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How green bonds can bridge infrastructure financing gaps

Pay-for-success bonds backed by the Rockefeller Foundation and others seek to fund urban resilience projects.

The Rockefeller Foundation, along with two financial partners, is launching a new challenge to fund so-called green infrastructure and resilience efforts in the United States.

This comes at a portentous time, given the devastating flooding in Houston and President Donald Trump's rollback earlier this month of an Obama-era order requiring resilient building standards for infrastructure projects in areas exposed to floods or rising sea levels. Trump also promised to allocate $1 trillion to fortify U.S. roads, tunnels and bridges, but has so far failed to offer a plan to funnel public and private investment into these much-needed projects.

With the Rockefeller-backed project, two cities or counties will be selected to issue the first publicly marketed environmental impact bonds (EIBs), enabling them to use a "pay-for-success" model to fund these projects by sharing performance risks with private investors.

By purchasing a bond, investors have a stake in the successful outcomes of local municipal projects and governments help green infrastructure get off the ground that needs to be piloted before it is widely adopted.

We are facing a time when there is growing constraint on public capital for environmental projects.

"This could be marketed to institutional and potentially retail investors," said Saadia Madsbjerg, managing director of the Rockefeller Foundation, which supported the first pay-for-success bond, used to lower inmate recidivism in the U.K.'s Peterborough Prison. "Cities are interested because they get access to a form of capital for projects that would otherwise be too risky."

Proceeds from EIBs will finance efforts targeting stormwater management or other projects aimed at building equitable resilience for vulnerable or low-income communities.

The recipients also will receive pro-bono planning, structuring and bond issuance services from impact investing company Quantified Ventures  — which issued the first EIB in Washington, D.C. — and Neighborly, which offers public financing for municipal projects through an online brokerage platform. 

The project was launched at the Mayors Innovation Project summer meeting in Burlington, Vermont, and is open for applications until Sept. 29

Investing in communities

The EIB financing tool provides up-front capital to pilot approaches to resilience that have been used only at a small scale. These projects can be used to determine environmental outcomes for potential replication elsewhere.

"We are facing a time when there is growing constraint on public capital for environmental projects," said Carolyn DuPont, associate director of impact at Quantified Ventures. "From agricultural best practices to wetlands restoration to forest management, there is a huge opportunity for applicability."

Rockefeller Foundation will work with city agencies, utilities and water and sewer authorities in the U.S. that have resilience projects developed enough to issue a proposal and start work by the fall of 2018. Potential projects include urban tree canopies in San Francisco's underserved communities; green roofs to alleviate urban heat islands in Chicago; affordable housing along Atlanta's BeltLine and hurricane preparedness along the shoreline of Norfolk, Virginia.

"This is to find new and creative ways for money to flow from private investors and support programs that have positive social and environmental impacts," said Madsbjerg. "[The EIB] allows money to be reinvested in communities because the cost of the project frees up public finance and allows the community, individuals and society to withstand the shocks and stresses of climate change and be able to bounce back faster when an event happens."

What is unique about EIBs are their pay-for-success model, where a contract between a public entity and the private sector determines payment based on measured outcomes.

The cities will receive assistance with marketing bonds, tailored EIB structuring and underwriting, stakeholder engagement support and help with legal documents.

Previously, Neighborly sold one of the first muni bonds to fund a portion of Burlington, Vermont's 10-year capital plan and support its sustainability program. And in 2017, the city of Cambridge, Massachusetts worked with Neighborly to provide residential bonds for infrastructure projects. David Kale, the city's assistant manager for Fiscal Affairs, said the mini-bonds sold out in six days. 

"Innovation is hard within cities and governments," said James McIntyre, Neighborly's head of public finance, and former executive director of public finance at Morgan Stanley. "Companies like Quantified Ventures are looking inside governments to solve problems by looking at underlying data. We take those outcomes and turn them into financeable solutions."

Their aim is to create a template for distributing standardized EIB models to cities: "It's one thing that is crucial to making the market work what good is this if it can't be repeated? It's essential to open up the field."

Big muni

Environmental impact bonds are a subset of green bonds, financial instruments used for sustainability initiatives, sometimes issued by companies (recently, Apple and Toyota) to catalyze energy-efficiency projects, construction and even electric vehicle design. Their issuance is expected to increase to $200 billion this year from $93.4 billion in 2016, according to Moody's Investor Service.

Unique to EIBs is their pay-for-success model, where a contract between a public entity and the private sector determines payment based on measured outcomes. In 2016, Washington, D.C, issued an EIB to reduce sewer overflow into local watersheds during heavy rainfall and protect wetlands. The $25 million bond, sold to Goldman Sachs and Calvert, transferred the project's risk from the government to the investors.

If runoff reduction from the program is above 41 percent, the DC Water and Sewer Authority will make an outcome payment to the investors of $3.3 million. If it is between 18.6 percent and 41 percent, no contingent payment will be made but if the environmental benefit falls short, the investors will make a risk share payment to DC Water.

At the time, Goldman Sachs wrote (PDF) that if the infrastructure financed by EIBs successfully managed stormwater runoff, then it would be validated as an effective climate adaptation tool, "enhancing the natural resilience of the District in the face of the adverse impacts of climate change and creating a healthier future for District residents."

The U.N. estimates that every $1 invested in disaster risk management generates $60 in avoided damages.

Not to underestimate the role of the government in supporting these financing opportunities: The D.C. water transaction resulted from a 2015 EPA decree that allowed the city's water and sewer authority to incorporate green infrastructure as a strategy for curtailing sewer overflows.

Planning early for environmental challenges pays off in the long-term: The U.N. estimates that every dollar invested in disaster risk management generates $60 in avoided damages. Also, Moody's Investors Service reports a $1 trillion gap for U.S. water and wastewater infrastructure in the next 25 years a prime opportunity for public-private partnerships, new financing solutions and market mechanisms.

The bonds are an "important component in the growth and uptake of the sector; otherwise, [resilience projects] will be limited to a handful of cities with limited capacity and resources to structure them," said Madsbjerg.

Environmental bonds are one new innovative model, such as ecosystem insurance, used to create resilience in natural systems where national initiatives have stalled.

Editor's note: The previous deadline of Sep. 15 was extended out of concern for cities in the path of Hurricane Irma and Harvey.

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