What Is a Green Bond?
A green bond is a type of fixed-income instrument that is specifically earmarked to raise money for climate and environmental projects. These bonds are typically asset-linked and backed by the issuing entity’s balance sheet, so they usually carry the same credit rating as their issuers’ other debt obligations.
Dating back to the first decade of the 21st century, green bonds are sometimes referred to as climate bonds, but the two terms are not always synonymous. Climate bonds specifically finance projects that reduce carbon emissions or alleviate the effects of climate change, while green bonds represent a broader category of instruments related to projects with a positive environmental impact.
Key Takeaways
- A green bond is a fixed-income instrument designed to support specific climate-related or environmental projects.
- Green bonds may come with tax incentives to enhance their attractiveness to some investors.
- The phrase “green bond” is sometimes used interchangeably with “climate bonds” or “sustainable bonds.”
- Green bonds are part of a larger trend in socially responsible and environmental, social, and governance (ESG) investing.
Understanding Green Bonds
Green bonds are designated bonds intended to encourage sustainability and to support climate-related or other types of special environmental projects. More specifically, green bonds 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. They also finance the cultivation of environmentally friendly technologies and the mitigation of climate change.
Green bonds may come with tax incentives such as tax exemption and tax credits, making them a more attractive investment vs. a comparable taxable bond. These tax advantages provide a monetary incentive to tackle prominent social issues such as climate change and a movement toward renewable sources of energy. To qualify for green bond status, they are often verified by a third party such as the Climate Bond Standard Board, which certifies that the bond will fund projects that include benefits to the environment.
History of Green Bonds
As recently as 2012, green bond issuance amounted only to $2.6 billion. But in 2016, green bonds began to sprout. Much of the action was attributable to Chinese borrowers, who accounted for $32.9 billion of the total, or more than one-third of all issuances. But the interest is global, with the European Union and the United States among the leaders, too.
In 2017, green bond issuance soared to a record high, accounting for $161 billion worth of investment worldwide, according to a report from the rating agency Moody’s. Growth slowed a bit in 2018, hitting only $167 billion, but rebounded the following year thanks to an increasingly climate-aware market. Green issuances reached a record $266.5 billion in 2019 and nearly $270 billion the following year.
The 2010s saw the development of green bond funds, broadening the ability of retail investors to participate in these initiatives. Allianz S.E., Axa S.A., State Street Corp., TIAA-CREF, BlackRock, AXA World Funds, and HSBC are among the investment companies and asset management firms that have sponsored green bond mutual funds or exchange-traded funds (ETFs).
2008
The year when The World Bank issued the first so-labeled green bond for institutional investors.
Real-World Example of Green Bonds
The World Bank is a major issuer of green bonds and issued $14.4 billion of green bonds from 2008 through 2020. These funds have been used to support 111 projects around the world, largely in renewable energy and efficiency (33%), clean transportation (27%), and agriculture and land use (15%).
One of the bank’s first green issuances financed the Rampur Hydropower Project, which aimed to provide low-carbon hydroelectric power to northern India’s electricity grid. Financed by issuances of green bonds, it produces nearly 2 megawatts per year, preventing 1.4 million tons of carbon emissions.
Types of Green Bonds
While all green bonds represent a form of debt financing for an environmental project, the specific characteristics of each instrument may differ based on its issuer, what the proceeds are used for, and the recourse of bondholders to the issuer’s assets in case of a liquidation, among other factors. The following list describes some of the different types of green bonds that may be available on the market:
- “Use of Proceeds” Bonds: This type of instrument is dedicated to financing green projects, but in the case of a liquidation, the lenders have recourse to the issuer’s other assets. These instruments carry the same credit rating as the issuer’s other bonds.
- “Use of Proceeds” Revenue Bonds or Asset-Backed Securities (ABS): These securities may finance or refinance green projects, but the collateral for the debt comes from streams of revenue collected by the issuer, such as taxes or fees. State and municipal entities may opt for this type of setup when issuing green bonds.
- Project Bonds: This type of bond is limited in scope to a particular underlying green project, meaning that investors have recourse only to assets related to the project.
- Securitization Bonds: These debt instruments involve a group of projects gathered together into a single debt portfolio, with bondholders having recourse to the assets underlying the full set of projects. Some examples of green securitization bonds have included green mortgages and solar leasing projects.
- Covered Bonds: This type of instrument also involves financing a group of green projects, known as the “covered pool.” In this case, investors have recourse to the issuer, but if the issuer is unable to make debt payments, then bondholders gain recourse to the covered pool.
- Loans: Financing for green projects may be secured (backed by collateral) or unsecured. In the case of unsecured loans, lenders have full recourse to the assets of the borrower. For secured loans, lenders have recourse to the collateral—and, in some cases, partial recourse to the borrower.
How to Buy Green Bonds
Investments in green bonds often come from institutional investors—entities like mutual funds, hedge funds, and endowments that can afford to invest large sums in debt instruments. However, for retail investors who want to align their fixed-income portfolios with their environmental sensibilities and values, there are numerous mutual funds and ETFs that offer exposure to the green bond space.
One example is the iShares USD Green Bond ETF (BGRN), which seeks to replicate the performance of an index comprising investment-grade bonds used to finance environmental projects. While the ETF focuses exclusively on U.S. dollar-denominated debt, it includes bonds from non-U.S. issuers as well as U.S.-based borrowers.
While ETFs like BRGN are readily available to purchase through a brokerage account or online brokerage platform, retail investors who want to buy individual green bonds may face a few more complexities. Your broker may allow you to invest in individual bonds, but when buying green bonds from corporate issuers, you may be subject to minimum deposits, maintenance fees, and commissions. Government-issued green bonds may also be available for purchase through your broker or directly from the government entity.
How does a green bond work?
Green bonds work just like any other corporate or government bond. Borrowers issue these securities to secure financing for projects that will have a positive environmental impact, such as ecosystem restoration or reducing pollution. Investors who purchase these bonds can expect to make a profit as the bond matures. In addition, there are often tax benefits for investing in green bonds.
How big is the green bond market?
According to the Climate Bonds Initiative, the issuance of green bonds reached $269.5 billion in 2020. The United States was the largest player, with $50 billion in new issuances. The same analysis found that the cumulative issuance of green bonds had reached more than $1 trillion.
How are green bonds different from blue bonds?
Blue bonds are sustainability bonds to finance projects that protect the ocean and related ecosystems. This can include projects to support sustainable fisheries, protection of coral reefs and other fragile ecosystems, or reducing pollution and acidification. All blue bonds are green bonds, but not all green bonds are blue bonds.
How are green bonds different from climate bonds?
“Green bonds” and “climate bonds” are sometimes used interchangeably, but some authorities use the latter term specifically for projects focusing on reducing carbon emissions or alleviating the effects of climate change. The Climate Bonds Initiative is an organization that seeks to establish a standard for certifying climate bonds.
How do I know if a green bond is actually green?
Despite efforts like those of the Climate Bonds Initiative, there is no universally recognized standard for determining the environmental friendliness of a bond. In some cases, debt instruments may be marketed to investors as “green” even if their positive environmental impact is dubious at best. Such examples of greenwashing—making exaggerated or misleading environmental claims—highlight the necessity for investors to carry out due diligence regarding potential green bond purchases. In addition to the Climate Bonds Initiative, other companies provide assessments of bond issuers’ environmental claims, including Bloomberg L.P., rating agencies such as Moody’s, and other specialized firms.
The Bottom Line
Green bonds are debt securities designated to finance environmentally friendly projects. Green bonds may offer tax advantages, providing incentives for investing in sustainable projects that do not apply to other, comparable types of bonds. Investors seeking assets that align with their environmental values should be sure to verify the claims of sustainability made by bond issuers.
