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Published on: Jul 22, 2024
#Financial Markets
Green bonds are financial instruments that promote environmental conservation by funding environmental-friendly projects. These bonds mainly support projects improving energy efficiency and sustainable farming, preserving water bodies, and mitigating climate change.
Key takeaways:
• Green bonds can be described as bonds in which the resources raised are used for environmental-friendly projects.
• Such projects include creating new energy sources, producing electric vehicles, or granting loans for environmentally-conscious structures to companies or individuals.
• Bonds link investors who wish to invest in green projects, while some businesses or consumers require funds to provide green products or implement green measures.
• Bonds are fascinating to major investment funds, including pension funds, asset managers, and insurance companies.
Climate change has made sustainable finance a priority in many countries. Some of the most valued tools in this financial sector include green bonds–environmentally friendly instruments provided by public and private companies.
The European Investment Bank (EIB) was an early bird in this regard and came up with the first green bonds in 2007. This was a good move to ensure the banking industry flowed in the right direction. However, sustainability does not equal the loss of profitability; many investors interested in green bonds are also interested in their return on investment. This does not detract from the green bonds’ attractiveness; on the contrary, it often increases it.
Therefore, to understand green bonds clearly, it is vital to explain them in general. Bonds are securities issued to raise funds for a longer period. They give liquidity to the issuer and, ultimately, provide the investor with a return of the initial capital plus interest. This differs from other short-term instruments like government securities, which are relatively safer.
Green bonds are financial instruments that promote environmental conservation by funding environmentally conscious projects. These bonds mainly cater to various projects, including improving energy efficiency and sustainable farming, water body preservation, and climate change mitigation. They also participate in advancing green technology and initiatives to combat climate change.
Like traditional bonds, green bonds offer certain tax advantages, such as tax credits and exemptions. These incentives make them a better investment opportunity than the other taxable bonds in the market. An independent entity often verifies the funds raised to confirm that the green bonds are used for their intended purpose.
For example, the Climate Bonds Standard Board offers certification, proving that the projects funded by those bonds are environmentally effective.
The origin of green bonds dates back to 2007, the same year that the Intergovernmental Panel for Climate Change, a UN body, issued a report that linked climate change to human activities. This report led several Swedish pension funds to fund projects that would benefit the environment. In 2008, the world saw the World Bank's first green bond. However, the market for green bonds has grown tremendously since the early years described above.
More than 50 countries have engaged in green bonds, with the United States being the leading country in issuing them. The Climate Bonds Initiative is a good reference source for getting updates on the development of the green bond market. According to this organisation, the global green bond issuance was estimated at $350 billion in 2020.
Green bonds, accepted as environmentally friendly investments, often have to conform to specific disclosure requirements. The most famous standard is the Green Bond Principles (GBP). These guidelines assist firms that offer green bonds by elaborating on how they can communicate information regarding the environmental outcomes of the green bonds to possible investors.
Adherence to these principles makes it possible to define how environmental strategies can be tailored to investors and how the use of the bond proceeds can be tracked. Investors also like to have a second opinion, so companies must showcase the environmental projects the bond will fund and how the project's success will be monitored.
Green bonds require a certain level of effort from the companies issuing them. However, they usually come with many benefits.
A key benefit of green bonds for companies is providing the much-needed capital for sustainable projects. Usually, the funds allocated for sustainable activities are limited; however, changing towards sustainability is rather costly.
Currently, companies are using green bonds to finance numerous sustainability projects. These projects include providing renewable and clean energy, efficient water management, afforestation, improving supply chain risk, and manufacturing electric automobiles or zero-emission taxis.
More and more investors are getting interested in green bonds. From the investors’ perspective, green bonds offer a way of financing sustainable projects and initiatives with no major risk. The demand for green bonds has always been higher than the supply due to investors’ desire to invest sustainably and use green bonds as a climate risk management tool. For businesses, this means a continuously expanding audience is ready for their investment offers.
Green bonds are not complicated for the corporate finance teams to manage despite the conditions. Although organisations may use other financial instruments, such as power purchase agreements (PPAs), these are not as well-known among the finance teams. Thus, there is learning involved in navigating the financial aspects. Communicating green bond issuance within the organisation is easier, and does not take much time for the finance team to get familiar with structuring a green bond.
Below, we list some of the main advantages and disadvantages of green bonds.
Image: Illustration of what green bonds may look like, by Moneycontrol
• Higher Ratings: Green bonds are often given better ratings by rating agencies such as Standard & Poor’s and Moody’s than similar bonds that are not ESG-related. This is mainly because companies that issue green bonds are usually more transparent than those which do not have the ESG orientation.
• Lower Risk: Green bonds have been recognised as reliable instruments that complement the investment portfolio. A study done at Jönköping International Business School, Sweden, has found although green bonds may yield lower interest rates, they are popular with individual and institutional investors because of their lower risk.
• Increased Transparency: Green bond issuers can potentially provide more information on the use of the funds or the desired results through extra reports or verification by a third party. This is not compulsory, though; it is usually anchored on the issuer and the force that investors may apply.
• Stable Returns: Like conventional bonds, ESG bonds offer steady returns. They provide a constant source of income and can be traded at any given time in the market, thus qualifying them as liquid investments.
• Impact Investing: ESG bonds are outstanding for those who want to invest in projects that correspond to their values regarding the environment, society, or corporate management. Green bonds are also expected to hold donors accountable to ensure the money donated is used for the intended green goal.
• Lack of Standard Reporting: Currently, there are no specific rules for presenting information about green bonds as there is no common framework, for instance, the U.S. Securities and Exchange Commission. Companies may use the International Capital Market Association standards or choose third-party compliance reporting, but the situation is imperfect. Investors could be under the impression that they are helping to support things like solar panels, but instead, their money could be going towards things like company cars, and there is little paperwork to show for it.
• Lower Interest Rates: The same Swedish study also established that, on average, ESG or green bonds offer slightly lower returns of 15-20 bps than traditional bonds.
• Price Fluctuations: All bonds are sold with market conditions in mind, and the price of green bonds can go up or down based on the market. This implies that the value of the assets can either rise or decline depending on the general performance of the market.
ESG bonds come in various types:
• Green Bonds: Green bonds are the most common type of ESG bonds, and they are mainly used to fund renewable energy, clean transportation, and other environmentally friendly projects.
• Social Bonds: These bonds are centred on food insecurity, shelter, and service delivery issues.
• Climate Bonds: These are like green bonds and are used to promote reducing greenhouse gas emissions or decreasing the use of energy derived from fossil fuels.
• Sustainability Bonds: These are some funds that are used to combine green and social agendas.
• Sustainability-Linked Bonds (SLBs): These bonds are unique because they require the issuer to be bound by certain ESG goals, which, if not met, attract penalties.
Some of the biggest corporations, such as Walmart and Apple, have launched sustainability bonds for climate change projects, and investment banks like JPMorgan Chase and BNP Paribas have acted as underwriters for green bonds. It is recommended that you seek the services of their financial advisors or investment service providers for advice and purchase.
Greenwashing, making false or exaggerated statements about a product's environmental friendliness, is a significant issue in green bonds and other sustainable investments.
It is important to note that regulators and the financial industry are working to solve this problem. Many organisations issuing bonds adhere to certain guidelines, like those from the Green Bond Principles. The International Capital Market Association endorses these guidelines to enhance the green bond market’s disclosure standards. Nonetheless, several firms offer a service that assesses and awards the green status of such bonds.
The European Union is working to enhance transparency by implementing its voluntary European Green Bond standard. This initiative aims to assist investors in understanding the green bond market and thus help them compare bonds marketed as green.
In a world where climate change is becoming a pressing issue, investors have directed more resources to conventional carbon-based sectors than to environment-friendly initiatives even after the signing of the Paris Agreement. Funding for green projects is much lower than that provided to oil, gas, and coal projects—it has been three times lower since 2016. However, Bloomberg Green noted that this practice changed in 2021, which may signify a turning point in the fight against climate change.
The World Economic Forum’s report on Fostering Effective Energy Transition in 2023 stated that the green bond market reached $270 billion in issuances in 2020. Thus, sustainable investments are expected to continue growing rapidly. Major government plans and programs, such as the European Green Deal and President Joe Biden's American Jobs Plan, support this growth. Green bonds are expected to continue to play a major role in such initiatives, as they offer the required funding for large sustainability projects worldwide.
Green bonds are financial tools to finance projects that improve environmental conditions, such as renewable energy, energy efficiency, and clean transport. They are meant to support sustainability and fund initiatives that fight climate change and its impacts.
People who invest in green bonds simply buy bonds, and the money received from the bonds is used to fund green activities. To avoid manipulation, a third party usually issues these bonds, usually only after the Climate Bonds Standard Board certifies that the projects financed create real climate change mitigation.
Green bonds are financial instruments through which an investor can advance environmentally friendly projects and earn a return on his investment. They are especially suitable for people who want to invest in green projects and help reduce climate risks in investors’ portfolios.
Unlike other bonds, green bonds are targeted towards projects with some form of environmental impact. Although they are like other bonds in terms of return on investment, they offer more advantages in the form of environmental benefits. Green bonds can also be associated with tax benefits through tax credits or exemptions to encourage investors.
Green bonds should follow the Green Bond Principles to avoid greenwashing, where green claims might be misleading. These principles guide how the funds shall be raised and used and how reporting shall be done to ensure that the funds raised are used for the intended green projects.
This article is for informational purposes only and not intended as investment or financial advice. It contains opinions and speculations that are subject to change without notice.
The author and publisher disclaim any liability for decisions made based on the content of this article. Readers are advised to conduct their own research and consult a financial advisor before making investment decisions.
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