In the last few years, green bonds have become a popular financing tool for governments and corporations looking to fund projects that have a positive impact on the environment.
Green bonds have not just attracted attention from investors but academics, consultants, and policymakers as well because they present an opportunity for market participants – especially institutional investors – to finance sustainable development at scale.
A report from New York-based market research firm Market Intelligence and Analytics Inc. shows that the total issuance of green bonds has risen by nearly 800% in just three years. This indicates the growing popularity of this financial instrument among investors and corporates alike.
As demand for them continues to grow, there is no doubt that green bonds will play a significant role in the development of sustainable financing strategies going forward.
But what exactly is a green bond? How does it work? This article explains everything you need to know about this type of bond.
What Is a Green Bond?
At the core, a green bond, or a socially responsible bond, is a debt security issued by a company that is targeted toward financing sustainable projects with positive environmental impacts.
Usually issued by corporations or governments with strong credit ratings, they are typically structured as fixed-income investments with special tax incentives or other contractual clauses designed to create incentives for issuing them.
The World Bank estimates that in the coming decades, capital needs related to environmental sustainability will exceed available financing by an estimated USD 370 billion per year. Green bonds provide one potential solution to this funding gap by enabling investors and borrowers to directly invest in projects and programs related to climate change mitigation and adaptation.
Green bonds can be broken down into two services: green subscription and green issuance.
A green subscription is when an investor pools capital from various sources to create an investment fund that can be used to finance green projects. Green issuance is when an issuer sells bonds directly to investors, which will be used to finance green projects.
How Do Green Bonds Work?
A company that wants to issue a green bond will typically have an idea of what kind of project they want to finance. They will work with an investment bank to determine how much financing they need for this project. The company will then issue bonds that will be backed by this project.
Note that large companies often issue green bonds because they have high credit ratings which makes them more attractive to investors. Smaller companies may find it more difficult to attract investors.
The cost of these bonds will be higher because the company will have to pay interest to cover the project’s financing. As the investment bank is issuing these bonds, they will ensure that they follow all the rules and regulations of the relevant authorities. They will also look at the risk of the project and its impact on the environment. This is because they will want to make sure they are promoting only sustainable projects.
If the authorities approve the project, then the investment bank will be able to sell the bonds directly to investors. These bonds will be considered green bonds because they will be backed by a sustainable project.
Types of Green Bonds
There are four main types of green bonds:
- Clean Energy Bonds – are used to finance clean energy projects, such as those that focus on solar, wind, hydro, geothermal, and tidal power.
- Clean Water Bonds – are used to finance water projects related to the conservation, protection, and restoration of water bodies.
- Sustainable Buildings Bonds – are used to finance sustainable buildings and/or the retrofitting of existing buildings to be more sustainable.
- Climate Risk Bonds – are used to finance projects that reduce or mitigate the impact of climate change, including those that reduce emissions from a company.
Benefits of Green Bonds
Green bonds provide a number of benefits to investors, issuers, and the environment.
For one, green bonds are a viable green investment option. This means that they provide investors with viable green investment options at a time when the environment and climate are increasingly important issues. Secondly, the green bond market is growing faster than any other type of bond, so it is important to understand what they are and how they work.
Moreover, the green bond market offers investors the opportunity to reduce risk and increase predictability around investment returns. This makes them very attractive to new investors with a heightened interest in sustainability and climate change.
Another appealing factor is the great potential to grow profitability since it can open up new investment opportunities that are focused on sustainability.
How Do You Select Green Bonds to Invest In
As with any other investment, you want to do your due diligence and research the different green bonds on the market. Keep in mind that there is no official rating system for green bonds, so you will have to do your own research.
You can start by reading the prospectus of the various bonds on the market to learn about the project that is being financed. There are also several organizations out there that have created research reports on green bonds.
Another great way to learn about green bonds is to speak with experts in the field and get their perspectives. They can help you understand the terms and conditions of each green bond which will help you determine whether the bond is going to be a good fit for your investment portfolio.
Final Words: Is the World of Green Bonds Bright?
The world of green bonds is still quite new and investors are still coming around to the idea that there’s an opportunity here. However, from what we have seen so far, this emerging market is set to become much bigger than it currently is.
With that said, the world of green bonds is certainly bright! Green bonds are the fastest-growing segment of the bond market, and they are growing rapidly. This is because people are becoming more and more aware of the negative effects that traditional bonds have on the environment. They are looking for a better option, which is exactly what green bonds offer them.
When we consider the factors driving the growth of the green bond market, such as increased investor interest, corporate demand for green financing, and regulatory support for green finance, there is little evidence to suggest that the growth will slow down any time soon.