Green Bonds

There exists a great potential for local governments to increase their debt and use it to finance local green investments. So far, the governments have raised funds mainly in the form of loans, but that may change. Bond issuance by local government units is complicated. A new report prepared by the Instrat Foundation proposes the creation of a Local Government Green Bonds Agency as a solution. The body would be able to issue and service green debt, making the cost of such investment financing much cheaper for local institutions.

Local governments can obtain financing cheaply

Local authorities are responsible for key areas for the transformation process towards a low-emission economy. Among many, those include public transport, water and heat supply, waste management or thermal modernization of public utility buildings. Despite the significant share of EU funds and national public funds, a major part of these projects will have to be financed with the use of debt financing. Green bonds issued by local governments can play such a role. The author of the report, Stanisław Stefaniak, assesses this instrument as follows: The task of the green bond market is to connect issuers who need external financing of pro-environmental investments with investors willing to provide such funds on attractive terms. Local governments have a great potential to increase debt in order to finance such investments. What is more, the efficiency in obtaining debt often determines whether it is possible to collect one’s own contribution to projects financed from EU funds.

The space to increase debt

The financial situation of local governments measured by their operating surplus is good. In 2021, a surplus was recorded by 88% of municipalities and 76% of cities with powiat rights. This shows that local governments have the space to increase debt in a sustainable way to finance the necessary projects. However, the size of this surplus varies depending on the given local government, which affects the financing conditions that they can obtain. When assessing the potential of financing the tasks of local government units (LGUs, Polish: JST) with green bonds, one cannot forget about the liabilities of municipal companies, which are several times higher than those formally assigned to the local governments themselves.

The role of bonds in financing local governments

The debt of local governments due to bonds amounts to about PLN 30 billion, thus constituting one third of their debt. However, only 15% of the bonds issued by local governments are introduced to organised trading. It is the banks that hold as much as 78% of municipal bonds and hold them until maturity, which is the equivalent of a bank loan. In addition, trading on the secondary market is not very liquid – in 2022, only 95 transactions on local government bonds were concluded on the Catalyst exchange. Therefore, local government debt is market-based to a small extent and is based mainly on bank financing. Meanwhile, expanding the base of potential lenders would make it easier for local governments to reach investors willing to finance green projects on attractive terms.

Main barriers

Above all, the issue of green bonds is associated with additional costs and workload. Local government units must first identify green projects in accordance with the requirements, hire advisors, obtain external opinions certifying the compliance of the emission with a given emission standard as green, and then report the use of funds. In addition, emissions require competence both in terms of obtaining financing as well as environmental and climate aspects (e.g. compliance of projects with the EU Taxonomy). These additional costs make the use of this instrument a challenge, especially for smaller local government units.

A local government agency, but at the central level

In a new report, the Instrat analytical centre proposes the creation of the Local Government Green Bonds Agency. The body would aggregate the projects of individual local governments that can be financed with green bonds, thus getting around challenges faced by smaller local government units. The Office would issue and service green debt, distributing the proceeds from the issue among individual entities. Aggregating projects would allow for reducing the share of fixed costs in the value of emissions and enable the centralization of competences in the field of green debt – certification, reporting and assessment of environmental aspects of the project, such as compliance with the EU Taxonomy. The author of the report lists the advantages of establishing such an institution: Greater creditworthiness of the agency, for whose obligations local governments or the State Treasury would be jointly and severally liable, would allow for lowering interest costs and unifying financial conditions for local governments in different financial conditions. Larger issue amounts and the possibility of issuing in foreign currencies would enable the agency to reach a wider group of investors, including foreign ones, willing to finance green projects on attractive terms.

Institutions enabling joint financing of local government projects are already in operation, e.g. in Denmark, Sweden, the Netherlands, France and the UK. Stanisław Stefaniak sums up: The experience of other European countries shows that the costs of financing through a central agency issuing green bonds on behalf of local governments are lower than the price that local governments themselves would pay for financing on market terms.

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