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Why Investors Bought the First Certified Green Bond to Protect Forests for Drinking Water

Lake Maumelle in central Arkansas is a blue gem surrounded by rich forests of oak, hickory and short-leaf pine. Not only is it popular with local boaters and fishers, it also supplies much of the drinking water to half a million people in and around Little Rock. However, much of the land around the lake is privately owned. The forests on this land are at risk of being cleared for development, threatening both the beautiful vista and drinking water quality.

Recognizing this threat, Central Arkansas Water (CAW), the local water utility, implemented a watershed protection fee to raise funds to acquire and protect the forest land. But to acquire forests at a larger scale, CAW needed to raise more capital from the private market and decided to issue a bond.

Bonding to protect forests for water quality is still novel in the world of finance and investment. CAW partnered with green finance experts Encourage Capital and WRI to pioneer the first-ever certified green bond to acquire forests for watershed protection. The $31.8 million bond will allow CAW to borrow money from investors and pay them back over time.

The “green” signifies that the borrowed money will fund projects with environmental and social benefits, such as investments in low-carbon infrastructure and natural infrastructure like forests. The “certified” indicates that the bond meets established water infrastructure criteria and commits the issuer to following transparent reporting guidelines.

When CAW issued the bond in November 2020, the capital markets responded enthusiastically. After receiving bids from several banks, CAW sold the bond to Morgan Stanley.

“Morgan Stanley is deeply committed to the green bond market and its ability to capitalize much-needed sustainable infrastructure projects,” said Zachary Solomon, an executive director with the bank. “We were excited by the opportunity to underwrite a bond that meets the markets’ demand for products that drive both financial and environmental outcomes.

Here are three lessons from the world’s first green bond to invest in forests for water quality:

1.  Municipalities and utilities like CAW increasingly see forests and other “natural infrastructure” as a key strategy to protect drinking water quality and increase water security

Through this green bond, CAW will invest in some traditional “gray” infrastructure, such as pipelines, generators and other improvements to the delivery systems. But 33% of the green bond proceeds are earmarked for green infrastructure to support forestland acquisitions, conservation easements and other protection measures in the watershed.

<p>Lake Maumelle now stands as a prime example of green-gray infrastructure. Photo by Central Arkansas Water</p>

Lake Maumelle now stands as a prime example of green-gray infrastructure. Photo by Central Arkansas Water

Forests protect utilities’ drinking water in several ways. Forests’ leaves, roots and rich soil act as a filter to keep pollution out of water by preventing erosion and absorbing nutrients and sediment. Forests also regulate local water cycles by storing water and releasing water vapor, which can influence rainfall, and blocking and slowing the flow of runoff from storms and floods. But when forests are disturbed and degraded, the cycles are disrupted and sediment flows into streams and pollutes water.

WRI research shows that a combined “green-gray” approach, which uses both human-made and natural infrastructure, is often an effective and low-cost way to protect water sources. In one of the most well-known examples, New York City invested $1.7 billion to protect more than 1 million acres of mostly forested watershed in the Catskills to save on water filtration costs. While the city continues to use networks of pipes and water storage, forest conservation allowed the city to avoid $6 billion to $8 billion on the cost of building a new water filtration plant.

And it’s not just the water supply that will benefit. Protecting forests can yield important climate and human benefits, such as carbon sequestration, increased biodiversity, improved health, access to recreation and job creation. The environmental and social benefits of the bond also attract investors interested in greening their portfolios and fulfilling sustainable finance commitments.

2. Response from capital markets indicates they increasingly see natural infrastructure and other climate-related investments as a smart bet.

Acquiring and protecting forestland requires a large up-front infusion of cash. It can take months, or even years, to unlock public and philanthropic funding in the amounts needed to acquire significant amounts of land. However, the capital markets can raise capital very quickly and efficiently, but only with a trusted repayment mechanism to assure investors that they will get their money back.

CAW is relying on its current rate structure for ratepayers and the dedicated watershed protection fee to repay the bond and the 2.136% true interest cost. CAW’s investment in forests will yield future savings through avoiding water treatment costs and potentially generate future revenue streams through voluntary carbon offsets, timber harvests and non-timber forest products. Investors see this as a good bet because utilities have predictable cash flows generated from providing an essential service — in this instance, supplying drinking water. This means the investors are likely to get their money back, while the “green” label ensures that their investment meets verified environmental criteria. This is increasingly important as institutional investors like pension funds look to increase their investments in green projects.

How do investors know that the investments are truly green, and not just a marketing ploy? For certified green bonds, third-party verifiers assure investors that the proceeds of the bond will be invested in climate-related or green projects that meet certified criteria. The bond was certified under the Climate Bonds Initiative’s water infrastructure criteria. This criteria was developed by the Water Consortium, including WRI, and supports green-gray approaches that advance climate mitigation and resilience.

Green bonds are gaining momentum in the market place with more than $222 billion in issuances in 2020, recently surpassing $1 trillion in cumulative issuances since the first green bond in 2007. This represents a broader shift to green investments, despite the pandemic-related economic downturn. In the capital  markets, U.S. environmental, social and governance (ESG) index funds are outperforming traditional index funds for a variety of reasons, including reduced investment in energy and fossil fuels.

3. Other cities and utilities across the country and the world can replicate CAW’s approach.

Municipalities and utilities can follow in CAW’s footsteps by replicating and innovating on their model. Healthy watersheds protect drinking water quality and quantity. With low interest rates and access to cheap capital, it is a good time to raise funds for long-term planning projects, like green- gray infrastructure.

This green debt instrument has previously been used for stormwater management investments by San Francisco’s Public Water Utility with annual operating budgets around $1.4 billion and New York City Water in excess of $1.5 billion. With CAW’s issuance, medium-sized utilities with annual operating budgets around $60 million are getting into the game. CAW’s green bond will also be the first to emphasize the value of cities’ “nearby forests,” not just urban green infrastructure such as street trees and green drainage systems.

A More Sustainable Future for Little Rock

CAW’s green bond exemplifies a true win-win-win situation for investors, local utilities and residents. The dedicated watershed protection fee is the foundation for CAW’s recent success, allowing the utility to raise capital for a long-term investment in natural infrastructure and take advantage of the low interest rates on the bond market. The green bond platform helps investors find strong projects to allocate earmarked “green” capital, supporting a much-needed transition towards low-carbon investments. The residents of Little Rock and the surrounding area benefit from a protected watershed in the form of clean drinking water without paying additional fees.

<p>CAW\'s water treatment facility in Little Rock. Photo by Central Arkansas Water</p>

CAW's water treatment facility in Little Rock. Photo by Central Arkansas Water

“Our priority is providing high-quality water to our 500,000 recipients in an affordable and efficient manner,” CAW Chief Executive Officer Tad Bohannan said, “and green bonds are one more tool in our toolbox that we can use as we strive to deliver on that priority in a manner that also provides many co-benefits to our communities.

Residents in Little Rock and surrounding areas will start to see more benefits than a protected watershed. Recreation will expand around the lake, wildlife will thrive in the protected habitat and the air may even become cleaner. The $6 billion timber industry may benefit from sustainable harvesting, supplying local jobs and raw materials. And perhaps most importantly, residents will be able to turn on the water faucet and count on the clean drinking water for generations to come.

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