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How green bonds can help fight the climate crisis

In 2015, the Paris Agreement set ambitious targets to mitigate climate change. Since then, the EU has rolled out its Green Deal, and the International Energy Agency (IEA) revealed its pathway to net-zero carbon dioxide emissions by 2050. In November 2021, the UN’s COP26 in Glasgow could generate even more major sustainability measures.

These and other efforts by governments and organisations often take a carrot-and-stick approach, including setting not only ambitious emission targets, but also providing or promoting business incentives. UN envoy Mark Carney called the net-zero transformation, for example, “the greatest commercial opportunity of our age.” The IEA estimates that annual investment in clean energy alone needs to more than triple by 2030 to over $4 trillion in order to meet that target.

Whatever the final number, the net-zero pathway should promote green projects around the world related to supply chains, farming, solar panels, heat pumps, electric vehicles and more.

A growing green bond market

Debt capital markets have a crucial role to play in bolstering green business. Issuing debt via bonds is one of the most popular ways for large organizations to raise funding. The global bond market is now worth a staggering $120 trillion, and green bonds are increasingly important in this space.

Green bonds are structurally the same as any other medium-term note, but the use of green-bond proceeds is unique. With green bonds, capital raised is used exclusively to invest in environmental projects, such as renewables, pollution prevention and products adapted for the circular economy. Returns are then measured in part by the lasting positive effects of the investments.

The World Bank launched the world’s first green bond in 2007, in response to demand from institutional asset owners. The first corporate green bonds followed in 2013, and the volume of global issuances has risen since.

One green bond — the UK’s inaugural 12-year Green Gilt — listed on the London Stock Exchange’s Sustainable Bond Market in September 2021 with a goal of supporting green jobs. It has raised £10 billion after attracting over £100 billion of demand from investors. In the EU, meanwhile, green bonds are expected to provide 30 percent of the funding for the European Commission’s Covid recovery package.

Companies have recently begun to issue green bonds. In April 2021, one organisation — the world's largest recycler of aluminium — listed green bonds on the International Stock Exchange in the Channel Islands to finance investments in renewable energy and pollution prevention and control.

The range of green bonds now available to investors is also expanding. It includes covered bonds and loan bonds, with varying debt recourse structured within the product. In asset-backed securities, green loans are backed by renewable technology such as solar panels and windmills.

In the US, businesses using a tax incentive to buy electric vehicles can use those sales as an asset-backed security, packaging and borrowing against them to fund other green projects. We can expect more options and incentives in the future, with green securitisation and repackaging, and the deployment of derivative strategies.

Considerations for investors

According to analysis by the Climate Bonds Initiative, green bonds are now in greater demand than their “vanilla equivalents.” Their success is due in large part to support from governments, increased visibility and increasing public demand for sustainable investments. 

Green bonds can be a relatively safe option for investors. Where issuers of regular bonds have freedom to use the capital raised any way they want, an issuer of green bonds must demonstrate where the money has gone and how it's coming back to investors through regular, transparent reporting. This transparency gives investors — typically institutional pension funds and fund managers — an added sense of security. Many of these investors are sitting on significant dry powder and are being influenced by their stakeholders’ increasingly strong taste for sustainability. For these stakeholders and investors, green bonds offer a chance to do good with the possibility of generating compelling returns and expanding an existing portfolio.

Green bonds do tend to be more expensive than regular bonds due in part to high demand and limited supply. There are, for example, fewer solar panels and windmills that can be packaged together into an asset-backed security than there are other, more traditional energy products. Furthermore, sustainability disclosure requirements increase administrative burdens and costs.

Investors should critically evaluate the issuer’s credentials and broader portfolio, in addition to the bond’s targets and sustainable outcomes, to help minimise risk. Some green bond issuers have been accused of exaggerating their environmental impact, often labelled greenwashing. If the issuer is later found to be doing so, they risk reputational damage.

While there is no established regulatory standard to address greenwashing, there are voluntary codes. The Green Bond Principles, for example, were introduced in 2018 by the International Capital Market Association. They provide a sound framework for the provision of transparently reported green finance. The principles help guide issuers in reporting on the use of the green bond proceeds and encourage fund-tracking transparency for environmental projects. They also help reinforce the green bond market’s integrity.

It’s worth remembering that the global bond market is huge, and green bonds now represent just 1 percent of that market. But recent trends suggest that the future of green bonds is bright. Many governments are pushing the transition to a low-carbon economy, and vast amounts of capital will be needed to make that transition. We can expect huge investment in everything from renewable energy and clean water to electric vehicles and green construction. Debt capital markets — and green bonds in particular — will likely play a critical role in deploying capital that’s environmentally and socially just.
 

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