Green Bonds – Everything You Need to Know
A green bond is like any other bond where a debt instrument is issued for raising funds from investors. However Green bond differs from other bonds in such a way that the proceeds of a Green Bond offering are ‘ear-marked’ for use towards financing ‘green’ projects. Financing countries climate and sustainable development commitments will require global investment on an unprecedented scale.IFC estimates cumulative climate investment potential of $29.4 trillion across six key sectors in emerging market cities through 2030. These sectors include waste, renewable energy, public transportation, climate-smart water, electric vehicles, and green buildings.
Green bonds are fixed income instruments whose proceeds are for environmental benefits focused on renewable, energy efficiency, water, clean transport, and climate change mitigation and adaptation. Rapid growth of the global green bond market over the past decade to more than $700 billion in outstanding issues has required collaboration among multiple stakeholders, including first mover issuance by multilateral institutions, the mobilization of private and public sector issuers and investors, and numerous policy actions to provide and encourage regulatory frameworks, taxonomies, and enabling environments. Green bonds, although still representing a small fraction of the over $100 trillion of bonds outstanding globally, represent a significant market opportunity for investors seeking to align their investment strategies with environmental considerations.
Benefits for investing in Green Bonds
- Investors Diversification
- Tax-exempt Income
- Potential for pricing advantage
- Better environmental performance and more green innovations
- Increase in ownership by long-term and green investors
- Improvements in financial performance
Investors have traditionally been wary of investing in green bonds. One of the main hurdles to a green bond boom in financial markets is the risk of ‘greenwashing’. A term coined by environmentalist Jay Westerveld in 1986, greenwashing is the practice of channelling proceeds from green bonds towards projects or activities having negligible or negative environmental benefits.
Greenwashing brings significant reputational risk for socially conscious investors seeking to diversify their investment portfolios by investing in environmental, social and governance practices.
The specific structure for a green bond can be determined based on the circumstances of the issuer and the applicable green projects.
Green bond issuance in emerging markets has grown thanks to increasing recognition among issuers and investors of the benefits they can provide. For investors, green bonds are traditional fixed-income instruments that offer yields commensurate with the risk exposure while providing assurance that the funds will be channeled to projects with clear environmental benefits. For issuers, green bond issuance provides a means to broaden their investor base and sends a signal to the market on their commitment to environmental considerations. Market participants cite encouraging signs of future potential in the increased investor appetite they witness among both international and local investors. This reflects growing adoption of ESG investment strategies as well as growing awareness about green financing products. Market participants expect a greater diversity of issuers to come to market as understanding grows that green bonds can help to meet funding needs. At the same time, the low yield environment encourages international investors to seek yield in emerging markets. Key challenges need to be addressed, however, to enable more rapid expansion of the market, including the following:
- Quality and availability of information to identify, measure, and track green investment
- Supply constraints, including the limited availability of labelled green assets and a pipeline of green projects
- Lack of awareness and know-how about issuing and investing in green products
- Overall macroeconomic and policy instability as well as challenges related to regulatory frameworks, including harmonized standards, green definitions, and green taxonomies
- Underdeveloped capital markets with insufficient liquidity and high transaction costs
Green bonds are a natural source of financing for issuers who have a financing or refinancing requirement for a green project. There does not currently appear to be a premium for green bonds compared to non-green bonds of the same issuer.
Further, issuers who would use the proceeds to finance projects towards its environmentally and socially responsible programmes (for example, to reduce the carbon footprint or waste from its ordinary business activities) could also tap the market and further signal its commitment to its cause. Green bonds can be attractive to issuers and investors alike with the right balance on the green and commercial aspects.