WHAT IS A BOND?
In its simplest form, a bond is a form of a loan. The borrower (such as a government agency, corporation, or other public agency) borrows money from the ‘“bondholders” (e.g. the bond issuer and/or investors) and will repay principal and interest on an agreed-upon schedule. Bonds are attractive to borrowers because they are seen as a relatively low risk means of investing money. This roadmap explains how bonds work at a basic level.
WHO BUYS BONDS & WHY DO THEY BUY THEM?
Bonds are an important part of a balanced investment portfolio. Institutional Investors (banks, insurance companies, pension funds, and large portfolio managers) buy bonds because they tend to be lower risk compared to other types of investments and can be reliable sources of predictable long-term income. In some markets, particularly the United States, they can also have significant tax advantages for their investors. Bonds have traditionally been used by governments and cities to build major long-term infrastructure. Examples include the national rail system in the USA and the city of London’s sewage system, both financed by large long-term bond issuance programs in the early part of the last Century. Since 2013, corporates have been using green bonds to improve their environmental footprint, with the fortuitous side benefit of improving their financial performance [Flammer, 2018].
WHAT IS A GREEN BOND?
The green bond concept is simple. Green bonds, with the backing of credible, third-party standards, are used to finance infrastructure and climate-related projects needed to adapt and respond to a climate-impacted world. Labelled Green Bonds help investors understand what their money is being used for and that it is aligned with green investment principles. These types of investments include clean energy, energy efficiency, climate adaptation (such as seawalls and programs), clean transportation (such as rail and electric vehicles), water and wastewater, natural infrastructure (such as wetlands) and green building projects, to name a few.
The green bond label is a tool to help investors understand what is being financed with bond proceeds and whether it is aligned with “green” investment goals.
WHY ISSUE A GREEN BOND?
Since the first issuance of a green bond in 2007 by the European Investment Bank, green bonds have provided an important source of financing for green projects around the world. The green bond market has grown from annual issuance of USD 2.6bn in 2012 to USD 167bn in 2018.
Governments or companies choose to issue green bonds for some of the following reasons:
- Green bonds can enhance an issuer’s reputation – showcasing their commitment towards green growth and sustainable development. Governments may want to make a political statement and demonstrate their commitment to certain environmental (e.g. combating climate change) and/or sustainability objectives (e.g. stimulating green growth or shifting to a green economy).
- Green bonds provide corporate issuers with improved access to a specific set of global investors who may have mandates to invest in green/sustainable ventures. Attracting new investors is often an important benefit of issuing a green bond and many green bonds issued to date report being oversubscribed.
- The issuance of green bonds can create new market demand – domestic bond issuances help strengthen and in some cases create domestic capital markets.
There are also challenges and uncertainties for green bond issuers given that they are a relatively new instrument. Green bonds do require enhanced levels of transparency regarding the “use of proceeds” and typically have enhanced reporting requirements that may add cost.
INTRODUCTION TO GREEN BONDS
Green bonds are simply bonds used to finance clean energy, climate adaptation, and other qualified “green” projects and programs. Examples of types of eligible projects and activities from the Green Bond Principles include:
- Renewable energy (including production, transmission, appliances and products);
- Energy efficiency (such as in new and refurbished buildings, energy storage, district heating, smart grids, appliances and products);
- Pollution prevention and control (including reduction of air emissions, greenhouse gas control, soil remediation, waste prevention, waste reduction, waste recycling and energy/emission-efficient waste to energy);
- Environmentally sustainable management of living natural resources and land use (including environmentally sustainable agriculture; environmentally sustainable animal husbandry; climate smart farm inputs such as biological crop protection or drip-irrigation; environmentally sustainable fishery and aquaculture; environmentally sustainable forestry, including afforestation or reforestation, and preservation or restoration of natural landscapes);
- Terrestrial and aquatic biodiversity conservation (including the protection of coastal, marine and watershed environments);
- Clean transportation (such as electric, hybrid, public, rail, rapid transit, non-motorised, multi-modal transportation, infrastructure for clean energy vehicles and reduction of harmful emissions);
- Sustainable water and wastewater management (including sustainable infrastructure for clean and/or drinking water, wastewater treatment, sustainable urban drainage systems and river training and other forms of flood mitigation);
- Climate change adaptation (including information support systems, such as climate observation and early warning systems);
- Eco-efficient and/or circular economy adapted products, production technologies and processes (such as development and introduction of environmentally sustainable products, with an eco-label or environmental certification, resources-efficient packaging and distribution);
- Green buildings that meet regional, national or international recognized standards or certifications.
Generally, the issuer (borrower) must track and report on the use-of-proceeds to assure that the funds are spent as promised, ensuring transparency for investors that the ‘green’ infrastructure is built in recognition of climate impacts and designed to maximize environmental benefits and outcomes.
- Asian Development Bank’s “Green Bonds in 2 Minutes”
- The World Bank’s “The World’s First Green Bond”
- International Capital Market Association’s Green Bond Principles
Caroline Flammer, Corporate Green Bonds, (Global Development Policy Center: Boston University, 2018)