Since their World Bank debut in 2008, green bonds have seen rapid growth from investors seeking to combat climate change and make a return on investment.
A bond has three fundamental components:
The borrower (bond issuer), Investor (bond purchaser), and agreed terms. A bond is essentially a long-term loan from an investor to a borrower with a set period of time (maturity date) and interest rate (coupon payment). Green bonds specifically use the borrowed money toward “green” projects, assets, or business activities that promote environmental benefits, such as renewable energy, low carbon transport, wastewater management, green buildings, and climate change adaptation.
Green Bonds are identical in structure to traditional bonds except the issuer publicly states that proceeds will be used toward green initiatives. This provides a bridge between climate change projects and the capital markets, whilst giving investors responsible investment opportunities.
Issuing Green Bonds
When issuing a green bond, there are 4 key components outlined by the Green Bond Principles (GBP) that must be established by the issuer to convey their approach to sustainability.
These components include:
Use of Proceeds: The issuer will clearly indicate the allocation of funds for a specific project that will reduce climate impacts.
Project Evaluation and Selection: Expenditures will follow the GBP’s for qualifying projects and assets ensuring alignment with one or more of the United Nation’s 17 Sustainable Development Goals (SDG). The SDG’s are a collection of global goals designed to achieve a better and more sustainable future.
Management of Proceeds: The issuer will create processes for internal tracking of allocation of funds for qualifying green projects and assets.
Impact Reporting: The issuer will establish key performance indicators based on environmental metrics that will distinctly measure climate change and publish these findings annually on the company website for public and investor viewing.
The Importance of Transparency
As it stands to date, the GBP’s are voluntary, enabling any organization to issue a green bond since there is not an internationally agreed set of standards or definitions for what qualifies as a green bond. This opens the door to reputational risk in the form of greenwashing accusations, making it explicitly clear why transparency is a must. In an effort to mitigate this risk, it is crucial to follow the guidance set out by the GBP’s, to conduct extensive project due diligence, and maintain transparent reporting with environmental performance indicators. In addition, it is encouraged to undergo a second party opinion prior to issuance, a third party review after issuance, and disclose use of funds annually through audits. Utilizing the aforementioned steps will convey good standing as an ESG, gaining the trust of investors and climate related organizations.
A Green Bond in Action
To illustrate a green bond in action, let’s tie it all together with an example. In this case, the green bond issuer is Breeze Inergy (BI) and the investor is Green Tree Capital (GTC). BI is seeking to raise $1 million for a wind farm project which aligns with the GBP’s qualifying projects of Renewable Energy and supports SDG 7, 9, and 12. BI catches wind that GTC is looking for a renewable energy project to add to their portfolio. BI proposes to issue a $1 million green bond to GTC over a 10 year period with a 3% interest rate. GTC agrees to purchase the green bond and releases the funds to begin work. Over the next 10 years, BI pays GTC an annual coupon payment of 3% ($30 thousand) at the end of each year. At the maturity date, 10 years from the green bond issuance date, BI pays GTC the last coupon payment and the initial $1 million in full. When it’s all said and done, Breeze Inergy maintains full ownership of the wind farm while Green Tree Capital walks away with an impressive $1.3 million and a reputation of responsible investing to reduce climate change.
Green bonds really are a win-win for everyone involved. The borrower is able to fund their green project, the investor receives a return on investment while contributing to environmental resilience, and the investments deliver a multiplier effect in the form of job creation, economic stimulation, development of innovative clean technologies and energy infrastructure. Additionally, green bonds are typically oversubscribed which attracts a premium, also known as a “greenium” and may be issued for a higher price therefore offering a lower yield. This means the issuer is able to secure a cheaper cost of funding by issuing debt with specified “use of proceeds” that benefit the environment compared to traditional bonds. When green bonds have an oversubscribed issuance, underwriters must allocate the bonds among investors because there is great demand for growth prospects. Green bonds have revolutionized the ability for capital markets to mobilize funds toward green initiatives that mitigate greenhouse gas emissions while establishing a low carbon economy setting the stage for a sustainable future for all generations to come.