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Fostering the Green Bond Market in Turkey

The overwhelming demand for Turkey’s TSKB green notes in May promised to open the floodgates for climate bond deals. While that promise has not yet materialised, enduring investor interest in Turkey and other parts of the world, coupled with an increasing emphasis on green bond standardisation, is raising hopes for the future of renewable energy finance.

Nov 11, 2016 // 10:50AM

In May 2016 Turkish development bank TSKB became one of the first emerging market entities to issue a green bond. The US$300m security, rated Baa3 by Moody’s and BBB- by Fitch at the time of issuance, was tightened by 62.5bp for a final spread of 387.5bp following a buoyant response from investors.

With a positive market backdrop and an investment-grade rated bond offering an attractive 5.048% yield, it seemed like only a matter of time before other local entities decide employ this instrument. But a number of factors may be holding the market back.

“Back in May, I was expecting to see a surge of interest in green bonds, but we have not seen that,”noted RichardO’Callaghan, Capital Markets partner at Linklaters – the law firm that advised on the deal.

According to O’Callaghan, this lack of new developments can be attributed to several factors.

“One obvious reason is that the Turkish markets have faced some big challenges in recent months, so that has not been the most forgiving backdrop. And, in general, it is essential to provide the right terms and conditions, including third party guarantees.”

This point was reinforced by Manuel Adamini, Director of Investor Outreach & Partners Programme at Climate Bonds Initiative, who pointed to post-coup tensions and rating agency downgrades as factors that “alienated investors to some extent.”

“The situation needs to stabilise for mainstream investors to flock back to the market. There are also “top down” challenges, in that traditionally Turkey tended to be more of a loan market, with banking sector dominance. But still, even if bank loans prevail, green bonds can be used for refinancing,” Adamini explained.

Focusing on the government’s role in encouraging investment into renewables, both experts agree that, aside from the macroeconomic and political challenges, it is setting the right conditions for more of these deals to happen.

Turkey’s Ministry of Energy and Natural Resources recently introduced details for operation, investments and license procedures regarding large-scale renewable energy resource areas.

“Investment Areas,” a concept first introduced into legislation in 2005 but not widely adopted, is intended to promote the development and efficient use of renewable energy resources. The newly introduced provisions aim to encourage new investment in these areas, enabling a more efficient allocation of renewable energy investments, and to support production and acquisition of equipment.

Renewables, a boon for green financing, look set to grow in Turkey over the coming year. In a recent interview with a local broadcaster, Turkish Energy Minister Berat Albayrak announced the government’s plans to solicit bids for renewable energy plants potentially worth at least US$1bn, with tenders taking place between November and December this year.

“I do not think that the Turkish government needs to do much more to encourage more of these deals, because there is no real tax “disadvantage” for green bonds in Turkey”, insisted O’Callaghan. “The majority of green bonds are just long-term senior unsecured issues, where there is a commitment to use the proceeds in a particular way. In reality though, investors have recourse to the entire balance sheet of the relevant issuer, rather than just to those projects.”

Adamini points to specific advantages for climate bond investors in Turkey, such as preferred fiscal treatment and a feed-in tariff forsolarfixedfora10-yearperiod.Meanwhile, for the state they provide an opportunity to cut the current account deficit by reducing reliance on energy imports.

“The government understands that investment is needed to make climate ambitions become a reality. Turkey set itself some ambitious targets in terms of energy projects that need to happen in a short timeframe. There is an opportunity to build up assets there, roughly US$130bn will be allocated to developing the renewable energy sector over the next 10 years,” Adamini pointed out.

Despite the fact that initial investor enthusiasm has not precipitated a climate bond boom, the popularity of this financial instrument is on the rise – in Turkey and around the world.

According to research by Climate Bonds Initiative (CBI), the second half of 2016 saw some US$35bn worth of “green” debt issued, and in the third quarter of this year it overtook last year’s tally of US$41.8bn. S&P Global Ratings dubbed green bonds “the most prolific of the green finance instruments developed to date.”

Notably, Climate Policy Initiative (CPI) researchers estimate that approximately US$2.2bn of total flows in the green bond market have been directed towards cities in developing countries, compared to US$17bn in developed countries.

In the aftermath of the TSKB deal, some have suggested the green component delivered up to 20bp in cost savings. Adamini, who was present at a more recent gathering of prospective bond issuers and investors in Istanbul, suggested that this would be a very attractive perk for companies and banks wishing to follow in TSKB’s footsteps.

“I talked to quite a few of them, financial and non-financial corporates, and their interest is more defined than it was a few months earlier. There were interested parties from many segments, and their questions were a lot more detailed than before.”

Investors on the ground were similarly intrigued and excited by the green market’s prospects, although Turkish banks’ high lending rates and low energy costs in Turkey still make them anxious.

Yet the main concern around green bonds, in Turkey and elsewhere, is the lack of industry standards or definitions – a grey area that allows for some flexibility, but also potential for exploitation.

There are ‘green bonds’ and there are ‘green bonds’,” O’Callaghan explained. “At one end of the spectrum are those where the issuer in question can only conduct green or environmentally responsible types of activities. It is a sort of green project finance limited-recourse type transaction, whereby the whole business that is drawing the investment is green. At the other end of the spectrum, where TSKB finds itself, an issuer that carries out different type of activities agrees to use the proceeds of the green bond for a defined set of purposes.”

Because such bonds attract both undiscerning mainstream capital holders familiar with the issuer, and increasingly, specialised “green bond” investors, they are an effective tool for expanding the investor base. But the danger is that this tool might be abused, especially with the “complementary” tax exemptions.

So in order to prevent “greenwashing,” some form of standardisation is required to provide “quality assurance” for climate bond issuances. While some progress has been made in that area by ICMA with its “Green Bond Principles” or the CBI’s certification and standardisation frameworks, it is not yet a unified system.

Establishing such universal frameworks and guidelines that ensure minimal negative environmental impact would help boost market confidence and create the pipeline for green bond deals to flow – both in Turkey and globally.

Middle East CEE & Turkey

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