What are Green Bonds? Trends and How they Relate to ESG

In 2007, the Intergovernmental Panel for Climate Change (IPCC) released a report that undeniably linked human activity to global warming. The finding, along with increasing occurrences of natural disasters, prompted investors to look for a solution, which led to the introduction of green bonds by the World Bank and some other development banks. Unlike regular bonds, green bonds are designed to offset the challenges of climate change by supporting environmental and sustainable development projects. Even though they only make up a small portion of the overall traditional bond market, it has received massive attention in the last decade. In 2020 alone, over $200 billion worth of green bonds fund have been issued, taking the cumulative total since the securities were launched in 2007 to over $1 trillion, research by Bloomberg New Energy Finance (BNEF) shows.

What is a Green Bond?

Green bonds are also referred to as climate bonds. These are fixed-income instruments that are specifically earmarked to generate proceeds to finance existing and new green projects.

Thus, green bonds are used to finance projects aimed at energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean transportation, clean water, and sustainable water management.

Thus, these bonds support climate change mitigation and adaptation goals, answering the increasing awareness of systemic climate damage by investors, insurers, banks, and governments.

Conventional bonds invested in green projects; these funds guaranteed by income; project-specific obligations; and securitized green bonds are the four major types exist.

Green bonds are typically asset-linked and backed by the issuing entity’s balance sheet, so they commonly carry the same credit rating as their issuers’ other debt obligations.

Further, green bonds come with tax incentives such as tax exemption and tax credits, to enhance their attractiveness to investors.

Key Trends in the Green Bonds Market

Although launched in 2007, the green bonds market kicked off in earnest in 2014, when the International Capital Market Association (ICMA) introduced the Green Bond Principles (GBPs). The GBPs oversee the use of proceeds, the process for project evaluation and selection, the management of proceeds; and reporting.  The establishment of these principles is regarded as a key driver of the green market growth as it created more transparency for investors and clarified requirements for issuers, which in turn increased the volume and diversity of issuers.

Bonds that meet the GBPs or the Climate Bond Initiative’s (CBI) Climate Bonds Standard (CBS) are qualified for certification by either third-party providers or the CBI. Certification assures investors that the bonds confer environmental or climate-related advantages, helping to safeguard against “greenwashing”.

Between 2015 – 2017, the green bonds market experienced exponential growth largely due to these factors: a strong increase in corporate green issuance, the introduction of municipals and emerging market issuers (particularly China), and the launch of the first sovereign green bonds. Before 2015, supranational and advanced economy issuers dominated the market. The corporate issuances that gained market share during this period were mainly from utility companies, banks, automotive, and real estate companies.

France’s EUR 14.8 billion green bond launch in 2017 paved the way for sizeable sovereign issuance in 2018-2019 from Belgium, the Netherlands, and Ireland, as well as several emerging sovereigns.

Also, issuance which was predominantly in euros and US dollars can now be made in other currencies. As a result, the market has gone from being mainly supranational and euro-based to representing a more broadly diversified universe in both issuer and currency terms.

ESG and Green Bonds

Environmental, Social, and Corporate Governance (ESG) refer to the three major factors in measuring the sustainability and societal impact of an investment in a company or business. Socially conscious investors use these three criteria to evaluate companies in which they might want to invest.

Since green bond fund are chiefly utilized in financing projects that benefit the environment and promote sustainability, this type of investment is compatible with an ESG framework (particularly the environmental and social factors). Thus, these fund are a critical component of ESG and socially responsible investing.

In the past, investors tended to pay more attention to governance factors to better understand the risks and opportunities associated with lending to different entities. Today, however, instruments like green bonds are enabling investors to directly address the environmental and social aspects of their investments.

Conclusion

Green bonds are standard fixed-income instruments whose proceeds are used to finance climate-related or environmentally friendly projects. Since its establishment in 2007, the market has witnessed healthy growth. According to the Climate Bond Initiative, the issuance reached an all-time high in 2019 when a total of $255 billion were issued, up 49% from 2018 issuance. With the significant increase in climate awareness and with the emergence of new initiatives to combat climate change, it is unsurprising that such a crucial vehicle to finance these initiatives is witnessing rapid growth, too.