipment.TheEUalso intends tosupport thedevelopmentofcarbon

captureandstoragetechnologiestotrapandstoreCO2frompowerplantsandotherlarge

installations.

However,astheInternationalEnergyAgency(IEA)estimated,around“USD3.5trillion

yearlyinenergysectorinvestmentswouldbenecessarybetween2016and2050inorder

tomaintaintherisingoftemperaturebelow2°C”.31

Theotherconceptcloselyconnectedto“mitigation”istheneedto"adapt"toachanging

climate.Inpractice,thismeansminimizingtheimpactofclimatechangeonthewell-being

ofcitizens,thesupplyofresourcesandthestabilityofecosystems.“Adaptation”hasbeen

definedbytheIntergovernmentalPanelonClimateChange(IPCC)asthe“adjustmentsin

practices,processesorstructureswhichcanmoderateoroffsetthepotentialdamageortake

advantageforopportunitiescreatedbyagivenchangeinclimate”.32

Climate change affects many aspects of our society and, in order to manage its

consequences,itwillbeessentialtointegrateadaptationpoliciesineverysector.Atthe

basisofthisconcept,therearealltheconsequencesthatclimatechangehasonagriculture

andlivestock(drought,desertification)andonfishing(meltingglaciers,acidificationof

theoceans)whichareonlyapartoftheproblemsthatfuturegenerationswillhavetoface,

togetherwithotherfundamentalissuessuchaspoverty,lackoffoodsecurityandwater

scarcity.Inaddition,urbanandengineeringchallengeswillhavetobefacedinorderto

preventcitiessuchasVenice,NewYorkorCairofromsufferingtheeffectsofrisingsea

levels.

Inthisframework,theroleofinnovationiscrucial,becauseitallowsfindingmoreefficient

technologies forenergyconversion,or tousealternativesourcesofenergy,orevento

31 IEA(2019);Link:https://www.iea.org/reports/the-critical-role-of-buildings 32 IPCC(2018)-GlobalWarmingof1.5°C.AnIPCCSpecialReportontheimpactsofglobalwarmingof1.5°Cabovepre-industriallevelsandrelatedglobalgreenhousegasemissionpathways,inthecontextofstrengtheningtheglobalresponsetothethreatofclimatechange,sustainabledevelopment,andeffortstoeradicatepoverty

18

capture and store CO2. The following areas may cover these and other mitigation

activities33:

- Energy

- Transportation

- Buildings

- Industry

- Agriculture

- ForestryandOtherLandUse

Asitwillbeshowedinthenextchapters,therenewableenergysectorhasbecomecrucial

forthemitigationagainstclimatechangeandoneoftherolesofpublicfinanceistofoster

the investments in this growing sector. Indeed, for the purposes of this research, the

energysectorwillbethesectorthatwillbetakenasexampletomitigateclimatechange,

highlighting inparticulartheEuropean(orCommunity)policiesthat fostertheenergy

transitionfromfossil-basedenergytowardsrenewableenergy.

1.7.1EnergySector

Energysupplyisthemaincauseofglobalgreenhousegasemissionswith35%ofthetotal:

itsgrowthacceleratedfrom1.7%peryearfrom1990to2000to3.1%peryearfrom2000

to2010.34

ComplyingwiththeParisAgreementwouldmeanprogressivelyreducingtheuseoffossil

fuelstozerobytheendof2100,sincetheyareresponsibleforabout70%ofgreenhouse

gasemissionsand,combined,meetabout86%ofenergydemand.Moreover,asstatedby

IRENA (2019), “the energy production sector offers amultitude of options for reducing

emissions: improvingenergyefficiencyandusingsourcesthatreduceemissions fromfuel

33 Link:https://archive.ipcc.ch/pdf/reports-nonUN-translations/italian/ar4-wg3-spm.pdf 34 IPCC(2014)

19

extraction,energyconversion,transmissionanddistributionsystems,ornewlow-emission

energyproductiontechnologiessuchasrenewableandnuclear”.35

However,inthefirsthalfof2020apositivereportwaspublishedbyEmber,focusingon

theanalysisofEurope’selectricitytransaction.

Themainfindingofthisreport isthatrenewableelectricitygenerationexceededfossil

fuelgeneration,forthefirsttimeever.Inthefirsthalfof2020,renewables(wind,solar,

hydro and bioenergy) generated 40% of the EU-27’s electricity, whereas fossil fuels

generated34%.Inparticular(seeFigure4),renewablesroseby11%.Thisgrowthwas

due to new wind and solar installations and favorable conditions. Wind and solar

recordeda21%increase inEurope’s totalelectricitygeneration,andreachedahigher

production in Denmark (64%), Ireland (49%) and Germany (42%). Fossil fuels

consumptionfellby18%.Fossilfuelusagedecreasedfortworeasons:byrisingrenewable

energygenerationandfora7%fallinelectricitydemandduetoCOVID-19.Finally,coal

fellby32%.Withinthisframework,hardcoalgenerationdecreasedby34%andlignite

fellby29%.Gasgenerationalsoreducedby6%,inelevencountries.Asaresult,EU-27

powersectorCO2emissionsfellbyabout23%.36

Figure4:Renewablesbeatfossilfuels.Source:Ember

35 IRENA(2019)-Link:https://www.irena.org/DigitalArticles/2019/Apr/How-To-Transform-Energy-System-And-Reduce-Carbon-Emissions 36 DaveJonesandCharlesMoore(2020)-Renewablesbeatfossilfuels-Ahalf-yearlyanalysisofEurope’selectricitytransition

20

1.7.1.1GSEIncentive

The energy transaction towards a renewable and sustainable future passes through

market-based instrumentssuchassubsidiesoremissiontaxes,controlovertheuseof

specificfuels,theperformancetobesupportedorthemaximumemissionsgranted.

One of the examples of the energy transition to renewable energy in Italy is the

mechanism of incentives managed by the company GSE S.p.a. (Gestore dei Servizi

Energetici).

ThecompanyisanItalianlimitedcompany,whollycontrolledbytheMinistryofEconomy

andFinance thatcarriesout its tasks inaccordancewith thestrategicandoperational

guidelinesdefinedbytheMinistryofEconomicDevelopment.37

TheGSEplaysacentralroleinthepromotionanddevelopmentofrenewablesourcesin

Italy. The main activity is the promotion, also through the provision of economic

incentives,ofelectricityproducedfromrenewablesources.

In particular, it acquires and redistributes energy from renewable sources into the

market.Itprovidesincentivesforproduction,itverifiesthatthesameproductiontakes

placeaccording to regulationsandprovides theGreenCertificates.TheGSEalsodeals

withthemonitoringofrenewableenergywiththegoalofachievingthetargetsset for

2020. It is responsible for providing data and technical advice to institutions, public

administrationsandoperatorsinthesectorinordertoencouragethedisseminationof

sustainableenergysources.38

In2018,morethan1GWofadditionalrenewableenergypowerwasinstalledinItaly.450

MWarerepresentedbysolarphotovoltaics.

Moreover,Enarray(2019)suggeststhat“thankstoover113TWhofenergyproducedfrom

renewable sources, Italy has exceeded, in 2018 and for the fifth consecutive year, the

thresholdof17%ofconsumptionsatisfiedbyrenewables”.39

37 Link:https://www.gse.it/en/company 38 Link:https://www.gse.it/en/company 39 Enerray(2019)-2018RenewableenergystatisticsinItaly,Link:https://www.enerray.com/blog/renewable-energy-statistics-italy-2018/

21

Figure5:EvolutionofphotovoltaicplantsinItaly.Source:Enerray

The Italian promotion and feed-in tariff system for renewable energy sources is

characterizedbyamultiplicityofmechanismsthathavefollowedovertheyearsinalogic

ofprogressivemarketorientationandreductionof the incentive level in linewith the

decrease of generation costs40 (see Figure 5). The FiT program Conto Energia41,

operating in Italy since the end of 2005, guaranteed a significant growth in the

photovoltaicsectorduringitsoperations,especiallybetween2011and2012.

1.8.ClimateChangeandCOVID-19

OnMarch11,2020, theWorldHealthOrganizationdeclared theCOVID-19outbreaka

pandemic.AsdefinedbytheU.S.DepartmentofHealthandHumanServices(2020),“data

from China have indicated that older adults, particularly those with serious underlying

40 Enerray(2019)-2018RenewableenergystatisticsinItaly,Link:https://www.enerray.com/blog/renewable-energy-statistics-italy-2018/ 41 Link:https://www.gse.it/servizi-per-te/fotovoltaico/conto-energia

22

healthconditions,areathigherriskforsevereCOVID-19–associatedillnessanddeaththan

areyoungerpeople”.42

COVID-19 pandemic has radically changed people’s lives around the world. The

consequencesoflockdownsinvariouscountrieshaveshown,probablyasneverbefore,

that human society is vulnerable. A constantly changing situation that has forced all

sectorslinkedtohumanactivitytorethinkproduction,socialandeconomicprocesses.

Climatechangehasalsobeenaffectedby theCOVID-19pandemicand theSustainable

DevelopmentGoalsReport2020wellframesthecurrentandfutureconsequencesofthe

pandemic.

Ingeneral,theannualSustainableDevelopmentGoalsReportprovidesanoverviewofthe

world’simplementationeffortstodate,highlightingareasofprogressandareaswhere

moreactionneedstobetakentoensurenooneisleftbehind.Asdescribedbythereport,

“the COVID-19 pandemic has unleashed an unprecedented crisis, causing further

disruptiontotheprogressofSDGs,withtheworld’spoorestandmostvulnerableaffected

themost”43 (United Nations, 2020). Using the latest data and estimates, this annual

stocktakingreportonprogressacrossthe17Goalsshowsthatitisthepoorestandmost

vulnerable– including children,olderpersons,personswithdisabilities,migrants and

refugees–whoarebeinghitthehardestbytheeffectsoftheCOVID-19pandemic.Women

arealsobearingtheheaviestbruntofthepandemic’seffects.

Fromanenvironmentalpointofview,lockdownrestrictionshavehadpositiveeffectson

GHGemissions.However,theseeffectsarecalculatedintheshorttermanditis

necessarytoanalyzetheeffectsinthemedium-longterm.AccordingtoForsteretal.

(2020),“theclimateeffectoftheimmediateCOVID-19relatedrestrictionsiscloseto

negligibleandlastingeffects,ifany,willonlyarisefromtherecoverystrategyadoptedin

themediumterm”.Intheiranalysis,theystudiedtheeffectofdifferentscenarios,

includingafossil-fuelledrecoveryandtwodifferentscenariosofgreenstimulus(see

Figure6).

42 U.S.DepartmentofHealthandHumanServices-CentersforDiseaseControlandPrevention(2020)-SevereOutcomesAmongPatientswithCoronavirusDisease2019(COVID-19)—UnitedStates,February12–March16,202043 UnitedNations(2020)-TheSustainableDevelopmentGoalsReport2020

23

Figure6:Probabilitydistributionsofpassing2050globalwarminglevels.Source:NatureClimateChange

Theyfoundthatboththetwo-yearblippathway,wheretheeconomicrecovery

maintainscurrentinvestmentlevels,andthefossil-fuelledrecoverypathwaysarelikely

toexceed1.5°Cabovepre-industriallimitby2050.Conversely,“choosingawaywith

stronggreenstimulusassumptions,includingclimatepolicymeasures,hasagood

chanceofkeepingglobaltemperaturechangeabovepre-industrialwithinthe1.5°Climit,

savingaround0.3°Coffuturewarmingby2050”.44

However, the conclusion is that the global temperature signal due to the short-term

dynamicsofthepandemicislikelytobeminor.Pursuingagreenstimulusrecoveryoutof

thepost-COVID-19economiccrisiscansettheworldontrackforkeepingthelong-term

temperaturegoaloftheParisAgreementwithinsight.

What is clear is that futurepolicieshave twopaths to choose: a short-termapproach,

which does not consider the consequences of future climate complications andwhich

aims at an immediate economic recovery, or a long-term approach, towards green

investments.Themost important thing to realize is thata short-termapproach to the

COVID-19 response that does not consider the climate issues ismore costly and less

effectivethantacklingthese issuestogether. Indeed,wecanchoosebetweenfinancing

nowacarbonintensiveeconomicrecoveryandlateralow-carbontransitionortofinance

rightawayagreeneconomicrecovery.45

44 Forster,P.M.,Forster,H.I.,Evans,M.J.etal.(2020)-CurrentandfutureglobalclimateimpactsresultingfromCOVID-19.Nat.Clim.Chang.(2020).https://doi.org/10.1038/s41558-020-0883-0 45 BillioMonica&VarottoSimone(2020)-ANewWorldPostCOVID-19.LessonsforBusiness,theFinanceIndustryandPolicyMakers,1.ed.,Venezia:EdizioniCa’Foscari-DigitalPublishing,2020.—374pp.;23cm.—(InnovationinBusiness,Economics&Finance;1)

24

AccordingtoBattiston,BillioandMonasterolo(2020), “reinforcingthesocio-economic

resilienceagainstfuturepandemicscallsforrecoverymeasuresthatarefullyalignedto

theobjectivesoftheEUGreenDeal”,asitwillbeshowedinthenextchapters.Tackling

theseobjectivestogetherismorecosteffectivethanaddressingtheCOVID-19crisiswith

short-termmeasures.Remarkably,becauseoftheinter-connectednessbetweenclimate

risk,pandemicriskandfinancialrisk(Monasterolo,Billio,Battiston,2020),thismaybe

actuallytheonlyfeasiblewaytobuildresiliencetofuturecrises.Theeconomicresponse

toCOVIDshouldrathertakeplacewithinaframeworkofhardconstraintsongreenhouse

gasemissions.Suitablepoliciesexist,butplausibly require to implement international

cooperation.46

46 BardsleyN.(2020),AvoidingaGreatDepressionintheEraofClimateChange

25

2.CHAPTER:CLIMATEFINANCE

Climate change is not just an environmental issue. It is an issue of global economic

importancethatconcernstheprospectsforgrowth,theexitfrompovertyindeveloping

countries, a careful use of resources to avoid penalizing future generations. In this

complexframework,theworldoffinanceplaysadecisiverole.

Climate finance is defined by the United Nations Framework Convention on Climate

Change(UNFCCC)tobe“local,national,ortransnationalfinancing—drawnfrompublic,

private, and alternative sources of financing — that seeks to support mitigation and

adaptation actions that will address climate change.” It is about investments that

governments,corporations,andhouseholdshave“toundertaketotransitiontheworld’s

economytoalow-carbonpath,toreducegreenhousegasconcentrationslevels,andtobuild

resilienceofcountries toclimatechange”.47Formitigation,climate finance isneeded in

ordertofosterlarge-scaleinvestmentsandtoreduceemissions.Itisequallyfundamental

foradaptationbecausenewfinancialresourcesareneededtoreducetheeffectsofclimate

change.

Alongwiththegoalsof“pursuingeffortstolimitthetemperatureincreaseto1.5°Cabove

pre-industriallevels”and“increasingtheabilitytoadapttotheadverseimpactsofclimate

change,”Article2oftheParisAgreementrecognizedthat“financeflows”areessentialto

achievethese longstandinggoalsof“lowgreenhousegasemissionsandclimate-resilient

development”48(COP21,2015).Moreover,theUNFCCC’sStandingCommitteeonFinance

(SCF) takes a comprehensive view of climate finance, defining it as finance aimed at

“reducingemissions,andenhancingsinksofgreenhousegasesandatreducingvulnerability

of, and maintaining and increasing the resilience of, human and ecological systems to

negativeclimatechangeimpacts”49.Morespecifically,climatefinancetypicallyconsistsof

grants,loans,equityintheformofpurchasedshares,anddebtrelief.IntheSCF’sBiennial

47 HongH.,KarolyiG.A.,ScheinkmanJ.A.(2020)-ClimateFinance,ReviewofFinancialStudies48 WhitleyS,ThwaitesJ,WrightH,OttC(2018)-MakingFinanceConsistentwithClimateGoals:InsightsforOperationalisingArticle2.1coftheUNFCCCParisAgreement.OverseasDevelopmentInstitute,London49 SCF(2014)-UNFCCCStandingCommitteeonFinance:2014BiennialAssessmentandOverviewofClimateFinanceFlowsReport.UNFCCCBonn.

26

AssessmentandOverviewofClimateFinanceFlows,isstatedthat“totalglobalfundingin

2016wascalculatedtobeUSD681billion,asahigh-boundestimate,anincreaseof17%

overtheprevioustwoyears,withmostofthegrowthoccurringinnewprivateinvestments

inrenewableenergyprojects”50.

However, literature on climate investment and finance is very poor, quantitative

informationislimitedandincomplete,asistheaccountingsystem.Thecrucialproblemis

that capital monitoring and verification systems invested in green projects at an

internationallevelhavenotbeensharedandimplementedyet.Thus,theavailabledata

areoftenobtainedusingdifferentmethodologiesdependingontheprojects.Forexample,

data referred to mitigation and adaptation costs changing with the policy and

technologicaldevelopmentconsideredintheanalysis.

2.1Low-CarbonEconomyTransition

Thetransitiontoa low-carboneconomywillrequire further investment inthecoming

decades and will require that the efforts, especially financial, of the recent years are

definitelystrengthened.Wearestillatthebeginningofthetransitionfromahigh-carbon

economytoalow-carboneconomy.Transformingourenergysystemwilltaketimeanda

significantamountofcapitalanditwillalsorequireclosecoordinationamongthreekey

elements:policy,technologyandcapital.

According to the International Energy Agency (IAE, 2010), “$10.5 trillion in global

incrementalinvestmentsinlow-carbonenergytechnologiesandenergyefficiencyby2030

will be necessary”. This estimate is across all sectors, including power, transport,

residentialandcommercialbuildingequipment,andindustrialsectors,inordertolimit

global temperature increases to 2 C°, the threshold that the United Nations

Intergovernmental Panel on Climate Change has identified as necessary for “avoiding

catastrophicclimatechange.”51

Moreover, the energy transition is affected by the problem of world overpopulation,

whichgrewfrom3billionpeopleatthebeginningofthe20thcenturyto7billionpeople

at thebeginningof the21stcentury.Theshockcausedby thescarcityof fossilenergy

50 SCF.(2018)-SummaryandRecommendationsbytheStandingCommitteeonFinanceonthe2018BiennialAssessmentandOverviewofClimateFinanceFlows.UNFCCCBonn.51 GoldmanSachs(2010)-OpportunitiesandChallengesoftheEmergingCleanEnergyIndustry

27

sources, in the absence of alternative energy sources, will drastically reduce world

agriculturalproductionresultinginfoodshockfortheworldpopulation.

Tounderstandtheclimatefinanceflowsoverthepastyearsandamountofinvestments

neededtoreachtheParisAgreementtargets,threedifferentanalysiswillbeshowed:IEA,

IRENAandClimatePolicyInitiativeanalysis.

According to IEA, clean-energy investments, in particular solar andwindpower, have

beengrowingrapidlyinrecentyears52.Forexample,in2015,investmentsinrenewable

energyamountedtomorethan300billionperyear.However,consideringfossilenergy

investments,theystilldominatetheenergyindustry.

ToachievetheambitioustargetsoftheParisAgreement,animportanteffortintermsof

investmentinrenewablesandenergyefficiency,combinedwithrapiddisinvestmentsof

fossilfuels,willbenecessary.Theimpactoffutureenergyandclimatepoliciesontotal

energy investments depends on the nature of the policies (see Figure 7). The NDC

scenariowould likely only necessitate amarginal increase in total future investments

globally. In contrast, according to most models, “more aggressive policies promoting

decarbonizationthroughaglobalenergysystemtransformation(‘2C’and‘1.5C’scenarios)

willrequireamarkedincrease”.53

52 OECD/IEA(2016)-WorldEnergyInvestment2016.(OrganisationforEconomicCo-operationandDevelopment(OECD),InternationalEnergyAgency(IEA),201653 McCollum,D.L.etal(2018)-EnergyinvestmentneedsforfulfillingtheParisAgreementandachievingtheSustainableDevelopmentGoals.NatureEnergy3,589-599,doi:10.1038/s41560-018-0179-z(2018)

28

Figure7:Globalaverageannualinvestmentsindifferentclimatepolicies(left).incrementalinvestments

anddisinvestmentsbycategoryrelativetothebaseline(right).Source:IEA

Inordertoachievethe1,5°Ctarget,renewableenergyinvestments,onaverage,haveto

increaseupto550billioneveryyear.Incontrast,fossilenergydisinvestmentwouldneed

to be greater. Finally, to reach the Paris Agreement targets, low-carbon investments

wouldneedtoaccountformorethan50%ofallenergysupplyinvestmentsbyaround

2025andthenriseto80%orabovebyaround2035inthe1.5°Cscenarioor2050inthe

2°Cscenario.54

Moreover,IRENA(InternationalRenewableEnergyAgency)sustainsthatinordertomeet

thelow-carbonenergytransitiontheinvestmentsinrenewableenergyneedtobescaled

upsignificantly.Initslatestanalysis,“Globalenergytransformation:Aroadmapto2050”,

IRENAestimatesthat“toputtheworldontrackwiththeobjectivesoftheParisAgreement,

cumulative investment in renewable energy needs to reach 27 trillion in the 2016-2050

period”(seeFigure8).55

54 IIASA(2018)-WhatinvestmentsareneededintheglobalenergysysteminordertosatisfytheNDCsand2and1.5°Cgoals?55 IRENA(2019)-Globalenergytransformation:Aroadmapto2050(2019edition),InternationalRenewableEnergyAgency,AbuDhabi.

29

Figure8:Investmentsneed.Source:IRENA

Inparticular,inthepowersector,thelow-carbonenergytransitionwouldneed

investmentof22.5trillioninnewrenewableinstalledcapacity.Thiswouldmeanatleast

doubleannualinvestmentscomparedtothelevelsof2018,fromalmost310billionto

over660billion(seeFigure9).

Figure9:Source:IRENA

Finally,the2019editionofClimatePolicyInitiative’sGlobalLandscapeofClimateFinance

provides one of the most comprehensive overview of global climate-related primary

investment.

Climate Finance flows increased of 25%during the period 2017/18.Moreover, green

flows for climate reached a high record of 612 billion in 2017, driven particularly by

30

renewableenergycapacityadditions inChina, theU.S., and India, aswell as increased

publiccommitmentstolanduseandenergyefficiencyandthiswasfollowedbyan11%

dropin2018to546billion(seeFigure10).56

Figure10:Globalclimatefinanceflows2013-2018.Source:CPIReport

However,asdescribedbythereport,climatefinancehasreachedrecordlevelsbutnot

enoughwithrespecttowhatisneededundera1.5Cscenario.Estimatesoftheinvestment

required to achieve the low-carbon transition range from 1.6 trillion to 3.8 trillion

annually between 2016 and 205057, while the Global Commission on Adaptation58

estimatescostsof180billionannuallyfrom2020to2030.

2.2ClimateFinanceActors

AfterdescribingtheinvestmentsnecessaryfortheLow-CarbonEconomyTransition,itis

importanttounderstandwhotheactorsofclimatefinanceareandwhatroletheyhavein

theglobalcontext.

Twocategoriesofactorsarerecognizedatinternationallevel:publicactorsandprivate

actors. The first category comprises governments and their agencies, the so-called

“Development Finance Institutions” (DFIs) (national, multilateral and bilateral) and

56 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London.57 IPCC(2018)-GlobalWarmingof1.5°C.AnIPCCSpecialReportontheimpactsofglobalwarmingof1.5°Cabovepre-industriallevelsandrelatedglobalgreenhousegasemissionpathways,inthecontextofstrengtheningtheglobalresponsetothethreatofclimatechange,sustainabledevelopment,andeffortstoeradicatepoverty58 GCA(2019)

31

climate funds. The second category is private actors: project developers, commercial

banks,financialorganizationsandintermediaries,multinationalcorporations,smalland

medium-sizedenterprises,cooperatives,entrepreneursandhouseholds,privateequiters

and venture capitalists and private institutional investors (pension funds, insurance

companies,foundations,etc.).

AsdescribedbyCPI(ClimatePolicyInitiative)inits“GlobalLandscapeofClimate

Finance2019”,“averageannualpublicclimatefinanceinvestmentstotaled253billionin

2017/2018,44%oftotalcommitments,whileprivatefinance,whichreached326billion

annuallyonaveragein2017/2018,continuestoaccountforthemajorityofclimate

finance,ataround56%”(seeFigure11)59.

Figure11:Globalclimatefinanceflowsbypublicandprivateactors2013-2018.Source:CPIReport

Asshowedbypreviousfigure,theglobalclimatefinanceflows,givenbythesumofprivate

actorsandpublicactors,aregrowinginthelast5yearswithanincreaseof37%from365

billionin2013to579billionin2018.Accordingtothisframework,itwillbenecessaryto

strengthenthecollaborationbetweengovernments,regulators,developmentbanksand

59 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London.

32

private investors in order to match all financing with climate and sustainable

developmentgoals(SDGs).

2.2.1PublicFinanceActors

As described before, the definition of public finance actors includes governments and

theiragencies,theDevelopmentFinanceInstitutions(national,multilateralandbilateral)

andclimatefunds.

Investmentsbypublicactorsincreasedof18%,from215billionannuallyin2015to253

billionin2018.

DFIsprovide themajorityofpublic finance investments, contributingwith213billion

annually, compared to 194 billion in 2015/2016. Bilateral andmultilateral DFIs have

continuedincreasinginvestments(seeFigure12)by47%and24%,respectively.Finally,

Government Budgets and Agencies doubled the financing up to 42 billion in 2018,

contributingfor15%ofpublicflows.ClimatefundsincreasedannualfinancingtoUSD3.2

billionin2017/2018,43%morewithrespectto2015/2016.60

Figure12:PublicSourcesandIntermediariesofClimateFinance(USDbillion).Source:CPI

Inthisframework,publicactorscanoperateintwodifferentways:throughpublicfinance

methodsorpublicpolicy.Thefirstwayisadirectfinancingfrompublicinterventions,by

governmentsorfirmsownedbythestate.Examplesofpublicfinancearegrants, loans

andbonds,debtbonds,equityinvestments.

60 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London.

33

Incontrast,publicpolicymethodsofferdifferentsourcestofinanceclimateprojects.In

thisway,apublicactorshouldcreateincentivesthatareattractivetoprivateinvestors.

Examplesofpublicpolicyareregulatoryandfiscalpolicies,suchastheEuropeanGreen

DealandtheFinancingSustainableGrowthissuedbytheEuropeanCommission.

2.2.1.1FinancingSustainableGrowthandTheGreenDeal

TheEUvisionontheroleof finance insustainabledevelopment isrepresentedby the

implementationofthe“ActionPlan”andthe“EuropeanGreenDeal”.

On8March2018, theEuropeanCommission issued theFinancingSustainableGrowth

(ActionPlan) inorder to finance sustainable growth. Inparticular, thepurposeof the

“ActionPlan”istoimplementafinancialsysteminordertosupporttheEuropeanUnion’s

activities on climate and sustainable development. The Plan represented a key step

towards the implementation of the Paris Agreement and the UN Agenda 2030 for

SustainableDevelopmentandcontributestothesustainabledevelopmentobjectivesset

outintheCommissionCommunication"Europe’ssustainablefuture:nextsteps.European

actioninfavourofsustainability".

ThePlanaimstomeetthreechallenges:

- orientinginvestmentflowstowardssustainabilitytoachievegreengrowth;

- integratingsustainabilityintoriskmanagement;

- fosteringtransparencyandlong-termvisionineconomicandfinancialactivities.

Thesethreeobjectivesarefollowedbytenspecificactionsthatshouldfacilitatetoachieve

them:

1) establishinganEUclassificationsystemforsustainableactivities,

2) creatingstandardsandlabelsforgreenfinancialproducts,

3) fosteringinvestmentinsustainableproducts,

4) incorporatingsustainabilitywhenprovidingfinancialadvice,

34

5) developingsustainabilitybenchmark,

6) anewsystemofratingsbasedonsustainabilityfactors,

7) clarifyingdutiesofinstitutionalinvestorsandassetmanagers,

8) incorporatingsustainabilityinprudentialrequirements,

9) strengtheningsustainabilitydisclosureandaccountingrule-making,

10) fostering sustainable corporate governance and attenuating short-termism in

capitalmarkets.

Inparticular,forthepurposeofthisresearch,thecreationofEUGreenBondsstandards

andlabelsforgreenfinancialproductsiscrucial.Basedonthefinalreportandusability

guideoftheTechnicalExpertGroup(TEG),theCommissionisexploringthedevelopment

ofavoluntaryEUGreenBondStandard.Moreover,theCommissionisworkingonanEU

Ecolabel for retail investment products. The extension of the Ecolabel framework to

financialproducts,bywayofaCommissionDecision,isexpectedforQ32021.61

ThepolicyareasoftheActionPlanare:

- Environment:first,withregardtothemitigationofclimatechange,aswellasthe

wider environment and the risks associated with it. Climate change and the

response to it by the public sector and society in general have led to the

identificationofnewsourcesoffinancialriskthattheregulatoryandsupervisory

communityispayingmoreattentionto;

- Social and governance: where the hottest issues are equity, inclusiveness,

working conditions and relationships, investment in human capital and

community.

61 EuropeanCommission(2020)-Renewedsustainablefinancestrategyandimplementationoftheactionplanonfinancingsustainablegrowth

35

In 2019, the European Commission President Ursula von der Leyen has promised to

strengthenEUclimatepolicy62.SheproposedaEuropeanClimateLawthat“wouldrequire

theEUtobecomeclimateneutralby2050,makingEuropethefirstcontinenttoreachthis

goal.Thestepstogettotheclimateneutralityrequireacomprehensivepolicy,comprising

climate, energy, environmental, industrial, economic and social aspects of this

unprecedentedprocess.ThisiswhattheEuropeanGreenDealisabout.”63

Concretely, the European Green Deal represents a “strategy”, a series ofmeasures of

differentnature,includingnewlawsandinvestmentsthatwillbeimplementedinthenext

thirtyyears.At themoment, theCommissionhasmadepreciseplans for the first two

years,themostimportantonebeingthesetupofastructurecapableofsupportingsuch

anambitiousproject.TheGreenDealwillbefundedwithalargeamountofpublicand

privatemoney.Inthefirsttenyears,theobjectivewillbetomobilizeabout1000billion

tofinanceit,moreorless100billionperyear.

Themainobjectiveistolimittheincreaseinglobalwarming,whichhastoremainwithin

1.5°Ccomparedtothepre-industrialyears,accordingtotheestimatesoftheIPCC.To

meetthistarget,theEuropeanUnionhascommitteditselftoputtozeroitsnetpollutant

emissionsby2050,andtomeetintermediatetargetsfor2030and2040.Fromthismain

objective,aseriesofconsequentmorespecificmovesshouldderive(seeFigure13).

62 vonderLeyen,Ursula(2019)-AUnionthatstrivesformore:MyagendaforEurope,PoliticalGuidelinesfortheNextEuropeanCommission2019-2024 63 GrégoryClaeys,SimoneTagliapietraandGeorgZachmann(2019)-HowtomaketheEuropeanGreenDealwork

36

Figure13:TheEuropeanGreenDealgoals.Source:EuropeanUnion

Themostimportantobjectivewillbetomaketheproductionofelectricitycleaner,which

iscurrentlyresponsiblefor75%ofgreenhousegasemissionsthroughouttheEuropean

Union. It means increasing the spread of renewable energies and at the same time

stopping encouraging the use of fossil fuels. It will be a problem especially for the

countriesofEasternEurope,wherethespreadofrenewableenergiesisstilllimited.Asan

example,Polandstillgets80%ofitselectricityfromcoal.Forthisreason,itistheonly

countrythathasnotyetofficiallyagreedtozeroitsnetemissionsby2050.

Anotherimportantobjectivewillbetomakemoresustainableaseriesofhumanactivities

thatcurrentlyconsumealargeamountofenergy.Thiswillimplyintroducingnewrules

forbuildingorrenovatinghomesandindustriesinEurope,makingproductionprocesses

less polluting, and enhancing public and rail transport, promoting biodiversity

(protecting forests and animal species from extinction),making the circular economy

more widespread, and reserving a fixed share of European funds for sustainable

initiatives.

Aswewilldescribeinthenextchapters,theCOVID-19outbreakhadacrucialimpactin

climatefinancefactors.Inparticular,inacontextofrecoveryfromthepandemicimpact,

the European Commission announced a new sustainable finance strategy, in order to

sustain the business transition towards sustainability. In order to foster private

investmentsandpublicsectorinitiatives,therenewedstrategywillmatchtheobjectives

of the European Green Deal investment plan. Itwill build on previous initiatives and

37

reports,suchastheactionplanonfinancingsustainablegrowthandthereportsofthe

TechnicalExpertGrouponSustainableFinance(TEG).64

2.2.2PrivateFinanceActors

Thedefinitionofprivateactorscompriseshouseholds,non-financialcorporations,banks

(financial institutions), institutional investors (asset managers, insurance companies)

andprivateequity,venturecapitalandinfrastructurefunds.

Privatefinanceinvestmentsincreasedby31%from2015to2018,providingonaverage

(during2017-2018)326billionperyear.

Assourcesofprivatefinance,corporationsaccountfor183billionperyearonaverage,

the 56% of private investments (2018) (see Figure 14). Moreover, the investments

providedbyprivatefirmsdecreasedinthelastfive/sixyears.Infact,CPI(2019)stated

that “the decline in the share provided by corporations is due to commercial financial

institutions and households engaging inmore climate-related finance and consumption,

respectively,thaninpreviousyears”.65

Figure14:Privatesourcesandintermediaries.Source:CPIReport

Commercialfinancialinstitutionsincreasedannualinvestmentsinclimatefinanceby25

billionperyearcomparedto2015and69billionin2018.66

64 EuropeanCommission(2020)-Renewedsustainablefinancestrategyandimplementationoftheactionplanonfinancingsustainablegrowth 65 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London. 66 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London.

38

Thegrowthofinvestmentsbybanksreflectsthetransitiontosustainabilityinfinancial

markets,inparticularforrenewableenergies,whichrepresent93%ofbankinvestments

in climate finance during 2017-2018. Although investments in renewable energy are

growing,themajorityofbankinvestmentsarerepresentedbyloans(650billion)tofossil

fuelcompanies67.

Althoughtheygobeyondthescopeofdirectprojectfinance,thesefiguresindicatethat

commerciallendersstillhavetoimplementamajorshiftininvestmentstrategytoalign

theirfinancingactivitieswithdecarbonizationpathwaysundertheParisAgreement.68

Finally,aswecanseeinthelastgraph,privateequity,venturecapitalandinfrastructure

fundsdoubledtheirinvestmentsinthelast5years,from2billionof2013to6billionof

2018.Alsointhissector,75%oftheinvestmentsareaddressedtorenewableenergies.

Thisrapidincreaseshowsthegrowthofrenewableenergymarketsandalowerperceived

risksamonginternationalinvestors.

2.2.3TheimportanceofPublicandPrivaterelationship

Aspreviouslyshowed,themajorityofinvestmentsintheclimatefinancesectoraremade

byprivateactors.Asaconsequence,theprivatesectorplaysacentralroleinfinancing

mitigationandadaptationactionsinmostcountries.

Theprivatesector,however,tendstoinvest incountrieswithawell-developedcapital

market,whereregulationisclearandwheretherearelowtransactioncostsandstable

prices,i.e.countrieswithlowcountryandcurrencyrisks.Suchrisksarefrequentlyhigh

in developing countries, where there is a high need for investment, especially in

adaptationactions.Public interventionbynationaland internationalgovernmentsand

bankstoencourageprivateinvestmentisthereforecrucial.

Appropriate policies and common actions between public and private sectors allow

mobilizingfinancialresourcesandhumancapitalandtocreateanenvironmentsuitable

for attracting private investment through a clear and stable regulatory framework.

Finally,risk-sharingthroughpublic-privaterelationshipsisveryimportant,especiallyin

67 RAN,Banktracketal.(2019)-BankingonClimateChange–fossilfuelfinancereportcard2019relationsandglobalclimatechange68 CPI(2019)-GlobalLandscapeofClimateFinance2019[BarbaraBuchner,AlexClark,AngelaFalconer,RobMacquarie,ChaviMeattle,RowenaTolentino,CooperWetherbee].ClimatePolicyInitiative,London.

39

thecaseofgreeninvestments,whichoftenrequiresubstantialinitialfundingandsuffer

fromamoreuncertainandlongerreturnoninvestment.

The public sector therefore plays an important role in this context in stimulating

investmentingreenprojects.Europeangovernmentsareexperimentingdifferentways

toattractinstitutionalinvestors,includingpensionfunds,whichhavehugeresourcesand

alowerlevelofriskthanthemarket.Inthiscontextitisoffundamentalimportancefor

climatefinancetheconceptandthedevelopmentofBlendedFinance.

2.2.3.1BlendedFinance

OECD describes Blended Finance as “strategic use of development finance for the

mobilization of additional finance towards sustainable development in developing

countries”69.Itoffersapotentialsolutiontoclosethedevelopmentfundinggapbetween

development and developing countries. As defined by OECD in the World Economic

Forum,BlendedFinanceiscomposedbythreecharacteristics:

- leverage,i.e.usingfinancedevelopmentfundstoattractprivatecapital,

- impact,i.e.investmentsthatdrivesocial,environmentalandeconomicprogress,

- returns,i.e.asdescribedbyWorldEconomicForum(2015)“financialreturnsfor

private investors in line with market expectations, based on real and perceived

risks”.70

Inthelastyears,ithasbecomeverycommontoconfusetheconceptofBlendedFinance

withthe“PublicPrivatePartnerships”one,whichareasubsetofBlendedFinanceand

representaformofcooperationbetweenpublicauthoritiesandprivateindividuals,with

theaimoffinancing,buildingandmanaginginfrastructureorprovidingservicesofpublic

interest.Thisformofcooperationwithprivateentitiesallowspublicadministrationsto

attractmoreinvestmentresourcesandexpertisenotavailablewithinit.

69 OECD(2020) 70 WorldEconomicForum(2015)-BlendedFinanceVol.1:APrimerforDevelopmentFinanceandPhilanthropicFunders

40

As stated by OECD, Blended Finance is a tool with the purpose ofmobilizing private

investmentsindevelopingcountries.Geographically,thereisaconcentrationof35%of

the initiatives in the sub-Saharan Africa and 19% in Asia. 31% of the initiatives is

addressedtomultipleunspecifiedregions.Instead,LatinAmerica,EasternEurope,Middle

EastandNorthAfricahavefewerinvestmentsandinitiativeswithrespecttotheSouth

AfricaandAsia.

AsdescribedbyClimatePolicyInitiative(2018),typicallyacleanenergyprojectlifecycle

is composed by three stages: the development stage, the construction stage, and the

operationalstage,withdecreasingriskastheprojectmovestowardsoperation.Because

ofthechangingriskandreturnprofilesthroughoutthecleanenergylifecycle,different

types of equity and debt investors are often active in different stages of the project

through vehicles thatmatch their risk appetite. In this framework, the role of risk is

fundamentalbothforinvestorsandprojectitself.Theserisksandbarrierstoinvestors

are summarized in four macro categories: political, technical risks, commercial and

market risks, and other investor barriers that are notmanageable or apparent at the

projectlevel.71

In particular, as described by the Climate Policy Initiative (2018) in “A report for the

Business&SustainableDevelopmentCommissionandtheBlendedFinanceTaskforce”,these

fourmacrocategoriesofriskaredividedasfollows:

- PoliticalRisks,whichcomprisepoliticalandsocialrisks,administrativerisksand

regulatoryrisksaschangesofsupporttotariffsorlevelofsubsidization;

- Technical Risks, which regard construction risks and operation risks like

uncertainty over the timing of construction and risks related to the technical

operationsintheplant;

- MarketRisks,includingaccesstocapital,financialandoperationcostsincreases,

currency risks and credit risks. In particular, all related risks for the project

developertoaccesscapitalandcostofcapitalforfinancing;

- OtherInvestorRisks,whicharenotmanageableatprojectlevelandrefertothe

investmenthorizonandthescaleofinvestment(sizeofinvestment).

71 CPI(2018)-BlendedFinanceinCleanEnergy:ExperiencesandOpportunities

41

In somestudies, itwas found that inmany initiatives, themost commonrisksare the

access to capital and the information gaps, also known as information asymmetries,

between the lenders and their counterparts, such as the investors’ lack of market

knowledge(seeFigure15).

Figure15:ProportionofrisksandbarriersinBlendedFinance.Source:CPI

InBlendedFinance,theriskperceivedbytheactorsisalsoafundamentalcomponentand

it could influence the choices regarding investments. For this reason, institutional

investorsareunder-represented.

Therefore,privateinvestors,VentureCapitalandPrivateEquityinvestorsrepresentthe

26%oftheinitiativeinvestments,duetothehighrisktolerance.Banks,Corporationsand

Hedge funds are involved in the 20% of the initiatives. Insurance and pension funds

participateonlytothe8%oftheinitiatives,duetothelowrisktolerance.

Finally,theBlendedFinanceinstruments(seeFigure16)compriseinvestmentsdirectly

totheprojectsthroughdifferenttypesofequityanddebt,indirectinvestmentsthrough

insurance,hedging,swapandderivativeinstruments.72

CPI,describing thedifferent sourcesof investments in the report, excludemanyother

instrumentsthatarefundamentalintheBlendedFinancefieldandCleanEnergysector,

such as the PPAs (Power Purchase Agreements, typical contractualmechanisms) and

subsidies,suchastariffsandtaxcredit.

72 CPI(2018)-BlendedFinanceinCleanEnergy:ExperiencesandOpportunities

42

Figure16:BlendedFinanceinstruments.Source:CPI

Recentclimatesummitshaverevealedthatfinanceiscriticalfortheimplementationof

IntendedNationallyDeterminedContributions (INDCs), inwhichnearly200countries

havepubliclyoutlinedtheirintentionsintermsofgreenhousegasreduction.73Formany

developingcountries,theseintentionsarehighlydependentonthepledgesofdeveloped

countriestoprovidethemwithUSD100billionayearfortheiradaptationandmitigation

projects74. However, the current economic turmoil that prevails in most developed

countries75 and the lack of common understanding about the balancing between

adaptation andmitigation finance76 suggest that developing countries are unlikely to

achieve their emission reduction targets by solely relying on those pledges. Rather,

developingcountriesmustalsoexplorenewfinancingmechanisms,suchasgreenbonds

iftheircommitmentsshouldberespected.

73 Banga,J.(2019)-Thegreenbondmarket:Apotentialsourceofclimatefinancefordevelopingcountries.J.Sustain.Invest.2019,9,17–32.74 UNFCCC(2009) 75 King(2017) 76 Pickering,J.,Jotzo,F.,&Wood,P.(2015)-Sharingtheglobalclimatefinanceeffortfairlywithlimitedcoordination.GlobalEnvironmentalPolitics,15(4),39–62.

43

2.3ClimateFinanceInstruments

ClimateFinanceneedstobeseenasanessentialtoolforacceleratingclimateactionand

effectivelymanagingtherisksandopportunitiesassociatedwithclimatechangeandmust

play a leading role in supporting this process. As described in the previous chapters,

strengthening the role of finance in achieving an efficient economy that also achieves

environmentalandsocialobjectivesisoneofthegoalssetbytheEuropeanCommunity.

Withthefirstactionplanonsustainablefinance,whichprovidesaunifiedsystemtofoster

clarity andguidanceon the activities tobe considered "sustainable" anduseful to the

mitigation of climate change, Europe is committed to promoting a more sustainable

societyandalow-carboneconomy.TheimplementationofSustainableFinancetocombat

climate change is crucial in order to bring sustainable financial instruments closer to

businesseswiththepurposetofosterglobalclimatechangeawareness.

InthewakeoftheParisagreement,concernaboutclimatechangehasbecomeadriving

force,new"green"financialproductshaveappearedandclimate-relatedbondscontinue

toshowstrongdemand.Finally,pensionfundsaroundtheworldaredemonstratingthat

they see sustainable investments as critical to long-term investment, increasingly

requiringtheintegrationofenvironmental,socialandgovernance(ESG)elementsintheir

investments.

Beforestudyinginadeepwaytheclimatefinanceinstruments,itiscrucialtomentionthe

ESG elements in the investments. As described by CFA Institute, ESG stands for

Environmental, Social, andGovernance. “Investors are increasingly applying these non-

financial factors as part of their analysis process to identify material risks and growth

opportunities”77.Numerousinstitutions,suchastheSustainabilityAccountingStandards

Board(SASB),theGlobalReportingInitiative(GRI),andtheTaskForceonClimate-related

FinancialDisclosures (TCFD)areworking to formstandards anddefinemateriality to

facilitateincorporationofthesefactorsintotheinvestmentprocess.ESGfactorsare“often

interlinked, and it canbe challenging to classify anESG issueas onlyan environmental,

social,orgovernanceissue”78(seeFigure17).TheseESGfactorscanoftenbemeasured

77 CFA(2021)-EGSInvestingandAnalysis,Link:https://www.cfainstitute.org/en/research/esg-investing 78 CFA(2021)-Link:https://www.cfainstitute.org/en/research/esg-investing

44

(e.g.,whattheemployeeturnoverforacompanyis),butitcanbedifficulttoassignthem

amonetaryvalue(e.g.,whatthecostofemployeeturnoverforacompanyis).

Figure17:ESGFactors.Source:DNBAssetManagement

AsdescribedbyGulati (2018), climate changemitigationprojects andprogramshave

drawnonawiderangeoffinancialinstruments.79Inparticular,theseinstrumentscanbe

broadlygroupedintwodifferentcategories:

- financialinstrumentstoraisefunds,usedtomobilizedfundsandraisefunds;

- financial Instruments todeploy funds, used as financial products to provide

capitaltospecificprojectsortoaddressspecificrisksofmitigationprojects.

2.3.1FinancialInstrumentstoRaiseFunds

Inside the category of financial instrument to raise funds we can identify different

instruments,someofthemalreadyexistingandothersproposedforthenextyears,that

wewillstudyindeepinthenextparagraphs:

- GreenBonds

- ClimateBonds

79 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation

45

- ClimatePolicyPerformanceBonds

- CatastropheBonds

- Insurances

- DebtforClimateSwaps

2.3.1.1GreenBonds

Aswewillseeinmoredetailinthenextchapter,greenbondsarerelativelynewfinancial

instruments,withanextraordinarygrowthratesince2007tonowadays.Theyarebonds

likeanyothers,butthegoaloftheissueislinkedtoprojectsthathaveapositiveimpact

on the environment, such as energy efficiency, the production of energy from clean

sources,thesustainableuseofland.Indeed,greenbondsallowtofinancevarioustypesof

projects with environmental sustainable characteristics, such as water and waste

treatment, initiatives related to pollution prevention and control and in general, the

RenewableEnergyindustry.Thedifferencesbetweengreenbondsandtraditionalbonds

arefour:

1) theprojectwhichneedstobefinancedhastobeselectedbeforetheissuanceofthe

bond;

2) the proceedsmust be constrained to the selected project. Themoneymust be

depositedintoaspecificaccountorotherwisetracedbytheissuer;

3) atleastonceayearastatementoftheuseoftheproceedsmustbemadeindicating

theprojectsforwhichtheyareused;

4) theremustbeasecondopinion,oranexternalauditormustcertifydocumentsand

objectives.

2.3.1.2ClimatePolicyPerformanceBonds

In order to sustain and foster the low-carbon transition of countries, new financial

instrumentshavebeenintroducedbygovernments.Assaid,greenbondsinthelastyears

46

are the most used and powerful among these instruments. 2015 was the fourth

consecutiverecord issuanceyear,withgreenbonds issuedfora totalvalueofover45

billion80.However,thisimpressivegrowthraisedsomechallengeslinkedtotransparency

of greenbondsand “greenwashing” risks, as themarket isnot transparent regarding

whatconstitutesthe“green”qualityofabond.81Incontrasttogreenbondsandinspired

bySocialImpactBonds,newbondscalledClimatePolicyPerformanceBonds(CPPB)have

beenestablished,asaninnovativeassetclasswiththepotentialtomobilizesignificant

resources for climate change mitigation projects on the ground while tackling the

challengesthatgreenbondsareencountering82.

In general, Governments issue Climate Policy Performance Bonds paying an interest

basedonclimatepolicyperformanceandtargets.Thesetargetscanbebasedforexample

ongreenhousegasemissionreductionsoranincreaseofrenewableenergypercentage

on total energy production. If these kind of bonds are directly connected with GHG

emissionsandtargets,thereisanincentivefortheissuertoreducethelevelofemissions.

Thisprocessisthemostimportantdifferencewithgreenbonds.Inthiswaytheriskof

“greenwashing”,whichisunderminingthecredibilityofthegrowinggreenbondmarket,

issignificantlyreduced.83

Climatepolicyperformancebondscouldprovideadvantages,dependingontheinvestors

(seeFigure18).Insurancecompanies,forexample,canbeadvantagedbyhedgingtheir

exposuretoclimaterisk.

80 Bloomberg(2016)-BondMarketAsking`WhatIsGreen?'CurbsClimate-FriendlyDebt;http://www.bloomberg.com/news/articles/2016-03-07/bond-market-asking-what-is-green-curbs-climate-friendly-debt81 Michaelowa,A.,Bouzidi,A.&Friedmann,V.(2016)-Boostingclimateactionthroughinnovativedebtinstruments.Combiningdebtforclimateswapsandclimatepolicyperformancebonds.ConceptNote.PerspectivesClimateResearchgGmbH&EmenaAdvisory.Freiburg,Germany.82 BouzidiandMainelli(2015)-EnvironmentalPolicyPerformanceBonds,Climate2020,p.152-15383 I4CE(2016)

47

Figure18:AdvantagesforCPPBinvestors.Source:MichaelowaA.etal.(2016)

Although climate policy performance bonds have not been deployed anywhere yet, a

variantoftheconceptcanbefoundinBrazil’sAmazonFund.84

The Amazon Fund is a mechanism created to raise donations for non-reimbursable

investments to prevent,monitor and combat deforestation, aswell as to promote the

preservation and sustainable use of theBrazilianAmazon.85 Indeed, as stated by FAO

(2015).“theaimofthisfundistostopandreducethedeforestationinBrazilandtobuilda

processinwhichfinancingisbasedoneffectivereductionofgreenhousegasemission.Inthis

process,resourcesareonlyraisedwhenemissionsintheAmazonfallbelowanhistorical10-

yearaverage,whichisrevisedeveryfiveyears”.86

2.3.1.3CatastropheBonds

The catastrophebondsareusually issuedbyan insuranceor reinsurance company to

transferpartoftherisksrelatedtoexceptionalevents(hurricanes,earthquakes,floods,

etc.) to other operators reducing their exposure to natural disasters. In the case of

classical bonds, coupons and repayment of principal are the result of the classic

mathematical formula.For thecatastrophebonds,whichare issuedonthecategoryof

«Insurance Linked Securities» (ILS), , the formula is based on the occurrence of a

predefined natural event. Upon the occurrence of the claim, the underwriter of the

obligationlosespartoralloftheinterestorprincipal.Thesebondshavearelativelyshort

duration(3yearsonaverage).Theseinstruments,whichmadetheirappearanceduring

‘90s,havefeaturesthatconvincedinvestors,firstofalldiversification.Thefluctuationsof

84 Leitmann,J.&Bishop,V.(2011)-ConcessionalClimateFinance:MDBExperienceandOpportunities.FY11ENVKnowledgeProduct85 AmazonFund.Link:http://www.amazonfund.gov.br/en/home/ 86 Fao(2015)-EmergingapproachestoForestReferenceEmissionLevelsand/orForestReferenceLevelsforREDD+

48

these assets are independent from the performance of the economy and very little

correlated to thatofotherassets. Inaddition, theyexhibit reducedvolatilityand their

risk/returnratioisgenerallyconsideredattractive.Insurersarethepredominantpartof

thetotalvolumeofcatastrophebonds,buttheseassetshavealsoattractedothertypesof

issuers,includingsupranationalbodiessuchastheWorldBank,whichissuesbondson

behalfofcountriesatriskofnaturaldisasters,andprivatecompanies.

AsdescribedbyArtemisInsuranceReport(seeFigure19),inQ32020catastrophebond

issuancetotaled1.63billionsofdollars,thethirdhighestrecordinthelastdecade,andin

totalatSeptember2020theissuancereached10.44billionsofdollars,2.64billionhigher

thanthetotal2019.

The Artemis Insurance report shows that as at the end of Q3 2020, the outstanding

Catastrophebondmarketsizestoodat41.97billionsofdollars,which,whileuponthe

endofQ2,remainslowerthanthe42.4billionsoutstandingmarketsizerecordedatthe

endofQ12020.87

Figure19:CatastropheBondsissuedandoutstandingoveryears.Source:ArtemisInsurance

87 Artemis(2020)-Q32020CatastropheBond&ILSMarketReport

49

2.3.1.4DebtforClimateSwaps

Ingeneral,adebtswapisatransactioninwhichtheobligationsordebtsofacompany,

individualoracountry(developedordevelopingcountry)areexchangedforsomething

ofvalue,namely,equity.88Inothercases,equityissubstitutedwithbondsorstockswhose

valueisdeterminedbythemarket.Thisprocessistypicalinpublictradedcompanies.A

debt/equity swap is a refinancing process in which a debt holder receives an equity

positioninexchangeforthedelayofthedebt.Thiskindofprocess,calledswap,isdoneto

helpacompanytocontinuetooperate.

Thisdealmaybeadvantageoustoboththedebtorandthecreditor, inparticularifthe

creditorhascancelledpartofthedebtbecausehe/shedoesnotexpectfullrepaymentby

thedebtor.Incaseofdebtswapsbetweencountriesandgovernments,inexchangefor

this partial cancellation of the debt, the debtor government commits to mobilize the

equivalent of the reduced amount in local currency for agreed purposes on agreed

terms.89

InthisDebt/EquitySwapsframework,thereisaparticulardebtswapinstrumentcalled

debtfornatureswap.Adebtfornatureswapisadealbetweencountriesthatreducea

country’sdebtoutstanding inexchange foran investmenttoprotectnature.Theseare

voluntarytransactionswherebythedonor(s)cancelssomeorallofthedebtownedbya

country’sGovernment90.AsdescribedbyFullerF.etal.(2018),“Debtforclimateswaps

areavariationofdebtfornatureswaps.Indebtforclimateswaps,bilateralandmultilateral

debt relief could enable vulnerable developing countries, including SIDS, to reduce their

external debt while investing the liberated funds in national climate adaptation and

mitigationprograms.”91

Traditionaldebtfornatureswapsareagreementsbetweenadonoranddebtorcountry,

asdescribedbyFigure20(seeFigure20).

88 Chenj.(2020)-Debt/EquitySwap.Link:https://www.investopedia.com/terms/d/debtequityswap.asp89 OECD(2007)-GreenInvestmentBanks.InnovativePublicFinancialInstitutionsScalingupPrivate90 UNDP(2018)–link:http://www.undp.org/content/sdfinance/en/home/glossary.html 91 FullerF.etal.(2018)-DebtforClimateSwaps:CaribbeanOutlook

50

Figure20:DebtforNatureSwapBasicModel.Source:OECD(2007).

Usuallytherearedebtfornaturewithathirdnon-governmentalactorinvolvedas

describedbyFigure21(seeFigure21).

Figure21:DebtfoNatureSwapTripartiteModel.Source:OECD(2007)

TheOrganization for Economic Co-operation andDevelopment (OECD) estimates that

between 1991 and 2003, debt for nature swaps generated almost US$1.1 billion for

conservation measures, in return for debt with face value volumes of almost US$3.6

billion.92

Themosteffectiveexampleofadebt forclimateswapisprovidedbyPoland. In1991,

Polandrestructured itsbilateraldebtwith itsParisClubcreditors (agroupofofficials

frommajorcreditorcountrieswhoseroleistofindcoordinatedandsustainablesolutions

to the payment of difficulties experienced by debtor countries93), wherein creditors

cancelled50%oftheirclaims.Inexchangeforfivecreditorscancellinganadditional10%

oftheirclaims,PolandfinancedanEcoFundof$474millionwithanequivalentamountof

92 OECD(2007)-GreenInvestmentBanks.InnovativePublicFinancialInstitutionsScalingupPrivate,Low-carbonInvestment.OECDEnvironmentPolicyPaperNo.6.93 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation

51

hardcurrencyusedtofinanceprojectsthatreducetransboundaryairpollution,reduce

pollutionintheBalticSea,lowerGHGemissions,andprotectthecountry’sbiodiversity.94

2.3.2FinancialInstrumentstoDeployFunds

Therearetwotypesofinstrumentsthatprovidefundingtoclimatechangemitigation

projects95:

- CapitalInstruments

- RiskManagementInstruments

2.3.2.1CapitalInstruments

Therearethreedifferenttypesofcapitalinstrumentsusedtomitigateclimatechange(see

Figure22):

- DebtFinance

- SubordinatedDebt/MezzanineFinance

- Equity

In particular, Debt Finance is called also Senior Debt, Mezzanine Finance can be

considered ad a subordinated senior debt andEquity comprises preferred stocks and

commonstocks.

94 DevelopmentFinanceInternational(2009). 95 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation

52

Figure22:CapitalInstruments.

2.3.2.1.1DebtFinance

a) ProjectFinance(SeniorDebt)

Withthisinstrument,debtisborrowedforaspecificproject;theamountofdebtmade

availablewillbelinkedtotherevenuetheprojectwillgenerateoveraperiodoftime,as

thisisthemeanstopaybackthedebt.Thisamountlentisthenadjustedtoreflectinherent

risks,e.g.thebankswillestablishfirst‘charge’orclaimovertheassetsofabusiness,as

describedabove.Thefirsttrancheofdebttogetrepaidfromtheprojectisusuallycalled

‘seniordebt’.

Itisdifferentfromanusualcorporatelendingbecauseinthislattercasebanksprovide

finance to companies to support everyday operations. An assessment is made of the

company’sfinancialstrengthandstability,anddebtispricedaccordingly.

b) SubordinatedDebt/MezzanineFinance

The instrument ofmezzanine finance is between seniordebt and equity. It comprises

quasi-equityfinanceanditincludesamixofdebtandequityfinancinginwhichalender

hastherighttoconvertthedebtinequityincaseofdefaultofthecompany,ingeneral

aftertheseniorlendersarepaid.

MezzanineFinance,alsocalledsubordinateddebt,standsbetweenthetoplevelofsenior

bankdebtandtheequityownershipofaproject.

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Fromariskpointofview,mezzanineloansareriskierthanseniordebtsbecause inthe

eventofinsolvency,itshallberepaidafterthebalanceofallotherdebtswhicharedefined

as"senior".Incomparisonwithotherdebts,itisusuallyshorterandmoreexpensivefor

theborrowersbutitismoreprofitableforthelenderanditmaybeprovidedbybanksor

otherfinancialinstitutions.

c) Refinancing

Inthiscase,thereisaprojectwhichhasalreadyadebtandwants,orneeds,toreplace

existingfinancingwithanewone.Thisprocessisequaltorefinancingamortgage.

Thereareseveralreasonstorefinanceaproject,forexampleiftherearetermsthatare

moreprofitableavailableinthemarketorifthelendersbecomemorefamiliarwiththe

technology of the project. Another reason could be in terms of duration, as loans are

usuallymoreexpensiveovertimebecausetheriskincreasesasthemarketconditionor

regulationschanges.

Loansmeasurethedegreeofsecurityandfeasibilityofaclimatemitigationproject.For

thepubliclender,grantingloansmeansallowingrepaymenttofinanceorrefinancemore

projects.However,theprocessofusingpublicloanstomobilizeprivatefundspresents

severalchallengesforexampleitisdifficultforthepubliclendertoestimatethedegreeof

lendingneededtoprovideusefulfinancetotheprojectwithoutwastingpublicmoney.

2.3.2.1.1EquityFinance Equity Finance consists in contributions directly in cash. In particular, in the cases in

which theowner(insoleproprietorships)ormembers (incollectiveenterprises)self-

financetheenterprises.

Thecontributionsconstitutethecapitalinjection,thesizeofwhichisgivenbythevalue

of thesharecapitaland, in thecaseofan increase incapital through the issueofnew

shares abovepar, by the excesspremium reserve. In the companies, it coincideswith

equity.Capitalinjectionsareformedatthetimeofestablishmentoratsubsequenttimes

inthelifeofthecompany,whenadditionalfinancingisrequired.

From a private investor’s point of view, the entities that use equity finance among

financial investors include, in addition to private investors, private equity funds,

54

infrastructure fundsandpension funds.These funds invest intocompaniesordirectly

intoprojectsorportfoliosofassets.

Theequityinvestorsdifferbythetypeofbusiness,thedegreeoftechnologyandtherisk

associated.Inparticular,venturecapitalinvestorsfocusonearlystageorgrowthstageof

aproject.Privateequityfirmsarefocusedmoreonlaterstageofaprojectandtheyexpect

todisinvest,makingreturns,in3or5years.Instead,infrastructurefundswillbefocused

onlowerriskinfrastructuresuchasroadsprojects,renewableenergyandotherprojects

in which they have a longer term investment horizonwith lower returns in the first

period. Finally, institutional investors, for example pension funds, have longer time

horizonsandlargerinvestmentamountsthanInfrastructureFunds,withlowerrisk.

Funds, inordertodecidetheinvestmentsprojects,usetypicallytheNetPresentValue

(NPV)andInternalRateofReturn(IRR)rules.NPVisthemostreliableandappropriate

method to assess the economic and financial convenience of different investment

alternatives.Instead,theIRRisunabletocompareinvestmentprojectsofdifferentsize

scale.

TheNetPresentValue(NPV)isthevalueofthesumofcashflowsdiscountedatzerotime

atarateequaltotheopportunitycostofcapital.Themodelassumesthepresenceofa

perfectmarket inwhich investorshave freeaccess to the financialmarket inorder to

calculatetheopportunitycostofthealternativeinvestmentwithequalrisk.

TheInternalRateofReturn(IRR) is thediscountratethatmakeszerothenetpresent

value of the cash flows generated by an investment project. It expresses the implicit

return of an investment project. Although it is easy and of common application, this

methodologyhidesnumerouspitfallsthatcanleadtoerrorsormanipulationofresults.

Fromapublicperspective,governments invest inequity forclimatechangemitigation

projectsprovidingacapitalinjectionwithoutreceivinganyguaranteeofrepayment.

Given that equity financing requires high levels of commitment, only highly qualified

projects are selected and the number of projects that can be upscaled through this

instrumentislimited.96

96 Lindenberg,Nannette(2014)-DefinitionofGreenFinance.DIEmimeo,2014,AvailableatSSRN:https://ssrn.com/abstract=2446496

55

2.3.2.2RiskManagementInstruments Risk Management Instruments in “Climate Finance” comprise both insurances and

guarantees. Insteadof financingdirectlytheproject, these instrumentsreducetherisk

perceivedbytheinvestorsinordertofosterinvestmentsforaspecificproject,reducing

costs.

Natural consequences of climate change are extreme weather events such as floods,

droughts,heatwavesandstorms.Theseclimatechangeconsequencesarebecomingmore

common, accompanied by an overall increase in risk. In order to reduce these risks,

insurance mechanisms can make companies and governments more resilient to the

impactsofextremeweathereventsinseveralways.AsdefinedbyEuropeanCommission

(2018),“insurancemechanismscanprovidefinancialcompensationforlargedisasterlosses

so that those affected can recover faster and they can play a large role in assessing,

communicatingand signaling risk throughpremiums,deductiblesandpayments, so that

thoseatriskcanhaveabetterunderstandingofthethreatsposed.”97

Insurancesinvolveanagreementbytheinsurer,topaypartofthecostsorlossesincurred

byaprojectinexchangeforafeeintheeventofnon-performanceoftheprojectordefault

ofobligationsbytheborrower.98

On the other hand, a guarantee involves three parties – a guarantor who offers the

guarantee,afinancierwhogetstheguarantee,andtheprojectthatreceivesthefinance.99

Guaranteesenableproject-basedinvestorstotransferriskstheycannoteasilyabsorbor

manageandareparticularlyeffectiveatmobilizinginvestment.Theyshouldonlycover

part of potential losses to avoid encouraging over investment in risky projects.100

Guaranteescanassumedifferentforms:

- CreditGuarantees

- PartialCreditGuarantees

97 EuropeanCommission(2018)-Usinginsuranceinadaptationtoclimatechange98 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation 99 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation 100 TheWorldBank(2020)-TransformativeClimateFinance:Anewapproachforclimatefinancetoachievelow-carbonresilientdevelopmentindevelopingcountries

56

- PerformanceRiskGuarantees

- RevenueGuarantees

Finally,alsostructuredfinancecanbeassessasaformofguarantee.Indeed, asstatedby

GulatiM.(2018),itis“amechanismthatlayerspublicguarantees,usuallyatconcessional

termsor ina juniorposition,aspartofanoverall investmentpackage. In theeventofa

partialdefault,seniorinvestorswouldberepaidfirst,withtheguarantorandotherjunior

partnerspotentiallyreceivingnorepayments”.101

Regardless of the different forms, guarantees are divided into “Pari Passu” and

Subordinated.

Withtheterm“PariPassu”,werefertothepracticethatguaranteesallbondholdersalevel

playingfield.Allofthemmustbetreatedinthesameway.Thismeansthattheholdersof

thesameobligationhavethesamedegreeofpre-emption:itisnotpossiblethatsomeare

privilegedintheeventofinsolvency.Theprinciplemustbeinterpretedasalevelplaying

field:itdoesnotmeanthatintheeventofdefault,everyoneisentitledtoa100%refund.

Instead,asubordinatedguarantee,initseasiestform,givesthefinancierthefirstrightto

berefunded.102

2.4SustainableFinanceandCovid-19

TheCovid-19 pandemic is changing people’s lives like fewother events in our recent

historyandthesustainablefinanceindustryisreactingquickly,inordertorespondtothe

hugedemandforcapitaltoaddresstheemergencyandfinancetherecovery.

Sincethebeginningof theemergency,weareseeingthecreationofanewcategoryof

financialinstrumentslaunchedpreciselyinresponsetothecrisis.Theseinstrumentsare

theso-called"Covid-19bonds",issuedtofinancethefightagainstthevirusandsupport

businessesandindividualsaffectedbythepandemic.

Inthebondmarket,untilthebeginningof2020,greenbondswerethemostissuedinthe

market. The green bonds, focused on energy efficiency projects and mitigation of

101 Gulati,M.(2018)-Financialinstrumentsusedbygovernmentsforclimatechangemitigation 102 TheWorldBank(2009),LondonSchoolofEconomics

57

environmentalimpact,arethepreferredtooltofinancingthetransitiontothelow-carbon

economy.

TheCovid-19pandemicisbroadeningtheperspectivetogivemorespacetosocialissues,

the“S”acronymwithinESG(Environmental,SocialandGovernance).Duringthepeakof

thepandemic,manyinstitutionsandcompaniesimmediatelymobilizedtoraisecapitalon

themarketwiththeaimoffinancingactivitiesinresponsetothehealthemergencyand

itsseriousconsequencesonthemostvulnerablecategories.Inthepandemic,themost

usedtoolsareSocialBondsorSustainabilityBonds.Sincethebeginningof2020,Social

andSustainabilityBondshavecovered40%ofemissions,whilein2019theirsharewas

23%.103

The bonds in response to the Covid-19 have been issued by supranational entities,

governments, regions and companies that will use the proceeds to support the fight

againstthevirusandtohelpthemostaffectedpopulationsandbusinesses.Thesebonds

areissuedinlinewiththeSocialBondPrinciplesortheSustainabilityBondPrinciplesof

theInternationalCapitalMarketAssociations(ICMA)andtheyhavethedenominationof

SocialBondsorSustainabilitybonds,whileotherbondshavebeenissuedas"response

bonds","Covidbonds"orwithoutaspecificlabel.

Internationally,the$1billionSocialBondissuedonMarch112020bytheInternational

FinanceCorporation(IFC-WorldBankGroupagency)wasoneofthefirsttobeissuedon

the market. Among the institutional investors who have joined the issue, aimed in

supporting the operation of companies engaged in the production and shipment of

medicalandpharmaceuticalmaterials,therewastheSwedishpensiongroupAlectaand

insuranceindustryoperators,alwaysSwedes,LansforsakringarandFolksam.

TheWorldBankhas issuedon themarket a sustainability bondof 8 billiondollars, a

recordforanissueindollarsbyasupranationalbody.The5-yearbondreceivedfundsof

12.5billionfromnearly190investors,mainlycentralbanks,treasuries,assetmanagers,

pensionfunds,andinsurance.Theuseofrevenueswillbefocusedonhealthprojectsand

programsconsideredcrucialforcountries'immediateresponsetoCOVID-19.

103 Bloomberg(2021)

58

At European level, the Council of Europe Development Bank (CEB) has launched the

"COVID-19ResponseSocial InclusionBond",asocialbondwitha7-yearmaturityof1

billion Euros. The proceeds will be used to support Member States in mitigating the

economicandsocialimpactsofthehealthcrisisandmayalsofinanceongoingprojectsto

supportsmallandmedium-sizedenterprisesincreatingorpreservingemployment.

InItaly,theCovid-19SocialResponseBondlaunchedbyCdp(CassaDepositiePrestiti)in

supportofItaliancompaniesandthelocalareahasreceivedrequestsalmosttwicethan

theissue.TheBondwasissuedintwotranches,at3and7yearsof500millioneuroseach,

and was subscribed by over 130 investors, mostly (53%) Italians. The proceeds are

intendedbothforshort-termprojects,torespondtotheemergency,andtosupportthe

recovery,tofinanceactivitiesthatwillcontributetotheachievementoftheSustainable

DevelopmentGoals.

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3.CHAPTER:GREENBONDS

3.1WhatisaBond

Abondisafixedincomeinstrument,adocumentissuedbyastateoracompanytofinance

itself. Therefore, it is a contract issued by an entity that needs financing. Issuing an

obligationmeanstocreateandofferittopotentialinvestorsforsubscription:thosewho

subscribeitwillbecomethecreditorsoftheissuinginstitution.Therefore,therearetwo

fundamental subjects: the issuer, called the debtor, and the underwriter, called the

creditor.

Abond,initssimplestform,isadocumentthatcontainssomebasicinformationasthe

dateofissue,theexpirydate,thenominalvalueinagivencurrencyandtheinterestrate.

Thedatesofissueandmaturityindicatehowlongtheloanwilllast.Atthematurity,so

theendofthebondloan,theissuerofthebondhastheobligationtoreturnthecapital

receivedtoeachholderofthebondandinasinglesettlement.Instead,theholder,thatis

theinvestor,receivesinterestsperiodically(coupons)ontheamountinvested(usually

quarterly,half-yearlyorannually),oratmaturitywiththeinvestedcapital(zerocoupon

bonds).

Themain differencewith a simple bank loan is that the payments of the bond go to

whoeverholdsitatthattime.Infact,theunderwritercouldtransferthebond,sellitto

anotherinvestor,whowillreceivetheremainingpaymentsaswritteninthebond.

Theissuepriceofabondmaybe:

a) atpar,whenitcoincideswiththenominalvalueoftheprincipalthatisredeemed

atmaturity;

b) belowpar,whenitislessthanthenominalvalue.Forcompanies,issuingbelow

par is a way to foster investors with a discounted price. The coupon will be

calculated,asalways,withthenominalvalueandtheinterestrate,butatmaturity

the investorwill receivemore than thepaid-upcapital:he/shewill receive the

differencebetweenthesubscriptionpriceandthenominalvalue;

60

c) above par, when it is above the nominal value recognized at maturity. This

scenario may occur if the bond is paying a higher coupon than other bonds

outstanding.Inaddition,itmaybetheresultofageneralfallininterestrateson

newbondsissuedbythesamecompaniesorgovernments:theolderbondswith

higherinterestratesguaranteehigherannualreturns.Thus,themarketplaysan

importantroleinthevaluationofbonds,mainlyreferringtotheriskassociated

withissuersandthesystemingeneral.

Theyieldofthebondisthesumoftheinterestreceivedandthedifferencebetweenthe

nominalvalueandtheissuepricepaid.Thevalueobtainedmustthenbereducedbythe

amountsequaltotaxationandtradingfees.

Eveniftheinterestrateremainsunchanged,intheanalysisitisfundamentalthesocalled

Yield-to-Maturity,theratethatmakesfuturepaymentsequivalenttothepricepaidatthe

beginning.

Ifthepricepaidtobuythebondisequaltotheprincipalrepaidatmaturity,therateof

returnwillbeequaltotheinterestrate.Ifthepricepaidislower,therateofreturnwill

behigherthantheinterestrateandviceversa.Sincetheinterestrateisusuallyfixedand

the maturities vary from bond to bond, in the markets the rate of return is more

comprehensiveand itallowsthecomparisonbetweenbondswithdifferentmaturities.

Indeed,therateofreturnisexpressedasanannualrate,irrespectiveofthematurityof

theindividualbond.Soitispossibletocomparedifferentbondsformaturity,butalsofor

differentinterestrates.

Regardingtheinterestrate,therearetwocategories:fixed-ratebondsandfloating-rate

bonds.Inthefirstcase,theinterestrateissetbeforetheissueandrecordedinthebond

document.Thebondholderwillreceivethesameinterestrate(thesamecoupon)ateach

maturityspecifiedinthebond.

Inthesecondcase,theinterestratemayvaryoverthelifeofthebond.Then,thevalueof

theratewilldependontheperformanceofotherratesorpricesofotherassetsthatserve

asabenchmark.

Finally,ifthereisnotafinalpayment,itiscalledperpetualannuity.Atregularintervals,

theunderwriter(orbondholder)willreceiveacoupon.Theparticularityisgivenbynot

receivingafinalrepaymentoftheprincipal,butcontinuingtoreceivethesameamountof

interestovertime.

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3.2TheGreenBonds

Greenbondsarefixedincomesecurities,whichfinanceinvestmentswithenvironmental

orclimate-relatedbenefits.104Greenbondsareacomponentofthemoregeneral“green

finance”, which aims to “internalize environmental externalities and adjust risk

perceptions”forthesakeofincreasingenvironmentallyfriendlyinvestments.105

Inparticular,agreenbondisaspecialkindofbondinwhichtherevenuesmaybeused

exclusivelytofinanceorre-finance,inpartorinwhole,newandexistinggreenprojects.

Currently,thereisnoglobalstandardtocertifyacertainbondas"green",butthereare

guidelinesdevelopedbytheInternationalCapitalMarketAssociation(ICMA).Asdefined

by ICMA, “The Green Bond Principles (GBP) are voluntary process guidelines that

recommendtransparencyanddisclosureandpromoteintegrityinthedevelopmentofthe

GreenBondmarketbyclarifyingtheapproachforissuanceofaGreenBond”andtheywill

beanalyzed in thenextparagraph.Given thestrongexpansionofgreenbondsand its

growingpresenceinthefinancialmarkets,theneedforclearrulesfromratingagencies

and institutional investors is increasinglycrucial.The ICMAalsoprovidesguidanceon

eligibleenvironmentalissues,butthelistispurelyillustrativeandnotexhaustive.Infact,

itisaself-regulation.Incaseofnon-compliancewiththeprinciplesintheyearsfollowing

theissue,therearenopenalties,otherthanthosegivenbythereputationalmarketitself.

Ingeneral,greenbondsareatoolcreatedtoincreaseliquidityinfinancialmarketsandto

facilitatethelow-carbontransitionfinancingspecificprojects.Greenbondscanoftenbe

amoreconvenientand"comfortable"solutionthanshorter-termbankloans,particularly

financing low-carbon projects and high interest rate environments. As described by

Zerbib O. (2017), “they are highly attractive financial instruments that foster the

environmentaltransitionwhileenablinglow-carbonprojectholderstoexpandtheirfunding

capacity”.106Therefore, the innovationforthistypeof instrument is tobeatraditional

investment,characterizedbyariskcomponentandtherelatedreturn,butalsoitaddsa

contributionthatgoesbeyondthepurelytraditionalinvestment,sensitizingtheinvestor

withits“green”characteristic.

104 Ehlers,Torsten,andFrankPacker(2017)-Greenbondfinanceandcertification.BISQuarterlyReviewSeptember:89–104.105 G20GreenFinanceStudyGroup(2016)-Greenfinancesynthesisreport2016,September.106 ZerbibO.(2017)-Thegreenbondpremium,DepartmentofFinance,TilburgSchoolofEconomicsandManagement

62

Greenbondsactastraditionalbondsand,intheirsimplestform,theyraisecapitaloffixed

amount and return it tomaturity,while theyperiodically pay off interest. In order to

pursuethisgoal,theissuermustgenerateenoughcashflows.

Dependingonthestructureofthebonds,themarkethaveclassifiedgreenbondsinfour

differentcategories107:

- StandardGreenUseofProceedsBonds:abondconsistenttotheGreenBond

Principlesandissueddirectlybythe issuer,actingasguarantor.Theinvestor is

remuneratedovertimewiththeprofitsfromthefundedproject;

- GreenRevenueBonds:a typeofbondalignedwith theGreenBondPrinciples

where investors are rewardedusingpledged revenues suchas commissionsor

feesandwhereproceedsareusedforenvironmentalprojectsthatareorarenot

relatedtotheseflows;

- GreenProjectBonds:asdefinedbyBangaj.(2019)itisa“bondissuedforasingle,

orapooled,greenproject(s) forwhichrisksareentirelyboreby theunderwriter,

withorwithoutpotentialrecoursetotheissuer”.108

- GreenSecuritizedBonds:akindofbondalignedwiththeGreenBondPrinciples

that uses the underlying assets as collateral. The first source of repayment is

usuallycashflowsfromsuchunderlyingassets.

Financedgreenprojectsmayalsohavesocialco-benefits.Forthisreason,theissuersofa

greenbondmustdefinetheuseofthecapitalraisedaccordingtothemainpurpose.In

addition, green bonds are exempt from taxes, or can have the so called "tax credits",

becausenationalandlocalgovernmentsknowaboutthepositiveimpactsthattheycan

haveinthefightagainstclimatechange.Forthesereasons,inadditiontothoseexplained

before, thegreenbond instrumentattractsnotonlysociallyresponsible investors,but

alsoinvestorswhoarelookingforasafevehicletoinvesttheirsavings.

107 Equita(2019)-GreenBond:newfundingopportunity,Researchteam,June10,2019108 JosuéBanga(2019)-Thegreenbondmarket:apotentialsourceofclimatefinancefordevelopingcountries,JournalofSustainableFinance&Investment,9:1,17-32,DOI:10.1080/20430795.2018.1498617

63

Giventhelackofuniversalstandardsanddefinitionforgreenbonds,itislikelythattheir

characteristicsmaydifferfromoneissuertoanother.109Nevertheless,thegoalremains

thesame,collectfinancingtogreenprojects.

3.2.1GreenBondsPrinciplesandClimateBondsStandard

Inordertoguaranteeinvestorsintheirgreeninvestment,ensuringthatboththecapital

raisedisactuallyusedtocontributetothefightagainstclimatechangeandthecredibility

oftheinstrumentitself,theGreenBondsPrinciplesandtheClimateBondsStandardshave

beenestablished.Theyprovidevoluntaryguidelinesthatthosewhointendtoissuegreen

bondscanfollowsothattheyaremorecredibleandreliable.Inparticular,theseprinciples

recommendtransparency,reportinganddisclosure,clarifyingtheapproachtofollowfor

theirissuance,aswewilldescribeinthenextparagraph.Ingeneral,theyprovidethebasic

features that the tool and theprojectmusthave inorder tobe financed for thegreen

transition110.

TheGreenBondsPrinciplesarefour:

1) UseofProceeds

Thisisthekeyaspectthatcharacterizesabondasgreen.Thecapitalraisedbythe

issuingmustbeexclusivelyusedforprojectswithclear,andpossiblymeasurable,

environmental benefits. Among the environmental objectives we can

acknowledge: climatemitigation, adaptation, conservation of natural resources

andbiodiversity,preventionandcontrolofpollution.Theycanbeinterrelatedat

thesametimeandthereforeinvolvemorethanoneenvironmentalcategoryand

objective. Projects that aim to contribute to the green transition and climate-

resilient economy are called "climate-aligned green bonds". The categories

allowedbytheGreenBondPrinciples(seeFigure19)willbeanalyzedattheend

oftheparagraph.

109 Flaherty,M.,A.Gevorkyan,S.Radpour,andW.Semmler.(2017)-FinancingClimatePoliciesThroughClimateBonds–AThree-StageModelandEmpirics.ResearchinInternationalBusinessandFinance42:468–479.https://10.1016/j.ribaf.2016.06.001 110 InternationalCapitalMarketAssociation(ICMA)(2018)–TheGreenBondPrinciples

64

2) ProcessforProjectEvaluationandSelection

The issuerofagreenbondhastoprovide, inadditionto thetraditionalproject

information, a disclosure to investors about the environmental sustainability

objectives,theprocessthatdeterminestheclassificationwithinoneormoreofthe

categories just mentioned, the eligibility criteria and the potential material

environmentalandsocialrisksassociatedwiththeproject.111

Inparticular,theGreenBondPrinciplesrecommendahighdegreeoftransparency

andthattheprojectevaluationprocessisalsosupportedandvalidatedbyexternal

professionals.

3) ManagementofProceeds

Oneofthemajordisputesrelatestothetraceabilityofincomecollectedfromthe

bondsale.TheGreenBondsPrinciplessuggestthatthenetproceedsfromtheissue

arecreditedtoaspecificaccount,eithertransferredwithinaspecificportfolio,or

otherwise properly controlled by the issuer to ensure traceability and

documentation.Thisdocumentationhastobeupdatedperiodically,untilall the

collectedcapitalisallocatedtotheprojectforwhichthebondswereissued.The

issuerhastoreportonthetemporaryallocationofcapitalnotyetaddressed.

4) Reporting

Theissuershallensureandmakeavailableupdatesanddocumentationontheuse

ofthecapitalraised.Theymustbereviewedannuallyuntilthetotalallocationof

capitalisraised,orwhenevertherearerelevantdevelopments.Inaddition,they

mustprovidealistoftheprojectsfinancedwithadescriptionofthem,together

with the expected impacts. However, if there are confidentiality agreements,

marketconsiderationsorotheraspectsthatlimittheinformationtobeprovided,

theGreenBondPrinciplessuggest that the informationhas tobedisclosed ina

genericmanner.Finally,thecommunicationoftheimpactsmustbesupportedby

qualitativeanalysesandquantitativeperformanceindicators.Everygreenbondis

differentbecausetheprojectbehindisdifferent.Asaresult,theevaluationofthe

111 ICMA(2018)-GreenBondPrinciples,VoluntaryProcessGuidelinesforIssuingGreenBonds

65

positive environmental impacts generated and thenegativeones avoidedoften

takesplacedifferentlyfromgreenbondstogreenbonds,fromprojecttoproject.

Although well outlined, these principles are still incomplete, because they are still

voluntary. In addition, there is a lack of reporting, monitoring and penalties for

infringements.

AsitispossibletoobservefromFigure23,thegreenprojectcategoriesaremappedfor

theircontributiontocombatclimatechangeandtotheirspecificobjectives.Theprocess

forprojectevaluationandselection,underthesecondcorecomponentoftheGreenBonds

Principles, calls for an issuer of a green bond to communicate to investors the

environmentalsustainabilityobjectivesoftheirgreenproject.112

112 ICMA(2019)-GreenProjectMapping

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Figure23:Mappingthecategoriestoenvironmentalobjectives.Source:ICMA(2019)

TheClimateBonds Initiative isan internationalnon-profitorganizationwith themain

objectiveofinforminginvestors.Itwasfoundedin2010tofosterlargeinvestmentsthat

supportthetransitiontoagloballow-carboneconomy.TheClimateBondsInitiativeaims

tostimulate investors, industryandgovernmentsto increasegreeninvestmentstothe

scalenecessarytoavoidthedangerousclimatechangedescribedinthepreviouschapters

andtoachievetheobjectivesoftheParisAgreement.Afundamentalcomponentofthe

ClimateBondsInitiativeisthe“ClimateBondsStandard&CertificationScheme”,theso-

called “Certification Scheme”. Indeed, “the Certification Scheme allows investors,

67

governments and other stakeholders to identify and priorities ‘low-carbon and climate

resilient’investmentsandavoid‘greenwash’”.113

The Climate Bonds Standard & Certification Scheme aims to provide the green bond

market with the confidence and assurance it needs to stimulate large investments.

Moreover, CBI (2019) stated that “activating themainstream debt capital markets to

financeandrefinanceclimate-alignedprojectsiscriticaltoachieveinternationalclimate

goalsandrobustlabellingofgreenbondsandisakeyrequirementforthatmainstream

participation”.114

The requirements are divided into pre-emission and post-issue (see Figure 24). The

formerrefertoallaspectsrangingfromprojectselectiontointernaltraceabilityprocesses

and, if respected, it provides the issuer support during internal activities and, to the

investor,identificationofobligationslinkedtoimproveenvironmentalperformance.The

latterinstead,allowstheissuertodemonstratetotheinvestorthesuccesses,theuseof

capitalandthestatusoftheprojectsimplemented.

Figure24:Processforcertification.Source:ClimateBondsInitiative(2019)

Once theprocess isover, thebondgets thecertification.Therefore, theClimateBonds

Initiative check the four key assumptions to define a bond as a "greenbond" and the

suitabilityofprojectsoractivities.Theauditmustbecarriedoutbyindependentverifiers

whoensureinvestors,governmentsandotherstakeholdersthatthefundsraisedhavethe

promisedfinaldestination. Inaddition, investorscaneasilyscreengreenbondsonthe

113 ClimateBondsInitiative(2019)-ClimateBondStandard3.0 114 ClimateBondsInitiative(2019)-ClimateBondStandard&CertificationScheme2.0.GuidanceforVerifiers.

68

marketandissuerscansellaguaranteedandcertifiedinstrument.However,therequest

forcertificationisvoluntaryandrecommendedaboveallasaguarantee.

3.2.2IssuingaGreenBond

Theprocessofissuingacertifiedgreenbondinvolvesatleastthreemajormarketplayers,

includingtheissuer,anindependentreviewer,andtheunderwriters(seeFigure25).115

Figure25:Theprocessforissuingagreenbond.Source:BangaJ.(2019)

The process begins when a company, or private entity, starts a green project. In the

projectpresentation,thecompanyisrequiredtoinclude,asfaraspossible,theexpected

positive impacts of its project on the environment. To avoid subjective assessments

regarding impacts, an independent auditor, specialized in environmental impact

assessment, is required to confirm whether the project is actually environmentally

friendly.Theroleof the independentauditor is tomakeaquantitativeandqualitative

assessmentoftheactualimpactsoftheproject,basedonthefollowingcriteriasuggested

byICMA(2017):

- Theuseofproceeds:beforetheissuance,alegaldocumenthastoguaranteehow

theproceedsofthebondwillbeinvested;

115 JosuéBanga(2019)-Thegreenbondmarket:apotentialsourceofclimatefinancefordevelopingcountries,JournalofSustainableFinance&Investment,9:1,17-32,DOI:10.1080/20430795.2018.1498617

69

- A technical assessment, regarding the risks and opportunities related to the

specificprojectandtheprobabilityofdefaultofthegreenbondissuer;

- The monitoring, reporting, and traceability requirements: several reports

mustbepublishedregularlytomonitortheprojectandtheuseoftheproceedsto

ensure that they have been invested in accordance with the Green Bonds

Principles.

Failuretocomplywiththesestepswillresultintheexclusionofthecompanyfromthe

greenbondmarket.Attheendoftheexternalauditor'sprocess,whichcertifiesthegreen

natureoftheprojecttobefinanced,thecompanyisauthorizedtoissueacertifiedgreen

bondtoraisefundsinthedebtmarket.Greenbondunderwritersthenprovidecapitalto

the issuer foracertainperiodof timeata fixedorvariable interest rate116.Aswillbe

described in the following paragraphs, this green bond issuance processmay involve

somesignificanttransactioncoststhatrepresentthemaindisadvantageofgreenbonds.

However,itisimportanttoconsiderthattheprocessillustratedissimplifiedcomparedto

reality.Inpractice,thisprocessmayvaryfromonemarkettoanother.

3.3GreenBondMarket

Attheendof2007,agroupofSwedishpensionfundswantedtoinvestinclimate-friendly

projects,buttheydidnotknowhowtofindtheseprojects.TheyaskedtotheWorldBank

forhelp.Ayearlater,theWorldBankissuedthefirstgreenbondandbydoingit,itcreated

a new way to connect investor finance to climate projects. The concept of a bond

dedicatedtoaspecifictypeofprojecthadneverbeentestedbefore.

Thegreenbondturnedouttobeahistoriceventthatradicallychangedthewayinvestors,

developmentexperts,politiciansandscientistsworktogether.

Greenbondshavechangedthebehaviorof investors:tenyearslater, investorspublish

theirnamesandprovidequoteswhen theybuygreenbondsand theyaremuchmore

awareoftheirpowertosupportinitiativeswiththeirinvestments.

116 GermanDevelopmentInstitute(2016)-GreenBonds:TakingOfftheRose-ColouredGlasses.BriefingPapern°2.https://www.die-gdi.de/uploads/media/BP__24.2016.korr_01.pdf.

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Thebasicpremiseofthegreenbond-withitsprocessfortheselectionofprojects,the

second-partyopinionandtheimpactreport-isappliedtootherareas.Asaresult,there

arenowsocialbonds,bluebondsandotherbondsthatcollectfundsdedicatedtoaspecific

developmentpurpose.Theyallfollowthegreenbondmodel,withafocusonreporting

impacts.

InMarch2013,theIFCissuedthefirstbilliongreenbondthatwasfullysubscribedwithin

an hour from its issuance.117 A few months later, Vasakronan, a Swedish real estate

company, issued the first corporate green bond. In any case, they were mainly

international institutions. Also in 2013, the first American greenmunicipal bondwas

issuedbyMassachusetts.In2014,theinstrumentbegantobeissuedcontinuously,and

around37billionwereissued,morethanthreetimesasmuchasin2013.

Inaddition,agroupofbanksandratingagencieslaunchedthefirstgreenbondsindices.

Theseindicesareintendedtolowerinformationbarriers,providinginvestorswithclear

dataontherisksandreturnsoftheinstrument.

Especially since 2015, the instrument has had a great success, thanks to the Paris

Agreement,anditbegantobeusedbycompaniesand,fromthefollowingyear,widely

alsobymunicipalitiessuchasNewYork.In2016,emergingeconomiesalsoenteredthis

landscape,especiallyChina.

3.3.1Developmentofthelastyears

As described in the previous paragraphs, the Climate Bonds Initiative (CBI) is an

international, non-profit organization dedicated tomobilizing the global bondmarket

towardssolutionsthatfacilitatethetransitiontoalow-carboneconomy.Inadditionto

providing theClimateBondsStandards,asdiscussedabove, theyprovideeveryyeara

reportabouttheconditionsoftheGreenBondMarket.

Asdescribebythefigurebelow(seeFigure26),in2019allregionsincreasedthevolume

oftheGreenBondMarket.Itwasthefirsttimesince2016.Inparticular,Europereached

the largest increase, i.e. 50 billion respect to 2018, representing 57% of the global

117 TrompeterL.(2017)-GreenisGood:HowGreenBondsCultivatedintoWallStreet'sEnvironmentalParadox,SustainableDevelopmentLawandPolicyBrief,Vol.XVII,No.2,2017.1maggio2017

71

expansion.AllEuropean issuer, apart from loansandABS, reached theirhighest level,

with non-financial corporates, government-backed entities and development banks

standingoutasparticularlystrong.118

Figure26:IssuanceofGreenBondsbyregion.Source:CBI(2020)

These percentages suggest that “the green bond market is well-established, both in

developed and emerging countries, supported by growing climate-awareness among

investors”.119AsBanga J. (2019)highlights, indevelopingcountries, themarket is still

comparatively young.120However, as statedbyCBI (2017), the riseof the greenbond

marketinemergingeconomies,suchasBrazil,India,Mexico,andChina,isboostingcross-

regionaltradesanddemonstratinginternationaltradingopportunities.121

Asseenwithregions,thewholevolumebyissuertypeincreasedin2019(seeFigure27).

Thesameappliestothenumberofissuersandtransactions,apartfromasmalldecrease

in the number of ABS transactions. In the area of private sector issues, non-financial

corporationsachievedparticularlypositiveresults,reachingthefirstplaceintheranking

of issuers.Theamountofbonds issuedhasmore thandoubled to59.1billiondollars,

118 Almeida,M.(2020)-GlobalGreenBondStateoftheMarket2019,ClimateBondsInitiative119 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.120 Banga,J.(2019)-Thegreenbondmarket:Apotentialsourceofclimatefinancefordevelopingcountries.J.Sustain.Invest.2019,9,17–32.121 ClimateBondsInitiative(2017)-TheRoleofExchangesinAcceleratingtheGrowthoftheGreenBondMarket,May2017.Availableonline:https://www.climatebonds.net/files/files/RoleStock%20Exchanges.pdf

72

surpassingthefinancialcompanies,whichincreasedbyonly12%,thelastcomparedto

otherissuers.Inparticular,itrepresentsaninvertedtrendcomparedto2018,whichhas

seenthevolumeoffinancialcompaniesmorethandoubledwhilenon-financialcompanies

havedecreased.Greenloanswerethesecondlargestin2019,withagrowthof98%.

Issuesfromthepublicsectorhavealsoexperiencedsignificantgrowth,withalltypesof

issuers achieving record size, with the exception of local governments. Most of the

increaseisduetoastrongpushfrompublicauthorities,mostofthemEuropean,andfrom

developmentbanks,whichhavebothalmostdoubled.

Figure27:IssuanceofGreenBondsbyissuer.Source:CBI(2020)

Allcategoriesofuseofproceedsshowedasignificantincreaseinvolumesin2019.This

statistic is in contrast with 2018, when the increases were less pronounced. While

allocationsroseacrosstheboard,thetop3categories-Energy,BuildingsandTransport

werethebestperformers,accountingfor80billiondollarsoftheoverall88billiondollars

added.122Buildings registered thehighestabsolute increaseonanannualbasis (+30.1

billiondollars),reducingthedifferencewiththeenergysector.Thetransportsector,on

theotherhand,reachedthehighestrecord inrelativeterms,reaching71%.With82%

overall,theirsharehasreachedthehighestlevelsince2015.

122 Almeida,M.(2020)-GlobalGreenBondStateoftheMarket2019,ClimateBondsInitiative

73

Figure28:Useofproceedscategoriesfor2019GreenBondsissuance.Source:CBI(2020)

Finally,theaveragesizeofgreenbondsincreasedfrom108millionsofdollarsin2018to

144millionsofdollarsin2019(seeFigure29).Thisstatisticsisextremelyimportantfor

thegreenbondmarketbecauselargertransactionsprovideliquidityandknowledgeto

the market, stimulating additional investors and integrating the green bond market

throughthecreationofadditionalmarketindices,whileatthesametime,allocatingmore

funds for greenprojects froma single corporate issuance. In 2019, 11%of the global

market was represented by the first 10 transactions together, issued by 36 different

issuers,foratotalof1billionsofdollars.Themajorityofthebondsissued,inparticular

the largest transactions, was issued by sovereign states, financial companies (mainly

Chinese), development banks (both national and supranational) and large private or

public entities supported by the government (mainly European). However, a good

numberofsmallerissuersgotalsoapositiverecord,demonstratingthatthemarketisan

effectivesourceofcapitalformanyissuerprofiles,includingthosewithsmallerfunding

requirements.

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Figure29:VolumeofGreenBondsissuance.Source:CBI(2020)

3.4CharacteristicsofGreenBonds

Thegreenbonds,beingrelativelynewinnovativeinstruments,haveadvantagesbutalso

disadvantagesandrisksduetothelimitedexperienceoftheinstrument.

AsstatedbyFlammer(2020),“theissuanceofgreenbondsmayserveasacrediblesignal

of the company’s commitment to the environment”. The signaling provides different

consequences.First, the literaturehas shown that “shareholders respondpositively to

companies’ engagement towards the environment”.123 Several researches and studies,

suchasFlammer(2013),KlassenandMcLaughlin(1996),Krueger(2015),showpositive

returnsinresponsetocompaniesgreenbehavior.Inaddition,Flammer(2015)findsthat

thestockmarketrespondspositivelytotheadoptionofclose-callshareholderproposals

advocatingthepursuitofeco-friendlypolicies.124Anotherimplicationisthat, following

the issuanceof greenbonds, issuerswould improve their environmentalperformance

(e.g.,thevolumeofCO2emissions).125Infact,asshowedbytheliterature,ifgreenbonds

signal a credible commitment to the environment, this should, in the end, result in

improvedenvironmentalperformance.Inaddition,followingtheissuanceofgreenbonds,

an increase in long-term green investors is expected. In fact, if companies can

123 FlammerC.(2020)-CorporateGreenBonds.QuestromSchoolofBusiness,BostonUniversity.124 Flammer,C.(2015)-Doescorporatesocialresponsibilityleadtosuperiorfinancialperformance?Aregressiondiscontinuityapproach.ManagementScience61,2549‒2568.125 FlammerC.(2020)-CorporateGreenBonds.QuestromSchoolofBusiness,BostonUniversity.

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demonstratetheircommitmenttotheenvironmentbyissuinggreenbonds,theyexpect

moreenvironmentallysensitiveinvestorstobestimulatedtoinvest.

Fromafinancialpointofview,greenbondshavethesameriskandreturncharacteristics

astraditionalbonds,butregardingtheissuers,theycanborrowcapitalbypayinglower

interest thantraditionalbank loans. Inaddition,anotherkeybenefitof this innovative

instrument is that it allows to raise large amounts of capital to finance ambitious

environmentalprojects,giventhatotherfinancinginstrumentswouldnotbesocheap.

Oneofthemostcommonlycitedchallengestotheexpansionofgreenbondmarketsata

nationalorglobalscalewas the lackofastrictagreementupon thedefinitionofwhat

‘green’ is.126AlthoughvoluntaryprinciplessuchastheGreenBondsPrinciplesandthe

ClimateBondStandardshaveattemptedtoresolvethischallenge,itappearsthattheissue

is not completely resolved, as the guidelines are notmandatory and tend to focus on

procedures.127Inaddition,transparencyandreportingareoftenweakand,inafewcases,

voluntarilybetter. Inanycase,as themarketgrows, theseaspectswillbe increasingly

importantandgloballysharedinamoreuniformway.

Thelackofadefinitionofwhatgreenis,isstrictlyconnectedtoanotherdisadvantageof

theGreenBondsMarket,thesocalled“Greenwashing”.

As stated by several studies, such as Berrone, Fosfuri, andGelabert (2017), Lyon and

Montgomery(2015),Marquis,Toffel,andZhou(2016),“greenwashing”isthepracticeof

making unsubstantiated or misleading claims about the company’s environmental

commitment.Moreover,FlammerC.(2020)definedthat“thegreenwashingconcernroots

inthelackofpublicgovernanceofgreenbondsandthegreenbondmarketreliesonprivate

governance regimes such as the certification standards described in the previous

paragraphs”.128 Thesemethodsofregulatingmarketgovernanceprivatelydonothavethe

sameeffectsaspublic regulationenforcementmechanisms.Despite thestronggrowth

andasteadilygrowingshare,thesizeofthegreenbondmarketremainssmallcompared

tothetotalbondmarket.Oneofthefactorslimitingexpansionisthelackofliquidity.

However,theproblemoflackofliquidityisexperiencingpositivesignsinrecentyears.In

fact,theincreasingemissionsarehelpingtostrengthentheliquidityprofileandtocreate

126 DuPont,C.,Levitt,J.andBilmes,L.(2015)-GreenBondsandLandConservation:TheEvolutionofaNewFinancingToolFacultyResearchWorkingPaperSeries.KarvardKennedySchool.127 PeterCripps(2017)-HowtogrowtheUSgreenbondmarket.EnvironmentalFinance 128 FlammerC.(2020)-CorporateGreenBonds.QuestromSchoolofBusiness,BostonUniversity.

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opportunities forportfolio investment.Anotherpositivesign in this framework is that

liquidity in the secondary market improved during 2019 thanks to France’s “jumbo”

transactionandthecreationofliquidgreenbenchmarksincountriessuchasIreland.

Finally,therisksofgreenbondsaresimilartothetraditionalbonds’ones:theinvestors

aresubjecttothedefaultriskoftheissuerwhoisnotabletogeneratesufficientcashflows

torepaytheprincipalandpayinteresttoinvestors.Ifthishappens,thecreditratingofthe

issuerswillbenegativelydowngradedforalongtime,especiallyinregulatedmarkets.

Otherrisksalsodependonthestructureofthebond.Forexample,bondswithvariableor

index-linked interest rates may, as appropriate, benefit one and disadvantage the

counterparty.Variabilityintaxationcanalsoactasdisincentiveforinvestors,especially

ifhighratesoftaxationarepresent.

3.4.1The“greenium”ofGreenBonds

The green bond issuance process is “similar to that of a regular bond,with an added

emphasisongovernance,traceabilityandtransparencydesignedto increaseinvestors’

confidence in the green credentials of the bond”.129 In general, the structure of green

bonds is similar to their brown equivalents and, for this reason, they are not more

expensive than conventional vanilla bonds.However,whatmakes a green bondmore

cost-effective than a traditional bond is the cost that ariseswhen the bond has to be

verifiedbyathirdparty,fromthemonitoringandreportingprocess.

Regarding the pricing of green bonds, the literature shows different opinions among

researches.Inparticular,manypapersandarticlesstudythepricingintheprimaryand

secondarymarketinordertodiscoverifagreenbondyielddiscountexists(alsoknown

as“greenium”).Ononeside,manyacademicarticlesshowedthatintheprimarymarket

thereisnogreenyielddiscount.LarckerandWatts(2020)examinedmatchedpairsof

greenandnon-greenmunicipalbondsandshowedthatwhenrisksandreturnsareheld

129 LiawThomasK.(2020)-SurveyofGreenBondPricingandInvestmentPerformance.TobinCollegeofBusiness,St.John’sUniversity,Queens,NY11439,USA

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constant,municipal investors view green and non-green bonds by the same issuer as

almostexactsubstitutesandthus,theyconcludethatthe“greenium”isessentiallyzero.130

Östlund(2015)“analyzesthespreaddifferentialsbetweengreenandconventionalbonds

of the same issuer to find out whether investors exhibit a green preference. As the

previousarticle,heconcludesthat“thereisnotevidenceofa“greenium”andinsteadhe

shows that green bonds are traded at a discount compared to their conventional

counterparts”.131

Ontheotherside,manyacademicpapersshowedanevidenceofa“greenium”.

NanayakkaraandColombage(2019)analyzethepricingdifferencebetweengreenbonds

and conventional bonds. In particular, they use option-adjusted credit spread to

investigate if investors are willing to pay a premium price for green bonds over

conventional bonds.132 The results of their analysis shows that green bonds have a

“greenium”.Bakeretal.(2018)studyUSmunicipalgreenbondsandfindthatmunicipal

greenbondsarepricedatapremiumtosimilarordinarybonds.KapraunandScheins

(2019)“consideralargesampleofover1500greenbondsissuedworldwideandestimate

thedifferencesinyieldsofgreenandcomparableconventionalbonds”.133Theanalysison

primarymarketshowsasignificant“greenium”forGreenBonds.However,theyshowalso

that this particular yield varies across issuers, currencies, andmaturity. Green bonds

issuedbysecuredentitiesorgreenbondsissuedinspecificcurrenciesarepricedatlower

yields.

Finally, the Climate Bonds Initiative (CBI) provides every year a report regarding the

pricingofGreenBonds in theprimarymarket.Their studies indicate that somegreen

bondsarepricedbelowwhilesomeothersarepricedonorabovetheirownyieldcurve

andthus,thereisnoguaranteethatgreenbondsbenefitfromalowercost.134Ingeneral,

the conflict among researchers is explained by the differences in data selection,

130 Larcker,DavidF.,andEdwardM.Watts(2020)-Where’sthegreenium.JournalofAccountingandEconomics6:101312. 131 Östlund,Emmi(2015)-AreInvestorsRationalProfitMaximizersorDoTheyExhibitaGreenPreference?—EvidencefromtheGreenBondMarket.Master’sthesis,StockholmSchoolofEconomics,Stockholm,Sweden.132 Nanayakkara,Madurika,andSisiraColombage(2019)-Doinvestorsingreenbondmarketpayapremium?Globalevidence.AppliedEconomics51:1–13.133 Kapraun,Julia,andChristopherScheins.(2019)-(In)-CrediblyGreen:WhichBondsTradeataGreenBondPremium?WorkingPaper.Frankfurt:GoetheUniversitätFrankfurt.134 LiawThomasK.(2020)-SurveyofGreenBondPricingandInvestmentPerformance.TobinCollegeofBusiness,St.John’sUniversity,Queens,NY11439,USA

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maturities,methodologies,ratings,currencies,andthecharacteristicsoftheissuingentity

andthebond.

Regardingthesecondarymarket,thereisevidencethatconcernsaslight"greenium",with

apriceadvantageinfavorofgreenbonds,especiallythankstoanincreasingdemandwith

respect to the available supply. Another explanation for the price advantage in the

secondarymarket is due to the lower volatility of the green bond price compared to

traditional.However,thestudiescarriedoutregardingthepresenceofagreenbondyield

discount on the secondary market are not conclusive, due to the differences on the

composition of the green bond indexes. Indices have the ability to allow investors to

investinaportfolioofgreenbondsinordertodiversifythespecificrisksofthecompany

while maintaining green investments. The most important green bond indices are:

Solactive Green Bond Index, S&P Green Bond Index, BofAML Green Bond Index, and

BloombergBarclaysMSCIGreenBondIndex.Eachoftheseindexescomprisesdifferent

portfoliosofgreenbondsandforthisreasonthereturnsoftheseindexes(seeFigure30)

donotshowanypattern.135

Figure30:PerformanceofGreenBondindexes.Source:Bloomberg

Inconclusion,itcanbearguedthatthepriceofgreenbondsissimilartotraditionalbonds.

Usually,theissuepriceisthesameasaconventionalbond,astheriskcharacteristicsare.

This is because they are basically the same as traditional bonds, they only have a

particularpurposeandreportingobligations.Inthiscontext,EhlersandPacker(2017)

135 LiawThomasK.(2020)-SurveyofGreenBondPricingandInvestmentPerformance.TobinCollegeofBusiness,St.John’sUniversity,Queens,NY11439,USA

79

arguethat“moreconsistentstandardsforissuinggreenbondsacrossjurisdictionswill

helpfurtherdevelopingthemarket”.136

3.5GreenBondMarketinItaly

MorethanhalfofItalianissuersdebutedin2017althoughtheItaliangreenbondmarket

was launched in2014withoffers fromthemulti-utilitycompanyHeraandtheenergy

companiesEnnaEnergia and Innovatec. Energy companies dominate themarketwith

77%oftotalemissions.Withinthesector,73%ofemissionscomefromenergycompanies,

aquarterofutilitiesand2%ofgridcompanies.

In2017,IntesaSanpaolobecamethefirstItalianbanktoenterthemarketwithagreen

bondof500millioneurosforrenewableenergysourcesandgreenloansforconstruction.

The firstpublic sectoragreementcamewithFerroviedelloStato Italiane, thenational

railwaycompany,with94billioneurosofinvestmentidentifiedinthecompany's2017-

2026 business plan. In terms of composition, 70% is allocated to renewable energy;

transport has reached 20% and the rest of the proceeds are distributed between

buildings,waterandwaste.ThediversityofdebtinstrumentsisalsoemerginginItaly:

theenergycompanyTernaissuedthefirstgreenprojectloantofinancetheTacuarembo

TransmissionLineinUruguayandattheendof2017Enelissueda5.6millioneurogreen

bondtofinancetwowindenergyprojectsinItalyandBrazil.Thisisalsothefirstcertified

Italianagreementonclimateconstraints.

BorsaItalianaplaysanactiveroleinpromotingthedefinitionofinformationstandards

abletopromotethedevelopmentofGreenBonds.Infact,itisamemberoftheClimate

BondsInitiativethroughtheLondonStockExchangeGroupandisoneoftheobserversof

theGreenBondsPrinciplesoftheICMA,InternationalCapitalMarketsAssociation.137

Moreover, it hasmade available to themarket a series of tools to better identify and

analyze the world of sustainable finance, in particular the list of green and social

instrumentstradedontheMOTandExtraMOTmarkets.Infact,startingfrom13March

136 Ehlers,Torsten,andFrankPacker(2017)-Greenbondfinanceandcertification.BISQuarterlyReviewSeptember:89–104.137 BorsaItaliana(2020)

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2017,BorsaItalianadecidedtoofferinstitutionalandretailinvestorstheopportunityto

identifytheinstrumentswhoseproceedsareallocatedtothefinancingofprojectswith

specific environmental benefits or impacts (green bonds and/or social bonds). The

identification requires the initial certification by an independent third party and the

renewal,atleastannually,oftheinformationregardingtheuseoftheproceeds.

3.5.1ExampleofGreenBond–EnelS.p.A.

EnelS.p.A. isamultinationalenergycompanyanda leading integratedoperator inthe

global electricity and gasmarkets,with a particular focus on the European and Latin

American markets.138 The Enel group is present across 35 countries, it manages the

productionof84.9GWofcapacityanditdistributeselectricityandgasthroughanetwork

ofapproximately2millionkilometers.

Enelinvestedalotintherenewableenergysources,researchanddevelopmentofnew

greentechnologies.Infact,ithasrecentlychangeditspositioninthemarket,committing

itselftophaseoutnewinvestmentsincoalandnaturalgas.

Beingaware thatenergy fromrenewablesources is thekey toasustainable future, in

2016itcreatedEnelGreenPower(EGP),acompanydedicatedtothedevelopmentand

managementofcleanenergy.EnelGreenPowerispresentin5continentswithover1,200

plants and has a managed capacity of over 42 GW (over 14GW in Italy) including

photovoltaic,wind,hydroelectricandgeothermal.Fromafinancialpointofview,Enelis

included in the most important sustainability indexes such as the Dow Jones

SustainabilityIndexWorldandtheFTSE4GoodandithasbeenincludedbyCassaDepositi

e Prestiti in the A list, among the best companies that have demonstrated to have

implementedavalidapproachtoclimatechangemitigationandinformationdisclosure.

Enelhasplacedenvironmental,socialandeconomicsustainabilityasthefoundationofits

corporatecultureanditisimplementingthedevelopmentofasustainablesystembased

on thecreationofsharedvalue,both insideandoutside thecompany. In linewith the

2018strategicplan,duringthe2017,EnelhaslaunchedthefirstgreenbondinEuropefor

138 Enel(2020),link:https://www.enel.com.co/en/the-companies/enel-group.html

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institutionalinvestors.Inparticular,thegroupissued1.25billioneurosandincludedthe

repaymentinasingleinstallmenton16September2024withthepaymentofafixedrate

coupon of 1%, payable annually starting from 2018. The issue price has been set at

99.001%andtheeffectiveyieldtomaturityisequalto1.137%.139Thegreenbondwas

issuedby“EnelFinanceInternationalNV,awhollyownedsubsidiaryofEnelS.p.A.(Enel,

ratedBBB+ forS&P's,Baa2 forMoody's,andBBB+ forFitch)andwasreserved for

institutionalinvestorsandsupportedbyaguaranteeissuedbyEnel”.

ThegreenbondhasbeenlistedontheregulatedmarketsoftheIrishandLuxembourg

stockexchangesandisadmittedtotradingonthe"ExtraMOTPRO"multilateraltrading

facilityorganizedandmanagedbyBorsaItaliana.

Attheendof2019,EnelS.p.A.placedthreegreenbondsontheEuropeanmarketfora

total of 3.50 billion euros, through its subsidiary Enel Finance International NV. In

additiontotheGreenBondjustdescribed,twootherGreenBondswereissued,thefirst

in2018(1.25billioneuros)andthesecondin2019(1billioneuros).BothGreenBonds

areintendedforinstitutionalinvestorsandguaranteedbyEnelSpA.Netproceedsfrom

theissuehavebeendedicatedtoprojectsinlinewiththeGreenBondsPrinciples.

Inparticular, as it ispossible to see fromGreenBondReport2019publishedbyEnel

S.p.A.:

- Green Bond 2017 (see Figure 31): new projects for the construction and

repoweringofplantsfortheproductionofelectricityfromrenewablesources.

139 Enel(2020),Link:https://corporate.enel.it/en/media/press/d/2017/01/enel-group-launches-its-first-green-bond-totalling-1250-million-euros-on-european-market-

82

Figure31:InvestmentineurosandtheshareofGreenBondproceedsin2017.Source:EnelS.p.A.

- Green Bond 2018 (see Figure 32): new projects for the construction and

repoweringofplantsfortheproductionofelectricityfromrenewablesourcesand

transmission,distributionandsmartgridprojects.

83

Figure32:InvestmentineurosandtheshareofGreenBondproceedsin2018.Source:EnelS.p.A.

- GreenBond2019(seeFigure33):projectsinnewinnovativeinfrastructures.

Figure33:InvestmentineurosandtheshareofGreenBondproceedsin2019.Source:EnelS.p.A

.

84

4.CHAPTER:GREENBONDS:ANALTERNATIVESOURCEOFFINANCING?ANEMPIRICALEVIDENCE

Theaimofthisdissertation,andinparticularofthischapter,istoanalyzewhetherthe

issueofagreenbondcanbeavalidalternativetotheconventionalsourcesoffinancingin

therenewableenergymarketinItaly.Inordertodoso,thechapterisstructuredasfollow.

Thefirstpartisdedicatedtothedescriptionofthemostconventionalsourceoffinancing

intherenewableenergyindustryinItaly,theprojectfinance,studyingasthisinstrument

iscomposed,theactors,thestagesanddocumentsrequired,themostcommonfinancial

covenantsrequestedbybanksandfinallythedifferentmethodsusedasvaluationproject.

ThesecondpartdescribestherenewableenergysectorinItaly,thedevelopmentofthe

lastyearsandthedescriptionoftheincentivemechanisms,whichrepresentasignificant

componentforthesector.

Inthelastpartofthechapter,anempiricalanalysisisproposed.Inlightofwhat

discussedinthepreviouschapters,theanalysisisconductedinordertoevaluateifitis

economicallyconvenientissuingagreenbondratherthanusingtheprojectfinance

instrument.Theanalysisisconductedontherefinancingprocessofahypotheticalwind

farmcompany,comparingthetwoscenariosinatimevalueof10yearsthroughthe

forecastofProfit&Loss,BalanceSheetsandCashFlowstatements.Finally,theanalysis

concludeswiththeNPVoftheprojectforbothscenarios,highlightingthedifferent

WeightedAverageCostofCapitalusedasdiscountrate.

4.1ProjectFinance

Theliteratureonstructuredfinanceandonprojectfinanceisveryextensive.Connected

totheterm“projectfinance”thereisawiderangeoffinancialinstrumentsandtechniques

withtheaimoffinancingspecific investmentprojects.Forthisreason, it isnoteasyto

define this tool ina simpleway.The current literatureplaces the financingof a given

project as fundamental characteristic of project finance. This type of financing is

guaranteed, not by the sponsor of the initiative, but from the specific project of the

financingand,therefore,initsabilityandcredibilitytogeneratecashflow.

85

Theprojectfinance,beingasourceoffinancing,hasthepurposetofinancebothpublic

andprivateprojects.Therearetwokeymodelsofprojectfinancingappliedtothepublic

sector:

- B.O.T.(Build,OperateandTransfer):“thepublicsectorgrantorgrantstoaprivate

companytherighttodevelopandoperateafacilityorsystemforacertainperiod

(the"ProjectPeriod"),inwhatwouldotherwisebeapublicsectorproject.”140

- B.O.O.(Build,OperateandOwn):inwhichaprojectcompanybuildsandmanages

agivenworkremainingtheowneroftheproperty.Thisschemecanalsobeapplied

towhollyprivateinitiatives,wherethereisnopublicconcessionact.

Incaseswherethegovernment is thesponsor, the longestestablishedmethodused is

B.O.T..141Theperiodbetweenoperatingandtransferofownershiptothesponsorenables

theprojectcompanytorecoupthe initial investment.142AsstatedbyMawutor(2014),

B.O.T.mighttaketwoforms,B.L.T.(Build,LeaseandTransfer)andB.O.O.(Build,Ownand

Operate).WithB.L.T.“Thearrangemententitlesthesponsortoleasetheprojectfromthe

contractor for a given period of time after which the sponsor takes full and final

possessionoftheprojectaftertheexpirationoftheleaseagreement”.143

Giventhenatureoftheprocess,projectfinancehasbecomethemaintoolinpublic-private

partnership(P.P.P.).

The economic revolutionmarkedbyproject finance is characterizedby the transition

fromasubjectivetoanobjectivevisionofthefinancial intervention144: fromcorporate

financetoprojectfinance.Themaindifferencebetweenthetwoapproachesliesinthe

operationsautonomyofprojectfinance:if,fromacorporate-orientedpointofview,the

lendercanrelyontheoverallassetsofthepromoteroftheinitiativetorepaytheamounts

140 WorldBank(2020)-Link:https://ppp.worldbank.org/public-private-partnership/agreements/concessions-bots-dbos#BOT_projects 141 MawutorK.M.J.&KwadwoO.(2014)-TheRoleofProjectFinanceinContemporaryFinancing:“TheoreticalPerspective”142 Sabramanianetal(2007)–TheparadoxofCapital,FinanceandDevelopment,aquarterlymagazineoftheIMF143 Hoffman,S.L.,(2001)-TheLawandBusinessofInternationalProjectFinance,2ndEd.,NewYork,TransnationalPublishers,Inc.&TheHague,TheNetherlands,KluwerLawInternational.144 Sambri,S.M.(2013)-Projectfinancing:lafinanzadiprogettoperlarealizzazionedioperepubbliche.Padova:CEDAM.

86

lent, in a project-oriented perspective, it has as a guarantee only the progress of the

projectfinanced.

Intheprojectfinance,theprojectassumeslegalautonomywithrespecttothecompanies

promoting the initiative and the aim is to create a separatemarketwhoseprofits are

intendedtorepaythedebtfortheimplementationoftheinitiativeandtheremuneration

ofcapital.

The use of project financing has some specific organizational and contractual

implications.Infact,thefinancingisnotdirectedtoapre-existingcompanybutisdirected

to a newly established company (“SPV” - Special Purpose Vehicle), whose exclusive

purposeistheimplementationandmanagementoftheprojectitself.TheSPVisalegally

distinct entity from the project promoter, with the resulting separation of the flows

generatedby theproject fromthoserelated to theotheractivitiesof thesponsor.The

twofoldresultisthat,intheeventofdefaultoftheproject,thelenderwillnotbeableto

relyonassetsofthepromoterotherthanthoseownedbytheprojectcompany(SPV)and,

symmetrically,intheeventofbankruptcyofthesponsor,theSPVwillcontinuetoexist.

In addition, the establishmentof a SPVallows the financing institutions to apply very

strict control formulas and the imposition of contractual and corporate constraints

necessaryforthestructuringofaprojectfinancingoperation.

Finally,itisfundamentaltohighlightshowtheinterestshavetobepaidtolenders.On

project finance loans, the interest rate (called also “margin”) is often adjusted “at the

currentwholesalemarketrateatwhichthelendersraisetheirfunding”145(inthisthesis,

IhaveusedtheEuribor6months).Inthisway,theinterestrateisa‘floating’raterather

thanafixed.

Inthisframework,inordertomitigatethefloatinginterestraterisks,companiesusually

useinterestratehedgingarrangements.AsstatedbyYescombe(2014),“thecommonest

typeofhedgingusedinprojectfinanceisinterest-rateswapsandinthisagreementone

partyexchangesanobligationforpaymentofinterestonafloating-ratebasistoonefor

paymentatafixedrate,andtheotherpartydoestheopposite.”Infact,itistypicalina

project finance operation that the SPV pays to the bank (the “swap provider”) “the

differencebetweenthefloatingrateandtheagreed-uponfixedrateifthefloatingrateis

145 Yescombe,E.R.,(2014)-PrinciplesofProjectFinance,2ed.,Elsevier.

87

belowthisfixedrate”.Ifthefloatingrateisgreaterthanthefixedrate,theswapprovider

hastheobligationtopaytheSPV.

IftheSPVwantstopaythedebtbeforetheexpirydate(itisusualincaseofrefinancingof

the old debt, as it will be analyzed in the last paragraph of this chapter) the swap

arrangementhastobe“broken”andtheswapproviderhastoenterintoanotherswapin

ordertobalance.

The difference between the original fixed rate and the new fixed rate, called the

“breakage”cost,representsalosstothe originalswapprovider.146

4.1.1.ProjectFinanceActors A project financing operation is characterized as a complex organization in which

different actors are involved and aim to meet the economic expectations of each of

them.147

Figure34:ProjectFinanceactors.

Typically,theactors,orsubjects,oftheprocess(seeFigure34)are:

146 Yescombe,E.R.,(2014)-PrinciplesofProjectFinance,2ed.,Elsevier. 147 Mariani,Menaldi&Associati.(2012)-Ilprojectfinancing:analisigiuridica,economico-finanziaria,tecnica,tributaria,bancaria,assicurativa.Torino:Giappichelli.

88

- SPV(SpecialPurposeVehicle)

- Sponsors

- Banks

- PublicActors

- InternationalFinancialInstitutions

- Suppliers

- IndependentTechnicalAdvisors

Belowananalysisforeachactor:

SPV

Asdescribedinthepreviousparagraph,projectfinancerequiresthecreationofanadhoc

companywhosesolepurposeisthe implementationandmanagementofthe initiative:

theprojectcompany.Thisvehiclenotonlyhasalltherightsrelatedtotheoperationbut

alsoitislegallydistinctfromthesponsor.Inthiswayaneconomic-patrimonialseparation

canberealized(theso-calledringfence)betweentheflowsgeneratedbytheprojectand

thosefromotheractivitiesofthesponsor.TheSPVinstrumentqualifiesthefinancingas

anoff-balanceoperation.

Sponsors

The sponsors are private companies or public institutions that, once identified an

investmentopportunity,decidetostartaprojectfinancingoperationbyestablishingthe

projectcompany. Thesponsorsaretheprojectplanners, theoperators“responsibleto

initiate,develop,completeandactivelyparticipateinthemanagementoftheproject”148.

Themotivationsthatdrivebothprivateandpublicinstitutionstowardsprojectfinance

are;• forpublicadministrations,toensurethecommunityaservicethatwouldnotbe

eligibleforfunding

• forprivatecompanies,toseizeanexcellentinvestmentopportunity.

Inbothcases,duetothecomplexityofthestructureandthesignificantlyhighcostofthe

operation, thesponsorsadoptproject financesolutionswhenother financingmethods

148 Esty,B.&A.SesiaJr.,(2005)-AnOverviewofProjectFinance,HarvardBusinessSchoolCase

89

arenotpracticable.Theequitycontributionplaysavery importantroleas itallowsto

support and finance the activities of study, design, and analysis of feasibility of the

initiativetillthepreparationofthebusinessplantobesubmittedtotheinvestors.

Banks

Bankinginstitutionsaretheprotagonistsofaprojectfinancingoperationbecausethey

areoftentheownersofthemajorityofthethird-partycapitalthatfinancestheproject.

Usually,theprojectsfinancedrequiresstronginvestmentsandforthisreasonitisusual

to require the intervention of a pool of banks led by one of them, characterized by

internationalstandingandhighspecializationinthefieldofprojectfinance.Thissubject

iscalledthearranger.

Thearrangerguidesthenegotiationactivityoftheoverallsizeandcontractualtermsof

the financing between the project company and the sponsors. It also has the role as

coordinatorofthepoolofbanks.Moreover,an"agentbank"shouldbeselectedwithinthe

bankingpool.Theagentbankhasthepowerofadministrationandcontroloftheflows

generatedbytheoperation.Inaddition,thisbankoftenassumestheroleofcontrolling

the deviations between the financial results recorded and the flows provided by the

businessplan.

Finally, the sponsors and SPV rely on the advisor in order to assess and confirm the

reliabilityoftheproject:theadvisorprovidesaconsultancyserviceintheformationof

theproject, inorder toevaluate the financialelements thatmake it reliable forbanks.

Advisorsusuallyproposetothebanksaseriesofanalysesbasedonindicesthatwillbe

studiedinthenextparagraph.

PublicActors

Publicactorsplayakeyroleinthesuccessofaprojectfinancingoperation.Infact,when

the public actor is not involved as a sponsor, itmonitors some characteristics of the

projectthatinfluencethefinalinitiative:inparticular,characteristicsasadministrative

authorizations,tariffpoliciesandthestabilityofthelegalandinstitutionalframework.In

mostcases,thegovernmentinstitutionsserveastheclientsandsponsorsconcurrently149.

149 Fight,A.(2006)-IntroductiontoProjectFinance.EssentialCapitalMarkets.Elsvier1stEdition.

90

InternationalFinancialInstitutions

This includes supranational organizations whose mission is to promote economic

development, particularly in developing countries. Within an operation of project

financing,theycanassumeboththeroleofsponsor,givingtheriskcapitaltotheSPV,and

theroleofbank,financingtheinitiativeatfavorableconditionscomparedtothemarket.

Commercialbanks,andmultilateralinstitutessuchastheCAF,IFC,IMF,playsucheminent

roles in project finance thereby making them the real participating financiers in

developedandemergingmarkets.150

Suppliers

Suppliersaretheentitiesthat,onthebasisofcertaincontracts,providetheinputstocarry

out the project. The contractor, on the other hand, is the subject of the project that

operates with a strictly defined budget of available resources and bears the primary

responsibilityincaseofdelaysintheimplementationoftheproject.

IndependentTechnicalAdvisors

Technical consultants may be requested by the SPV, the sponsor or other subjects

involvedintheprocess,inordertoevaluatethefeasibilityoftheprojectfromatechnical

pointofview.Thequalityoftheprojectisfundamentalfortheoperation,beingtheproject

atthecenterofthefinancing.

4.1.2TypicalProjectFinanceTransaction

Aprojectfinancingoperationisdividedintoseveralphases.Eachphaseischaracterized

by the development of specific relationships between the subjects described in the

previousparagraph.Despitethedifferentscenariosthatprojectfinancecanassume,itis

possibletodescribeastandardprocessdividedindifferentstepsoftheoperation(see

Figure35).

150 Taylor(2003)

91

Figure35:TypicalProjectFinanceProcess.Source:personalelaboration

Inthefirstphase,thesponsorspreparetheinitiativedrawingupaseriesofdocuments.

Thefirstisthefeasibilitystudyoftheproject,whichfocusesonestimatingboththepay-

backperiodandtheabilityofcashflowstorepaydebtandcapital.Moreover,itprovides

informationonhowtoacquirethenecessarypublicconcessions.Anotherkeydocument

istheMemorandumofUnderstanding,whichdefinesthecontractualpartoftheinitiative

highlightingtherelationshipsandthedistributionofrisksbetweenthepartiesinvolved.

According toGraham (2005), “thememorandumof understanding is a document that

containsmanagement’sestimationoftheprojectsexpenditurerevenuetermsheet,and

other relevant information in relation to the project”. This is a phase of negotiation

betweentheparties(investors,sponsors,projectcontractcounterparts)involvedinthe

implementation of the project, with variable duration and aimed to reach an optimal

distributionofriskamongthem.Thisstageincludesthenegotiationandpreparationofa

seriesoflegaldocuments.

ThesecondphaseischaracterizedbytheconstitutionoftheSPV:firstofall,theanalysis

ofadvisors isstudiedfroma legalandtechnicalperspective, inordertostructure ina

definitivewaytheoperationinallitsaspects.Atthisstage,theSPV,withtheassistanceof

legal and financial advisors, draws up the project’s information memorandum. The

informationmemorandumisafundamentalinformationdocumentthatallowstheSPV,

with the direct support of the sponsor(s), to promote the initiative with potential

FeasibilityoftheProject

Memorandumof

Understanding

ConstitutionofSPV

LoanAgreement

92

investors.Thisdocumentusuallycontainsinformationsuchastheproject’sfinancialand

operationalplan,costsandrevenuesstructure,descriptionofthetechnologyused,etc..

The next step is the loan agreement, through which the banks undertake to pay the

funding to support the implementation of the project. After the signing of these

documents, thenextstage correspondsto theconstructionof theprojectand it is the

mostrisky.

Finally,builttheworkandstandardizeditsmanagement, it isusuallystipulatedanew

debttopaytheprevious,linkedtotheconstructionoftheproject,financingthecurrent

management.

4.1.3ProjectValuation

In a typical project financing transaction, the analysis for financial evaluation is an

essential tool to promote the initiative and, at the same time, to convince banks and

investors to take part in the project and consequently to establish the necessary

guarantees.

Thevaluationofaprojectisbasedonthedeterminationofcashflowsgeneratedbythe

project,beforefinancialchargesbutaftertax.Infact,aswewillseeintheanalysismodel

proposed in the following paragraphs, the analysis focuses on the estimation of the

operatingcomponentsoftheprojectcashflow,inwhichthedifferencebetweenincome

andexpensesbeforethefinancialcomponentsareincludedinthecashflowstatement.

Thecashflowanalysisshowsthataprojectissustainableonlyaccordingtothesizeand

the variability over time of the cash flows generated by the project in order to repay

investorsandshareholders.Inaddition,theinvestorscannotrely,inthecaseoflimited

recourse,onthesponsorsforthesatisfactionoftheircredit.Forthisreason,thecashflows

analysisofanoperationiscrucial,asithasaparticulartrendrelatedtothelifecycleof

theprojectitself.

In the construction phase, in the absence of revenues, the project cannot generate

revenuesorcashinflows(seeFigure36)duetothestronginvestmentsthatcharacterize

therealizationoftheproject151.

151 V.Khmel,S.Zhao(2016)-IATSSResearch39,138–145

93

Figure36:OperationalCashFlowtrendinProjectFinance.Source:Khmel&Zhao(2016)

Regardingtheindexesusedtoassessthefeasibilityoftheproject,theyarecalculatedin

ordertomaketheinitiative"bankable".Theterm"bankability"referstotheabilityofa

projecttopresentstructural featuresthatdemonstrateanacceptablerisk/returnratio

forthelenders.

Theindicatorstakenintoaccountforthesepurposesare:

- DebtServiceCoverRatio(DSCR)

- LoanLifeCoverRatio(LLCR)

- Debt-to-EquityRatio(D/E)

TheDSCRiscalculatedastheratiobetweenCashAvailableforDebtServiceandtheDebt

Service(principalandinterestpluscommissions).Thisvalueiscalculatedforeachyear

(orsemester)oftheoperationallifeofaproject.Itisnotcalculatedintheconstruction

periodiftheprojectfinancialstructureissetcorrectly.

Thepurposeofthisindicatoristoreportthecapacityoftheprojecttogenerateoperating

cashflowstocoverdebtservice.Iftheindexisequaltoone,itmeansthattheinvestment

generatessufficientresourcestocoverthedebt.Avaluegreaterthanoneindicatesthe

possibilitynotonlytorepaythefinancingbutalsotopaydividendstoshareholders.

94

𝐷𝑆𝐶𝑅 =𝐶𝐹𝐴𝐷𝑆𝐷𝑆

Where:

• CFADS:CashFlowAvailableforDebtService

• DS:TotalDebtService(Principal,InterestsandCommissions)

TheLLCRhasasimilarmeaningtotheDSCR,butithasamorecomplexcalculationandit

islessimmediateininterpretation.

TheLLCRiscalculatedbytheratioofthesumofavailablediscountedcashflowsbetween

thetimeofthevaluationandthelastyearofrepaymentofthedebtandthetotalamount

ofoutstandingdebt.Itrepresentstheamountofcashflowsthatlenderscancountonto

meetthedebtrepayment. Anindexvalueequaltoonerepresentsstability.Thehigherthe

value,morefinanciallyprofitabletheinvestmentwillbe.

𝐿𝐿𝐶𝑅 = ∑ 𝐶𝐹𝐴𝐷𝑆!

(1 + 𝑖)! + 𝐷𝑅"!#$

𝑂!

Where:

• CFADS:CashFlowAvailableforDebtService

• t:Thetimeperiod

• s:Thenumberofyearsexpectedtopaythedebtback

• i:TheWACC(WeightedAverageCostofCapital)expressedasinterest.

• DR:Cashreserveavailabletorepaythedebt(thedebtreserve)

• O:Thedebtoutstandingatthetimeofvaluation

AsstatedbyYescombe(2014),ahigherD/ERatioistheessenceofprojectfinance.The

debt-to-equity ratio identifies in a company the relationship between total corporate

liabilitiesandequityand it isa typicalratioapplicatedbybanks inorder tostudy, for

example,thefinancialsustainabilityofacompany.Fromamathematicalpointofview,the

formula can be derived just as the relation between debt and equity capital, but it is

usuallycalculatedalsoasfollow.

𝐷𝑒𝑏𝑡𝑡𝑜𝐸𝑞𝑢𝑡𝑦𝑟𝑎𝑡𝑖𝑜 =𝐷𝑒𝑏𝑡

𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

95

Themostcommoninstrumentsusedtoevaluatetheeconomicvalueofaninvestmentare

theNPV(NetPresentValue)andtheIRR(InternalRateofReturn).

Thenetpresentvalue(NPV)ofaprojectisthesumofthepresentvaluesofeachofthe

cashflows,positiveaswellasnegativethatoccuroverthelifeoftheproject.152

𝑁𝑃𝑉 = >𝐶𝐹!

(1 + 𝑟)!

%

!#&

Where:

• CF=CashFlowinperiodt

• r=Discountrate

• N=Lifeoftheproject

TheNPVrepresentsincrementalprofitability,whetherapositivevalue(NPV>0)and,if

itisnegative(NPV<0),itrepresentsthedestructionofvalue,generatedbyaninvestment,

expressedasifitwereavailableatthetimeofthevaluation.

Thediscountrateusedrepresentsthecostofcapitaltofinancetheinvestment.Indeed,it

isused theWACC (WeightedAverageCostofCapital),which represents theweighted

averagecostofthird-partycapitalandequity.AssociatedtotheWACCarethetaxbenefits

of the debt,more concretely in the use of the after-tax cost of debt and the expected

additionalriskthatderivefromthisissuanceofdebt,intheformofhighercostsofequity

anddebtathigherdebtratios.153

𝑊𝐴𝐶𝐶 = 𝐾' ∗ 𝐸

𝐸 + 𝐷 +𝐾( ∗ 𝐷

𝐸 + 𝐷 ∗ (1 − 𝑡)

where:

• 𝐾! =CostofEquity

152 DamodaranA.(2016)-AppliedCorporateFinance,FourthEdition,Wiley,Hoboken,NJ153 DamodaranA.(2002)-InvestmentValuation:ToolsandTechniquesforDeterminingtheValueofAnyAsset,NewYork:Wiley

96

• 𝐸=Equity

• 𝐾" =CostofDebt

• 𝐷=Debt

• (1 − 𝑡)=Taxshields

Thecostofdebtisthecurrentcostthatthecompanyhastoundertaketofinanceaproject

throughthird-partycapital.Itiscalculatedasfollow:

𝐾( =𝑟) + 𝐷𝑆

Where

• 𝑟#=RiskFreerate

• 𝐷𝑆=DefaultSpread

Thecostofequityrepresentstheaveragereturnexpectedbyshareholderscomparedto

an investmentprojectwithsimilarcharacteristicsandrisks.For thecalculationof this

component different methods are used, but usually the most used one is the CAPM

(CapitalAssetPricingModel).IntheCAPM,allofthemarketriskiscapturedinonebeta,

measuredrelativetoamarketportfolio,whichatleastintheoryshouldincludealltraded

assetsinthemarketplaceheldinproportiontotheirmarketvalue154.

𝐾' =𝑟) + 𝛽 ∗ (𝑟* −𝑟))

where:

• 𝑟#=RiskFreerate

• 𝛽=asstatedbyKolleretal. (2005), “anestimateto theexposureofacompanytothe

marketrisk”.

• (𝑟$ −𝑟#)=theequityriskpremium,whichmeasureswhatinvestorsdemandoverand

abovetherisk-freerateforinvestinginequitiesasaclass.155

TheIRRisdefinedastheratethatmakestheNPVequaltozero,whichmakestheinitial

investmentperfectlyequaltothepresentvalueofallcashflows.

154 DamodaranA.(2016)-AppliedCorporateFinance,FourthEdition,Wiley,Hoboken,NJ 155 DamodaranA.(2016)-AppliedCorporateFinance,FourthEdition,Wiley,Hoboken,NJ

97

>𝐶𝐹!

(1 + 𝐼𝑅𝑅)!

%

!#&

= 0

AsarguedbyDamodaranA.(2016),theIRRhastobecomparedtothediscountrate.“If

theIRRisgreaterthanthediscountratetheprojecthastobeacceptedandviceversa”.156

4.2RenewableEnergysectorinItaly

TherenewableenergysectorinItalygrowsyearafteryearwith17GWofinstalledpower

and42.000Gwhproducedbetweenwind,biomass,hydroelectricandgeothermal (see

Figure37).Inparticular,thegenerationofelectricityfromphotovoltaicrecords20.7GW

installedandatotalof874.520plants.

Photovoltaics,andmoregenerallytheproductionofenergyfromrenewablesources,isa

strategicandprofitableinvestmentforcompaniesintheenergysector,asdemonstrated

bythedataprovidedbyEnelS.p.A.onitsinstalledproductioncapacity:50.2%renewable

plants.

ItalyisoneofEurope’sleadingcountriesintheproductionofelectricityfromRES:itranks

second,behindGermany,bynationalimpactontheEuropeanUniontotal,contributing

10.7%.157

Figure37:RenewableElectricityEnergyinItaly.Source:personalelaboration

156 DamodaranA.(2016)-AppliedCorporateFinance,FourthEdition,Wiley,Hoboken,NJ 157 GSEREPORT-RenewableenergyinItalyandEurope2018

98

InItaly,theenergysectoristheonewheretheprojectfinancingtechniqueismostapplied.

Forexample,in2012thevalueoffinancialclosewas61.081millionofEuros,anincrease

of10.2%comparedtothepreviousyear.Despitebeingmostlyrefinancingoperations,the

new investment sector is driven by the renewable energy market with a value of

operationsof1.2billionofEurosforphotovoltaicand0.5forwindpower.

Investmentsintheenergysector,andmoreparticularlyintherenewableenergysector,

sharecharacteristicsthatvaryfromcasetocase.Indeed,energyprojectstendtobecapital

intensiveandrequiresignificantinvestmentsatthestartoftheinitiative.Theseprojects

are characterized by a long life of the assets. For example, hydropower plants can be

operativeforfiftyyears,exposingtheprojecttogreaterrisksregardingthefuturecosts

andbenefitsofthebusiness.Moreover,thetimesofrealizationoftheworkscanbevery

long,makingriskiertheevaluationofthefeasibilityoftheprojectwithlongmaturity.

The energy sector in Italy attracts the resources of venture capitalists despite these

investmentshavedifferent characteristics compared to thehigh-tech, inwhichVCare

traditionallyusedtooperate.Indeed,projectsinrenewableenergyrequiremorecapital

andmoretimetogenerateprofits.

Theoverallfinancingcanberaisedthroughtheinterventionoflargecompanies,venture

capitalfundsorthecapitalmarketorbankloans.Amongthemostwidelyusedsourcesof

financing,itiscommontouseprojectfinancebutalsofinancingbylargecompanies,the

useofthecapitalmarketandbondissues.

TheEuropeanpoliciesinsupportofrenewableenergiesarefocusedonsupportingthe

development of electricity production from renewable sources. Themostwidespread

incentivemechanismatthegloballevelisthefeed-in-tariff,whichconsistsinthepayment

of anadditionalpriceorabonus foreachKWofelectricityproduced fromrenewable

sources.Inrecentyears,therehasbeenareshapingofthesepoliciesinordertoadaptto

newmarketscenariosand,inparticular,tofacetheeffectsoftheglobaleconomiccrisis:

themajorityoftheincentivetariffsinusehavebeenreducedandtheeligibilitycriteria

forthesystemhavebecomemorestringent.

InItaly,thenationalsystemprovidesthreedifferentsystemstosupporttheproduction

ofelectricityfromrenewablesourcesthataredescribedinwhatfollows.

99

GreenCertificates(CV)

Green certificates (CV) are a form of incentives for the production of electricity from

renewable sources and is based on the obligation to introduce annually a share of

electricityproducedfromplantspoweredbyrenewablesourcesinthenationalelectricity

system.158 Theycanbetradedonthemarketthroughbilateralondedicatedplatforms.

They are recognized to energy producers according to the electricity produced and

technology.

Feed-InTariff(FIT)

“Itisanenergypolicyinstrumenttosupportthedevelopmentofnewrenewableenergy

projects,basedonlong-termpurchasecontractsforelectricityproduced”.159

Utilities,whichowntheelectricitygrid,areobligedtopurchaseelectricitygeneratedfrom

renewablesourcesataratesetbythepublicauthoritiesandguaranteed foraspecific

periodoftime.Thesepurchasecontractsarecommonlysignedfor10-25yearsandthey

covereveryKWhofelectricityproduced.Thecalculationmethodsarebasicallytwo:ifthe

installedpowerislessthan1MW,theall-inclusivetariffwillbebasedonthetechnology

andsize,addedtootherspecificincentives.Iftheinstalledcapacityisgreaterthan1MW,

theall-inclusivetariffwillbereducedbythezonalhourlypriceandaddedtootherspecific

incentives.

ContoEnergia(CE)

The Conto Energia (CE) is the incentive mechanism provided for solar energy

(photovoltaic),whichconsistsinthesupplybytheGSE(describedinchapter1)ofatariff

establishedonthebasisoftheenergyproducedbytheplantsandoftheinstalledpower

size,additionaltothesellingprice,throughtheexchangeorconsumptionoftheelectricity

produced.

158 Link:http://www.mercatoelettrico.org/it/mercati/cv/cosasonocv.aspx 159 CoryK.,CoutureT.,KreycikC.,WilliamsE.(2010)-APolicymaker'sGuidetoFeedinTariffPolicyDesign,NationalRenewableEnergyLaboratory(NREL),U.S.DepartmentofState,p.6.

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4.3GreenBondsvsProjectFinance:anempiricalevidence

4.3.1LiteratureReview

Asdescribedinthepreviousparagraphs,“theenergysectorisakeyfactoragainstclimate

change since it is responsible for 80% of the CO2 emissions that are causing global

warming”.Regardingthefinancialstructureoftheenergysector’scompanies,wehave

seenthattheconventionalsourceoffinancingisprojectfinance.Ontheotherhand,the

emissions of green bonds are increasing exponentially, proposing themselves as

alternativetotraditionalsourcesoffinancing.

Inthisframework,theliteraturedoesnotproposeasolutionbetweenthechoiceofthe

twoalternatives.

Ingeneral,bonds“areespeciallysuitableifaprojectisbeingrefinancedafterithasbeen

builtandhasoperatedsuccessfullyforaperiodand,conversely,thegreaterflexibilityof

bankloanstendstomakethemmoresuitablefortheconstructionandearlyoperation

phases of a project, projects that require long-term financial flexibility,more complex

projects,orprojectsinmoredifficultmarkets.”160

Thegreenbondshaverarelybeenstudiedfortheperspectiveofgreenfinancialproducts.

In fact researches prefer to study the link between green bond prices and financial

markets.161

Thepurposeof this thesis is to studywhether, in renewable energy sector, there is a

financial incentive to issue green bonds rather than using project financing, from the

issuers’pointofview.Themosteffectiveresearchinthiscontexthasbeenconductedby

Condeetal. (2020), inwhichtheytaketheperspectiveofaproject financesponsor in

ordertoanalyzewhetherthereisadirectfinancialincentiveforissuinggreenbondsin

contrast to other types of financing. They conclude that the analysis proposed

demonstratesahigherIRR(internalrateofreturn)forshareholdersissuinggreenbonds

rather than bank loans. Moreover, they confirm the lack of researches on this topic.

160 Yescombe,E.R.(2014)-PrinciplesofProjectFinance,2ed.,Elsevier. 161 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

101

Indeed,asstatedbyCondeetal.(2020),theirarticleis“oneofthefirstresearchpapersto

explicitlystudytheimpactofthecostofgreenfinancingontheprofitabilityofacompany

intheenergysector,fromapurelyfinancialperspective”.

Ontheotherhand,theliteratureonprojectfinanceiseffective.

Gatti(2013),definedprojectfinanceas“astructuredfinancingofaspecificeconomicentity

(theSPV),createdbythesponsorusingeitherequityormezzaninedebtandforwhichthe

lenderconsiderscash flowstobetheprimarysourceof loanrepayment,while theassets

representonlycollateral”.162

Moreover, project financing presents advantages and disadvantages, as described by

Finnestry (2007). For example, Kleimeier, S. andMegginsonW.L. (2000) showed that

projectfinancingismoreeffectivelypricedthanothertypesofloan.Furthermore,Miglo

(2010) presents

ananalysisinwhich“thequalityoffirmsthatissueatleastoneclaimwithoutrecourseis

higher than that of firms that only issue corporate claims and when the asymmetric

information is largeanduniformlydistributedacrossprojects,companiesgenerally issue

corporateclaims,meaningthatnon-recoursedebtisgenerallyissuedwhentheasymmetric

informationisnotuniformlydistributed”.163Indeed,Müllner(2017)claimedthat“aclear

separation between the SPV and the sponsor balance sheet reduces the asymmetric

informationbetweenthelenderandthesponsorandamoreefficientevaluationofcredit

quality”.164 Also in this context, Conde et al. (2020) sustain that one of the main

advantagesofprojectfinanceisitsabilitytoexpandtheproject’sborrowingcapacity.In

fact,thisstructureimpliesthatprojectdebtisnotadirectobligationforthesponsorsand,

therefore,doesnotappearontheirbalancesheets:forthisreason,thedealcansupporta

debt-to-equityratiothatcouldnototherwisebeattained.165Finally,Esty(2005)stated

that “project finance resolvemarket imperfections. Inparticular, theauthorexplained

162 Gatti,S.(2013)-ProjectFinanceinTheoryandPractice,2nded.;Elsevier:Atlanta,GA,USA,2013;pp.1–21.163 Miglo,A.(2010)-ProjectFinancingVersusCorporateFinancingunderAsymmetricInformation.J.Bus.Econ.Res.2010164 Müllner,J(2017)-Internationalprojectfinance:Reviewandimplicationsforinternationalfinanceandinternationalbusiness.Manag.Rev.Q.2017,67,97–133.165 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

102

that when projects are carried out on a stand-alone basis, they are better analyzed,

mitigatinginformationcosts”.166

Ontheotherhand,projectfinancingpresentsseveraldisadvantages,dueinparticularto

separationoftheSPVandthesponsor.Ingeneral,Condeetal.(2020)statethatdiverse

riskscanarisebothduringtheconstructionphase,whentheprojectisnotyetgenerating

cash, and during the operations phase. In fact, “lenders delegate responsibility to

shareholders, so covenants are made to reduce moral hazard that can result in

opportunisticpracticesthatdestroyvalueforlendersandconflictsofinterestbetween

lenders and sponsors often arise when setting dividend policy and restructuring

distressedcompanies”.167

Regardinggreenbonds,assaidabovetheliteraturedoesnotprovideaclearvisionasfor

projectfinancing.Thislackisdueinparticulartothelittleexperienceofthisinnovative

instrument.However,asEsty(2005)stated,projectfinancecontributessignificantlyto

transparencyintheconstructionphase,leadingtoareductioninthecostofcapital.Inthis

regard,Condeetal. (2020)explainedthat “effectcanbenefit fromtherequirements for

public informationestablished for the issuanceofgreenbonds,which largelyexplain the

relativelylowinterestrate”assumedintheiranalysis.

Moreover, Maltais and Nykvist (2020) proposed one of the first empirical studies

designedtoaddressthebroaderquestionsofwhatattractsinvestorsandissuerstothe

green bond market, the role of green bonds in shifting capital to more sustainable

economic activity, and how green bonds impact the way organizations work with

sustainability.Theyconcludedthat“thethreemostimportantincentivestoissuegreen

bond are broadening the investor base, lowering the cost of capital,meeting investor

demandforsustainableinvestmentproducts”.168Furthermore,“greenbondissuersfocus

166 Esty,B.C.Petrozuata(2005):Acasestudyofeffectiveuseofprojectfinance.J.Appl.Corp.Financ.2005,167 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695. 168 Maltais,A.;Nykvist,B.(2020)-Understandingtheroleofgreenbondsinadvancingsustainability.J.Sustain.Financ.Invest.2020.

103

onavarietyofbenefits,suchasattractingcustomersandstaffinterestorincorporating

sustainabilityintointernaloperations”.169

Finally,Tangetal.(2020)constructacomprehensivedatasetcoveringallcorporategreen

bondissuanceworldwidetoprovidethefirstempiricalanalysisofthemarket’sreaction

tofirms’environmental,social,andgovernance(ESG)activities.Theyfindlittleevidence

thatgreenbondsareissuedatloweryieldsthanregularcorporatebondsfromthesame

issuers, suggesting that the main advantage of green bonds is not cheaper debt

financing.170Moreover,issuinggreenbondscanstimulatetheexposuretonewinvestors,

attractingmoremediaexposureandsatisfyinginvestors’requirements.

Toconclude,Condeetal.(2020)statethatgreenbondfinancingdelivershigherreturns

for shareholders than conventional financingbut it is important tohighlight that they

focused on the supply side, assuming demand as given. This is an important point

considering that the consolidationand strengtheningof greenbondmarketwill likely

comefromthealignmentofincentivesbetweenissuersandinvestors.171

4.3.2EmpiricalAnalysis

In lightof thediscussionsof the literature regarding theeffectsof greenbonds in the

companies’ financial structure, an empirical analysis is proposed in the following

paragraphs.Theanalysisisconductedonahypotheticalwindfarmcompanylocatedin

Italyandthemainpurposeistoinvestigatewhethertheissuingofagreenbondcouldbe

an alternative source of financing in the renewable energy sector. In particular, the

analysisisfocusedonthecomparisonbetweentheissuingofagreenbondandthemost

conventional source of financing in the renewable energy sector in Italy, the project

finance,fromashareholder/investorperspective.

The analysis is computed through the construction of a financial model, in order to

forecastthefinancialstatementofthecompanyinatimevalueof10years.

169 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695. 170 Tang,D.Y.;Zhang,Y(2020)-Doshareholdersbenefitfromgreenbonds?J.Corp.Financ.2020,61,101427.171 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

104

4.3.2.1Methodology

InthenextparagraphsIwillanalyzeahypotheticalonshorewindfarmcompanycalledq

WindS.r.l.,locatedinItaly.Thewindfarmiscomposedby11turbines,withapowerof2

MWeach.Thetotalpowerinstalledis22MW.

qWindS.r.l.ispartofElectricUtilitiesIndustryanditgeneratesandsellselectricenergy

in the market. Moreover, the company holds Green Certificates that expire at

30/06/2026.

Theanalysishasthepurposetostudytheimpactoftwodifferentsourcesoffinancingin

theqWindS.r.l.financialstructure,incaseofrefinancingoftheolddebt.Infact,starting

fromtheFinancialStatementat31/12/2019,itwillbeanalyzedtheNPVoftheprojectin

two different cases: in the first case a traditional source of financing in the energy

renewablesector,whichisprojectfinance,andinthesecondcasetheemissionofagreen

bond,anewfinancial instrumentwhich isgrowingexponentially. Ithasbeenusedthe

sameperspectiveofCondeetal.(2020)whoanalyzedwhetherthereisadirectfinancial

incentive for issuing green bonds in contrast to other types of financing, taken the

perspectiveofaprojectfinancesponsor,.172

Themain difference with Conde et al. (2020)’s work is that the forecasts of the two

sources of financing have been studied starting from an actual situation in 2019. The

FinancialStatementat31/12/2019showsthatqWindS.r.l.hasanoutstandingbankdebt

of 18.916k € and an Interest-Rate-Swap which hedges the company to the floating

interestrate.AssumingthatqWindS.r.lwantstorefinancetheexistingdebt,thepurpose

ofthisthesisistoanalyze,thoughttheuseofafinancialmodel,therefinancingprocess

withprojectfinancingorwiththeemissionofagreenbond,comparingtheNPVofthe

projectinthetwodifferentcases.

Asapremise,ithastobesaidthatqWindS.r.l.meetsalltheprerequisitesnecessarytobe

refinancedonbothprojectfinanceandgreenbondbasis.Inthiscontext,itisfundamental

tohighlightthatgreenprojectscanberefinancedusinggreenbonds(seeFigure38).

172 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

105

Figure38:ComponentsofEuropeanUnionGreenBond(EUGB).Source:Condeetal.(2020)

Infact,asstatedbyCondeetal.(2020)“whenrefinancingisforeligiblegreenassets,no

specific look-backperiodisrequiredbeforethe issuance,providedthatatthetimeofthe

issuancetheassetsfollowtheeligibilitycriteria”.

Theprojectfinancescenariohasbeenbuiltwithcharacteristicsalignedtothemarketand

with covenants typically used in similar projects. In particular, as described in the

previousparagraphs,themostusedcovenantsinprojectfinanceareaminimumDSCR

andLLCRandinadditionamaximumDebt-to-Equityratio.

Ontheotherhand,forthegreenbondcase,ithasbeenusedmostofthecontractualterms

ofthegreenbondissuedbyAsjaAmbienteItaliaS.p.A.,whosepurposeiscomparableto

thatofqWindS.r.l.Inparticular,thegreenbondtakenasreferencewasissuedbyAsja

Ambiente Italia S.p.A. in December 2019 with ISIN IT0005394868. It is completely

suitableforthecaseunderanalysisandithasbeenselectedinordertomaketheanalysis

asrealisticaspossible.

106

4.3.2.2FinancialData

P&LStatementsandBalanceSheets

Inorderto forecasttheProfit&LossStatementandtheBalanceSheetofqWinduntil

2030, different assumptionshavebeenmade starting from theFinancial Statement at

31/12/2019.Asdiscussedpreviously,inthefirstsemesterof2020thecompanyredeems

theolddebt(18.916k€),andthereforepaystheIRSBreakagecosts(2.500k€),issuinga

greenbondorusingprojectfinanceforanamountof20.000k€.Inordertoanalyzethe

impact of the two sources of financing on the financial structure as realistically as

possible, the analysis proposes two forecasts of the statements: the former in the

refinancingcasewithprojectfinance(seeFigure39)andthelatterintherefinancingcase

issuingagreenbond(seeFigure40).

Figure39:Profit&Loss/BalanceSheet–Projectfinancecase.Source:personalelaboration

107

Figure40:Profit&Loss/BalanceSheet–Greenbondcase.Source:personalelaboration

Assumingthattherefinancingprocessstartsinthefirstsemesterof2020forbothcases,

macro-economicassumptionshavebeennecessarytoforecastthestatements:

o Inflationrate:thesourceistheInternationalMonetaryFund173.Itwasneeded

forthecalculationoftheprojectionsuntil2030.

o Electric Energy Prices: the energy prices are fundamental for the revenues

calculationinthelongterm.Theelectricitysaleinthemarketisthemainsourceof

revenueinawindfarmcompany(with,inthisspecificcase,theGreenCertificate).

ThepricevaluederivesfromEEXPricesFutureswebsite.174

173 Link:https://www.imf.org/external/datamapper/PCPIPCH@WEO/WEOWORLD/VEN/ITA 174 Link:https://www.eex.com/en/market-data/power/futures

108

o GreenCertificates:AsdescribedintheGSEwebsite175,thecalculationofthetariff

isbasedontheenergyprices.ThepriceofthetariffisthenmultipliedtotheMWh

oftheplantinordertocalculatewhatisactuallyreceivedfromtheincentivetariff.

Additionally, for theconstructionof theP&LStatementsandtheBalanceSheets,other

assumptionshavebeennecessary:

o The Operating Expenses (Operation & Maintenance, Insurances and other

generalexpenses)areassumedconstantduringtheanalysis,adjustedeveryyear

withtheinflation.

o The percentage ofDepreciation, as in the analysis conducted by Conde et al.

(2020),isassumedtobeconstantinthefutureperiods.

o RegardingTaxes,projectionsconsiderthecurrenttaxcreditsthatresultfromtax

lossesandtheconstraintsforthedeductionofinterestexpenses.176Inparticular,

thepercentageoftaxesusedintheanalysisare24%ofIRESand3,9%ofIRAP177.

DebtAssumptions

Intheprojectfinancecase(seeFigure39), thenewdebtissuedin2020iscompletely

usedtorepaytheolddebtandtopaythebreakagecostsoftheInterest-Rate-Swap.The

newbankloanhasamaturityof6years,withasix-monthlyprincipalrepayment.Infact,

thedebtexpiresat30/06/2026and,asshowedintheFigure41,therepaymentstructure

iscomposedbytheseniorrepaymentandtheinterests’payment.

175 Link:https://www.gse.it/servizi-per-te/fonti-rinnovabili/impianti-a-fonti-rinnovabili-grin/modalità-di-calcolo 176 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695. 177 AssumedIRAPofRegionedelVeneto,link:https://www1.finanze.gov.it/finanze2/dipartimentopolitichefiscali/fiscalitalocale/aliquoteirap/dettaglio_irap.php?id=265&reg=21&anno=2019&privacy=ok

109

Figure41:Repaymentstructureinprojectfinancecase.Source:personalelaboration

Theinterestsarepaidaspercentageoftheoutstandingbalanceoftheperiodandtheyare

calculatedasthesumofaMarginplustheEuribor.TheMarginapplicatedintheanalysis

is2,8%andtheEuriborusedistheEuribor6months.Themarginisalignedontheaverage

ofthesector.178Inaddition,asintheolddebt,anInterest-Rate-Swap(IRS)isneededin

ordertomitigatetheinterest-raterisk,beingafloating-rateloan.Thishedgingpolicyis

assumedtocoverthe70%ofthedebt,payinganIRSof0%179.

Moreover,asdiscussedpreviously, the financialcovenants,whichareessentials in the

calculationof thedividend flows for shareholders, areassumedcomparable to similar

projects. It is assumed that for the financing period the lenders request a minimum

AnnualDSCRof1,40x,aminimumLLCRof1,35xandamaximumDebt-to-Equityratioof

80%.

DueDiligencecostshavetobetakenintoconsideration.“Thelendersneedtoevaluatethe

termsoftheproject’scontractsinsofarastheseprovideabasisforitsconstructioncosts

andoperatingcash flow,andquantify therisks inherent in theprojectwithparticular

care”.180 The costs of this process are called Due Diligence costs and for the project

financingcaseareassumedtobe150k€.Finally,theAnnualAgencyFee,thefeepayable

totheagentbank,isassumed40k€.

Ontheotherhand,thegreenbondcasehasbeenbuilttakingasreferencethecontractual

termsof the greenbond issuedbyAsjaAmbiente Italia S.p.A. inDecember2019.The

178 Theinterestmarginsinprojectfinanceloansaretypicallyintherangeof2-3,5%asstatedbyE.R.Yescombe(2014)in“PrinciplesofProjectFinance”(SecondEdition). 179 TheIRS7yearsat30/06/2020.Link:https://mutuionline.24oreborsaonline.ilsole24ore.com/guide-mutui/irs.asp#storico 180 Yescombe,E.R.,(2014)-PrinciplesofProjectFinance,2ed.,Elsevier.

110

repaymentstructureapplicated(seeFigure42)isthesameofthegreenbondtakenas

reference.181

Figure42:Repaymentstructureingreenbondcase.Source:personalelaboration

Thegreenbondisaplainvanillacorporatebond,issuedforanamountof20.000k€and

listedonExtraMOTPRO3,thededicatedsegmenttogreenbondsofBorsaItaliana.

Consideredthebondstructure,afixedcouponpaymentatpre-determinedfixedintervals

isapplicated,asshowedinFigure42.Therefore, thematurityof thebondisalsopre-

determined.Inordertobeconsistentwiththeanalysis,thedateofissuanceisassumed

on 30/06/2020 with a maturity of 7 years. In fact, the expiry date is assumed on

30/06/2027.Thecouponamount,paidonasix-monthbasis,isassumedtobe1,82%of

theoutstandingbalanceofthebond.Theinterestrateapplicatedrepresentstheaverage

of the latest 10 green bonds issued in the same dedicated segment of the market,

consideringsimilarpurposes.182Thiscalculationwasneededinordertobeasrealistically

aspossible.Incontrasttoprojectfinancecase,ahedgingpolicyisnotnecessarybeingthe

bondafixed-ratebond.

Thegreenbondissuedhasthesamepurposeoftheprojectfinancecase,i.e.torepaythe

olddebtandtopaythebreakagecostsoftheInterest-Rate-Swap.

Thefinancialcovenantsproposedareconsistentwiththecontractualtermsofthegreen

bond issued by Asja Ambiente Italia S.p.A.. In particular, for the financing period a

maximumNFP/Equityratioof5xandamaximumNFP/EBITDAratioof8xarerequired.

181 Contractualterms:https://www.asja.energy/wp-content/uploads/2019/12/Documento-Ammissione-completo.pdf 182 Calculatedat30/06/2020

111

DueDiligencecostsandAnnualAgencyfeesareassumedhigherthanprojectfinancecase,

amountingrespectivelyto200k€fortheformerand60k€forthelatter.

InFigure43asummaryoftheDebtAssumptionsapplicatedforbothcasesispresented.

Themaindifferenceswillbeexplainedinthenextparagraph.

Figure43:DebtAssumptionsapplicatedinthefinancialmodel.Source:personalelaboration

CashFlowStatements

Finally,startingfromtheP&LStatementsandBalanceSheetsprojectionsproposedabove,

the Cash Flow Statements have been calculated for both cases:Figure 44 for project

financecaseandFigure45forgreenbondcase.Asitispossibletosee,theOperatingCash

Flows is similar for both cases, focusing on the cash flows generated by the regular

operatingactivitiesoftheproject.

Figure44:CashFlowStatement–Projectfinancecase.Source:personalelaboration

112

Figure45:CashFlowStatement–Greenbondcase.Source:personalelaboration

In order to estimate these statements, different assumptions have been requested. In

particular:

o ∆NetWorkingCapital:theincomefromthesaleofelectricityisassumedafter

1month,whiletheincomefromtheincentivetariffisassumedafter2months.

o DividendsandReservesDistribution:Thedividendpolicyisassumeddifferent

dependingonthesourceoffinancing.Inprojectfinancescenario,thecompany

has to take into account, in every dividends distribution date, the financial

covenantsdiscussedpreviously(ADSCR;LLCR;D/E)andinadditionthecompany

hastokeepenoughamountofcashinordertobeabletopaythenextcalculation

date's debt service (Principal Repayment + Interests). In green bond case the

mechanismisthesamebutthefinancialcovenantstotakeintoconsiderationare

different(NFP/Equity;NFP/EBITDA)

RegardingtheOperatingCashFlows,itispossibletoseeasubstantialreductionbetween

2025and2027.ThisreductionistotallyexplainedbythecontractionoftheEBITDA,a

decreaseof73%between2025and2026,andadecreaseof96%between2026and2027

(intotal,areductionof239%between2025and2027).Thisimportantcontractionisdue

totheexpirationoftheGreenCertificateson30/06/2026,asitispossibletonoteinthe

P&LStatementsinFigure39andFigure40.

113

4.3.2.3ResultsandConclusions

Inordertoanalyzeifissuingagreenbondcouldbeanalternativesourceoffinancingin

theItalianrenewableenergysector, inthissectiontheresultsachievedintheanalysis

developedforqWindS.r.l.arepresented.

StartingfromtheCashFlowStatements,Figure46showsthecomparisonbetweenthe

cashflowsafterdebtserviceforbothcases,projectfinanceandgreenbond.

Figure46:CashFlowAfterDebtServiceforbothcases.Source:personalelaboration

Inthegreenbondscenario,thecashflowafterdebtserviceismoreirregularduringthe

valuationperiod,resultingdecidedlyhigherinthefirstyearsofthefinancingandthen

becomingnegativeinthelasttwoyearsofdebtservice(2026and2027).Ontheother

hand,intheprojectfinancecase,thecashflowafterdebtservicepresentsaregulartrend.

This valuable difference is due to the different amortizing plans (see Figure 41 and

Figure 42) of the two sources of financing. However, it has to be said that the debt

sculpting scheme is more frequent in bank loans than in bond emissions, depending

alwaysbythecontractualterms.

Moreover,thecontractualtermsarecrucialforthedividendstoshareholders.Figure47

showsthetrendofthedividendsfrom2020to2030,highlightingthatthegreenbondcase

presentsaslight,butstillbetter,abilitytorepaytheshareholders.

Figure47:Dividendstoshareholdersforbothcases.Source:personalelaboration

114

Thisresultisobviouslyinfluencedbythedebtassumptions(seeFigure43).Inparticular,

asdescribedabove,thedividendpoliciesincludedifferentcovenants,whichaffectedthe

twodividendtrends.Inaddition,thematurityandtheinterestrateinfluencetheability

torepaytheshareholders.

Regardingtheinterestrateofthetwosourcesoffinancing,itisinterestingtonotethat

evenifprojectfinancecasepaysahigherinterestratethangreenbondcase,theformer

payslessinterestsinpercentagetermsontheoverallfinancing(seeFigure48).Infact,

inthebankloancasethecompanypays93%inseniorrepaymentand7%ininterests,

meanwhileinthegreenbondcasethecompanypays91%inseniorrepaymentand9%in

interests.

Figure48:PercentageofSeniorRepaymentandInterestpaidinbothcases.Source:personalelaboration

Thehigher costs inDueDiligence andAgency Fees and a longerMaturity explain the

higherpercentageofinterestspaidinthegreenbondcase.

Regarding the quality ratios,Figure49 shows theAnnualDSCR from31/12/2020 to

30/06/2027forbothcases.TheDSCRcalculationinthegreenbondcasestartswiththe

firstseniorrepaymentdate(30/06/2022)andendsintheexpirydate(30/06/2027).

Figure49:AnnualDSCRforbothcases.Source:personalelaboration

115

TheDSCRreflectstheproject’sdebtcapacityanditisaratiothatthelenders,especially

inbankloans,relyontodeterminethefinancialviabilityoftheproject.183Forthisreason,

aminimumDSCRisacovenantintheprojectfinancecaseandtheamortizingplanisbuilt

takinginconsiderationtheDSCRtrendovertheyears.Ontheotherhand,inthegreen

bond case, the DSCR is not a covenant and this kind of analysis is affected by the

amortizingplan taking as reference.However, theAverageDSCRduring the financing

periodishigheringreenbondcase(1,94x)thanintheprojectfinancecase(1,66x).

Finally,theNPVAnalysisisconductedbydiscountingtheCashFlowsFromOperations

(FCFO) taking into consideration theWACC as discount rate. As discussed above, this

assumptioniscrucialfortheprofitabilitycalculationandfortheoverallresult.TheCost

of Equity is calculated on different assumptions. The Risk Free rate applicated is the

ItalianBOT10Yupdatedat01/10/2020184andfortheMarketRiskPremiumcalculation

ithasbeenusedthedataprovidedbyAswathDamodaran185.TheMRPtheniscalculated

as the spread between the Equity Risk Premium and the Italian Rating-basedDefault

Spread.TheBetaUnleveredhasbeencalculatedasaverageoftheBetaUnleveredofthree

competitivecompanies in the Italianrenewableenergysector186.Finally, thechoice to

applyanAdditionalRiskPremiumisconservative,giventhecompany’ssmallsize.

Moreover,Figure50showstheWACCcalculationforbothcasesandtherelativeNPV.

Although the greenbond casepresents a higherNPVof theproject, the final result is

similar.

183 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695. 184 Link:https://mercati.ilsole24ore.com/obbligazioni/spread/GBITL10J.MTS 185 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html 186 Asaveragebetween:0,66EnelGreenPower;0,81FalckRenewables;0,71ERG

116

Figure50:NPVanalysisforbothscenarios.Source:personalelaboration

Theslightbutbetterperformanceoftheprojectinthegreenbondscenarioisexplained

bythelowerinterestrateofthegreenbond.Thisassumptionisconsistentwiththeresults

providedbypart of the literature in this context,which emphasizes the lower cost of

capitalresultingfromgreenfinancingcomparedtoothertypesofdebt187.

Inconclusion,iftheresearchquestionofthisanalysisiswhethertheissueofagreenbond

canbeavalidalternativetotheconventionalsourcesoffinancingintherenewableenergy

marketinItaly,theanswerispositive.However,ithastobesaidthatthisanalysistakes

intoconsiderationonlysomeoftheoverallassumptionsforbothcases,focusingonthe

investorperspective. For this reason, themainpurposeof this thesis is not to state a

generalresultbuttodemonstratethatinthishypotheticalspecificcasetheissuingofa

greenbondcouldbeeffective.Inaddition,inlightofthegreenbondliterature,thisthesis

aimstofosterfuturefurtherresearchesonthistopic,inordertooutlinetheprofitability

ofthisinnovativeinstrument.

Intermsofimplications,thisanalysissuggeststhatthegreenbondinstrumentcanplay

animportantroleinthelow-carbontransition,aligningprivatecompanies’objectivesto

thenationalandsupranationalpurposesinvolvedagainstclimatechange.

187 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

117

CONCLUSIONS

Themain purpose of this thesis is to study and analyze green bonds in depth. More

specifically, the underlying question of this research is whether green bonds can be

consideredanalternativesourceoffinancingintherenewableenergymarketinItaly.The

examinationconductedinthisthesissuggestsapositiveanswer.

Inordertoreachthisgoal,thethesisstartsfromageneraldescriptionofthephenomena

related to climate change. From the earliest studies in the 1800s to the most recent

European and international agreements, such as the Green New Deal and the Paris

Agreement,itisincreasinglyevidentthatclimatechangewillbeoneofthemostdifficult

challengesthathumankindwillhavetofaceinthenextdecades.

TheongoingCovid-19pandemicisstressingtheimportanceofaglobalchangeinorderto

limitglobalwarmingbelow1.5C°,comparedtopre-industriallevels.

Inthiscontext,climatefinance,definedbytheUnitedNationsFrameworkConventionon

Climate Change (UNFCCC) as “local, national, or transnational financing—drawn from

public,private,andalternativesourcesoffinancing—thatseekstosupportmitigationand

adaptationactionsthatwilladdressclimatechange”playsakeyrole.

In fact, inorder toaccelerate the transition to lowcarbonenergy, several studiesand

analysesestimatethatanimportanteffortcombinedwitharapiddisinvestmentsoffossil

fuelswillbenecessarytoachievetheambitioustargetsoftheParisAgreement,especially

intermsofinvestmentinrenewablesandenergyefficiency.AccordingtoIEA,inorderto

achievethe1.5°Ctarget,renewableenergyinvestmentsneedtobeincreasedupto550

billionsofdollars everyyearand, in contrast, fossil energydisinvestmentsneed tobe

muchmoresubstantial.Climatefinanceoffersseveral instrumentstoachievethisgoal,

dividedbetweenfinancialinstrumentstoraisefundsandfinancialinstrumentstodeploy

funds. The former are composed by instruments such as green bonds, climate bonds,

climatepolicyperformancebonds,catastrophebonds, insurancesanddebt forclimate

swaps.Thelattercomprisecapitalinstrumentsandriskmanagementinstruments.

In this context, given their exponential growth in the last decade, green bonds are

recognizedasthemosteffectiveandinnovativetoolsofclimatefinance.

118

Agreenbondcanbedefinedasaspecialkindofbondinwhichtherevenuesmaybeused

exclusivelytofinanceorre-finance,inpartorinwhole,newandexistinggreenprojects.

The main purpose of these financial instruments is to increase liquidity in financial

marketsandtofacilitatethelow-carbontransitionfinancingspecificprojects.Infact,as

statedbyZerbibO.(2017),“theyarehighlyattractivefinancialinstrumentsthatfosterthe

environmentaltransitionwhileenablinglow-carbonprojectholderstoexpandtheirfunding

capacity”.188

Raisingawarenessofinvestorsaboutthe"green"componentisthemostinnovativepart

of this instrument, as it goes beyond the purely traditionalmindset focused on profit

maximization.Fromthepointofviewofagreenbondissuer,thiscantranslateintolower

interestratesthantraditionalbonds.Regardingthislastpoint,theinternationalliterature

isdividedanditseemschallengingtoagreeonadefinitivesolution.

Asmentionedabove,theempiricalcontributionofthisthesisaimstoobservewhether,in

aspecificcaseexamined,theissuanceofagreenbondintherenewableenergymarket

canbeavalidalternativetoconventionalsourcesoffinancingusedinItalysuchasproject

finance,fromashareholderperspective.Inordertoanswerthisquestion,firstofallthe

projectfinancemechanismisdescribed,studyinghowthisinstrumentiscomposed,the

actors, the stages and documents required, the most common financial covenants

requestedbybanksandfinallythedifferentmethodsusedasvaluationproject.Moreover,

aparagraphisdedicatedtothecurrentsituationoftherenewableenergysectorinItaly.

Inparticular,thedevelopmentofthemarketinthelastdecadeistakenintoexamination,

aswellasthefunctioningofincentivemechanismsmanagedbyGSE(GestoredeiServizi

Energetici),whichrepresentsasignificantcomponentforthesector.

The finalempiricalanalysis is conducted inorder toevaluate if there isaprofitability

convenienceinissuingagreenbondratherthanusingtheprojectfinanceinstrument.The

examinationisconductedontherefinancingprocessofahypotheticalonshorewindfarm

companylocatedinItaly,withatotalpowerof22MW.Theanalysishasthepurposeto

study the impact of two different sources of financing within the company financial

structure,incaseofrefinancingoftheexistingdebt.Inordertodothat, thecompany's

financialstatements(profit&loss,balancesheet,cashflowstatement)overatimevalue

of 10 years (from 2020 to 2030) have been calculated through the construction of a

188 ZerbibO.(2017)-Thegreenbondpremium.DepartmentofFinance,TilburgSchoolofEconomicsandManagement

119

financial forecasting model based on various assumptions. The results have been

obtainedby theanalysisof thesestatements.Regarding theresultsobtained, theCash

Flows FromOperations (FCFO) have not been compared, as they are similar for both

scenarios.Ontheotherhand,inthegreenbondscenariotheCashFlowAfterDebtService

presentsamoreirregularflowduringthevaluationperiod,resultingdecidedlyhigherin

the first years of financing and then becoming negative in the last two years of debt

service.Thisdifferenceisgivenbythedifferentrepaymentplandefinedbytheagreement

terms. These terms also influence the company’s ability to repay the shareholders,

highlightinga slightbutbetterperformance in thegreenbond scenario.This result is

impactedbythedebtassumptionsoftheanalysis,inparticularbythedividendpolicies,

thecovenants,thematurityandtheinterestrate.Inconclusion,themostcomprehensive

result isgivenby theNPVanalysis, calculatedbydiscounting theFCFOandusing two

differentWACCasdiscountratedependingonthescenario.Theanalysisshowsaslight

betterresultinthegreenbondscenarioanditisexplainedbythelowerinterestrateof

thegreenbond.Thisassumption isconsistentwiththeresultsprovidedbypartof the

literatureinthiscontext,whichemphasizesthelowercostofcapitalresultingfromgreen

financingcomparedtoothertypesofdebt189.

Inconclusion,theissuingofagreenbondcanbeavalidalternativetotheconventional

sourcesoffinancingintherenewableenergymarketinItaly.Asalreadystated,themain

purposeofthisthesisisnottostateageneralresultbuttodemonstratethatcompanies

should seriously consider green bonds as potential alternatives to more traditional

financialinstruments.

Regardingthelimitationsfoundonthedraftingofthisthesis,theyaretobefoundinthe

assumptionsnecessary for the constructionof the evaluationmodel and in the scarce

literatureonthissubject.Moreprecisely,theassumptionsatthebaseofthisanalysisare

strictly influenced by the real cases taken as reference. Furthermore, the literature is

stronglyfocusedonthestudyofthegreenbondfromaninvestor'spointofview,trying

toanalyzeiftheycanbemoreprofitablethantraditionalbonds,oronthestudyofgreen

bondpricesinthemarkets.Oneofthefewresearchesthathasbeenusedasareference

hasbeenconductedbyCondeetal.(2020)whotook“theperspectiveofaprojectfinance

189 Alonso-Conde,Ana&Rojo-Suárez,Javier.(2020)-OntheEffectofGreenBondsontheProfitabilityandCreditQualityofProjectFinancing.Sustainability.12.6695.10.3390/su12166695.

120

sponsor”,analyzingwhetherthereisadirectfinancialincentiveforissuinggreenbonds

in contrast to other types of financing. For this reason, this thesis does not intend to

achieveadefinitiveresult,butratheraimstostimulatefutureresearchonthesametopic.

Toconclude,itispossibletostatethatgreenbondsrepresentinstrumentsthatdifferfrom

the usual conventional financial instruments, shifting the main objective from profit

maximizationtotheenvironmentalandgreendimension.

121

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