Green Bonds: Investing for a Greener Future
As the world increasingly focuses on addressing climate change and other environmental challenges, green bonds have gained popularity among investors who wish to align their financial goals with their values and contribute to positive change. Green bonds are a type of fixed-income investment used to fund projects with a positive environmental impact. Like traditional bonds, green bonds offer investors a stated return and a promise to use the proceeds to finance or refinance sustainable projects, either in part or whole.
These bonds are issued by public, private, or multilateral entities to raise capital for initiatives that contribute to a more sustainable economy and generate identifiable climate, environmental, or other benefits. Projects funded by green bonds include renewable energy, energy efficiency, clean public transportation, pollution prevention and control, conservation, sustainable water and wastewater management, and green buildings that meet internationally recognized standards and certifications.
Key Takeaways
- Green bonds are designed to support specific climate-related or environmental projects.
- Green bonds may offer tax incentives that make them more attractive to investors.
- The term “green bond” is sometimes used interchangeably with “climate bonds” or “sustainable bonds,” but they are not synonyms.
- Green bonds are part of a larger trend in socially responsible and ESG (Environmental, Social, and Governance) investing.
Understanding Green Bonds
Green bonds are meant to encourage sustainability and support climate-related or other environmental projects. They fund initiatives ranging from energy efficiency and sustainable agriculture to protecting aquatic and terrestrial ecosystems. They also finance the cultivation of environmentally friendly technologies and climate change mitigation.
Like other bonds, the green variety often comes with tax incentives in the form of credits and exemptions, making them more attractive than comparable taxable bonds. Green bonds are often verified by a third party, such as the Climate Bonds Standard Board, which certifies that the bond will fund projects that provide environmental benefits.
The Booming Green Bond Market
In recent years, the green bond market has seen significant growth as governments introduce new requirements to tackle climate change, and many investors seek opportunities that meet their ESG goals. In 2023, sales of green bonds reached a record $575 billion, with $190 billion issued by governments.
Demand for green bonds is expected to increase, thanks to cheaper borrowing costs and European regulations aimed at improving the transparency, comparability, and credibility of the green bond market.
Green bond funds developed in the 2010s, broadening the ability of retail investors to participate in these initiatives. Major investment companies and asset management firms, such as Allianz, Axa, State Street Corporation, TIAA-CREF, BlackRock, AXA World Funds, and HSBC, have sponsored green bond mutual funds or exchange-traded funds (ETFs).
First Green Bond: 2008
The World Bank issued the first so-labeled green bond for institutional investors in 2008.
Real-World Example of Green Bonds
The World Bank is a major issuer of green bonds. In 2022, it reported issuing $40.8 billion in bonds, with $28.2 billion in funds disbursed and $33.1 billion in new lending committed. Previously, the bank had reported issuing $14.4 billion in green bonds from 2008 through 2020. The funds supported projects in energy and efficiency (33%), clean transportation (27%), and agriculture and land use (15%).
One of the World Bank’s first green bond sales financed the Rampur Hydropower Project in India, providing low-carbon hydroelectric power to the northern electricity grid and preventing 1.4 million tons of carbon emissions annually. In 2022, the bank’s combined projects reduced carbon emissions by 8.4 million tons.
Types of Green Bonds
Various types of green bonds exist in the market, each characterized by the issuer, the use of proceeds, and the recourse of bondholders. The primary types include:
- “Use of proceeds” bonds: Focus on financing green projects, but if the issuer liquidates, lenders have recourse to other assets of the issuer. They share the same credit rating as the issuer’s other bonds.
- “Use of proceeds” revenue bonds or asset-backed securities: May finance or refinance green projects, backed by revenue streams collected by the issuer, like taxes or fees. These are often issued by states and municipalities.
- Project bonds: Limited to a particular underlying green project, giving investors recourse only to assets related to the project.
- Securitization bonds: Combine a group of projects into a single debt portfolio, with bondholders having recourse to the assets of the complete set of projects.
- Covered bonds: Finance a group of green projects known as the “covered pool.” Investors have recourse to the issuer, but if the issuer cannot make debt payments, bondholders have recourse to the covered pool.
- Loans: Financing for green projects can be secured (backed by collateral) or unsecured, allowing lenders to access the collateral if necessary.
How To Buy Green Bonds
Investments in green bonds often come from institutional investors, mutual funds, hedge funds, and endowments that can afford large sums in debt instruments. However, many mutual funds and ETFs offer retail investors exposure to green bonds, allowing them to align their portfolios with environmental values.
For example, the iShares USD Green Bond ETF tracks the performance of investment-grade bonds that finance environmental projects. While focused only on U.S. dollar-denominated debt, it includes bonds from non-U.S. issuers and U.S.-based borrowers.
Retail investors looking to buy individual green bonds may face a more complex situation. Brokers may offer access to individual bonds, but corporate-issued green bonds may require minimum deposits, maintenance fees, and commissions. Government-issued green bonds may be available through brokers or directly from issuers.
Key Challenges in Buying Green Bonds
When purchasing green bonds, transparency and reporting can be challenging as you’ll need detailed information about the use of proceeds and the environmental impact of funded projects. The green bond market is still developing, and some bonds may have lower liquidity than traditional ones, making it difficult to buy or sell at desired prices and times. Additionally, the lack of a universal standard for green bonds can cause confusion and lead to greenwashing, where exaggerated or misleading ecological claims are made.
Different Shades of Sustainable Bonds
Blue Bonds: These sustainability bonds finance projects that protect the ocean and related ecosystems, such as sustainable fisheries, coral reef protection, and pollution reduction. All blue bonds fall under the category of green bonds, but not all green bonds are blue bonds.
Climate Bonds: While sometimes used interchangeably with green bonds, climate bonds specifically target projects that focus on reducing carbon emissions or combating the effects of climate change. The Climate Bonds Initiative has set detailed standards for certifying climate bonds.
Assessing the “Greenness” of a Green Bond
Due diligence is crucial in determining if a green bond is genuinely environmentally friendly. Without a universally recognized standard, investors must navigate potential greenwashing. Organizations like the Climate Bonds Initiative, Moody’s, and Bloomberg provide assessments to help with this analysis.
The Bottom Line
Green bonds are debt securities designed to finance environmentally friendly projects and often come with tax advantages. Investors interested in these securities should verify the sustainability claims of bond issuers to ensure their investments align with their environmental values.
Related Terms: ESG criteria, Climate Bonds, Blue Bonds, Greenwashing.
References
- Municipal Securities Rulemaking Board. “About Green Bonds”.
- Raj M. Desai, et al., eds. “From Summits to Solutions: Innovations in Implementing the Sustainable Development Goals”, Pages 67-79. Brookings Institution Press, 2018.
- World Bank. “Green Bond Impact Report”.
- Climate Bonds Initiative. “Climate Bonds Standard Board”.
- The European Commission. “Green Bonds: New Study Shows Extraordinary Growth and Signals Potential in Financing Europe’s Climate and Environment Goals”.
- Bloomberg. “Green Bonds Reached New Heights in 2023”.
- S&P Global. “Global Green Bond Sales to Get Boost in 2024 as Interest Rates May Fall”.
- Sustainable Research and Analysis. “New Green Bond Fund Investing Options Double in Number”.
- The World Bank. “10 Years of Green Bonds: Creating the Blueprint for Sustainability Across Capital Markets”.
- The World Bank. “The World Bank Impact Report 2022: Sustainable Development Bonds and Green Bonds”, Page 15.
- The World Bank. “The World Bank Impact Report 2020: Sustainable Development Bonds and Green Bonds”, Pages 100–101.
- Climate Bonds Initiative. “Explaining Green Bonds”.
- iShares. “BGRN: iShares USD Green Bond ETF”.
- Cristina Dolan and D. B. Zalles. “Transparency in ESG and the Circular Economy: Capturing Opportunities Through Data”, Pages 61-62. Business Expert Press, 2021.
- World Economic Forum. “Blue Bonds: What They Are, and How They Can Help the Oceans”.
- Climate Bonds Initiative. “Frequently Asked Questions; Standard”.
- Bloomberg Professional Services. “What Are Green Bonds and How ‘Green’ Is Green?”
