As the name suggests, a Green Energy Bond (“green bond”) is a fixed income instrument that is earmarked for climate and environmental projects, typically issued by a corporation or government agency. Green bonds function similarly to traditional bonds, except the funds are publicly slated for sustainability-focused uses, which are formalized in a “framework” developed by the issuer.
The popularity of green bonds has seen a dramatic upswing in recent years as more and more investors look for investments that yield more than monetary gains.
Understanding Green Bonds
Green bonds were developed to encourage sustainability and support climate-related projects, connecting investors to organizations with ambitious goals. More specifically, green bonds have been issued to finance projects aimed at energy efficiency, water management/conservation, pollution prevention, the protection of various ecosystems, sustainable agriculture, and many other massive endeavors.
Green bonds come with tax incentives (such as tax exemption and tax credits) making them an attractive alternative to taxable bonds, beyond the social benefits. The government offers these tax advantages as a means to drive the movement behind climate change and renewable energy, aligning the interests of investors and corporations with its own agenda of reducing the collective environmental impact.
To qualify for green bond status, third parties (such as the Climate Bond Standard Board) are often called to certify a bond is to be used for environmental causes, though no universal requirements exist. Issuers rely on the strength of their balance sheets to receive favorable terms when issuing, and receive credit ratings in the same vein as their other debt.
In addition to how the funds will be used, green bonds differ from traditional bonds in their typical size of issuance. The customized-nature and large administrative costs of each bond issuance call for projects funded by the sale of green bonds to be exceedingly large and ambitious in scope. This often leads to failed attempts at raising the full amount required of the bond sale.
For investors, the benefits are two-fold: The monetary incentive of a positive return-on-investment while simultaneously bringing about a positive social benefit. Green bonds are an excellent way for investors to drive change they are passionate about while still retaining their principal (plus interest). This allows for further investments into similar ventures well into the future.
It also allows for targeted investing – only subjecting themselves to the risk they’re comfortable with taking, similar to traditional bonds. Compared to other forms of ESG investments, green bonds allow investors to invest in specific projects, regardless (or maybe in spite of) the agent behind the project.
Put simply, investors want a safe place to put their money and know they’re making a difference. Not to mention the tax benefits.
For issuers, the real benefit is less obvious and more intangible. Yes, many corporations and government organizations are authentically driven toward social benefits as an end in itself. However, the extra publicity never hurt.
The fantastic rise in ESG-style investing has opened the door for creative institutions to have access to an unheard of amount of capital. The greater the publicity any one of these institutions receives for tackling ambitious projects, the better.
The low-cost, flexible terms, autonomy, and enormous public visibility make issuing green bonds attractive for an organization in any sector, both in terms of furthering social causes and building public goodwill.
Given the advantages for both investors and issuers alike, it’s no wonder why green bonds have exploded in popularity over the last decade.
History and Future
In 2009, The World Bank issued the first official green bond, creating the blueprint for sustainable investing in capital markets. This initial issuance forever changed the way investors, issuers, policymakers, and scientists work together. Since the first issuance in 2009, the quantity of green bonds issued has grown, slowly at first, with a dramatic increase in the last several years.
As recently as 2012, green bond issuance totaled a mere $2.6 billion. In 2017, the market began to soar, with a total issuance amounting to $161 billion. A new record of $269.5 billion was set last year, beating the record set in 2019 of $266.5 billion, despite COVID-19’s dampening effects on the market.
The projections for 2021 amount to a staggering $450 billion, with no signs of slowing down.
One thing is sure: Any investor who may be interested in adding green bonds to their portfolio will face no shortage of options in the years to come.