What is a Green Bond ?
A Green Bond is any type of debt security for which the issuer agrees to allocate exclusively funds to eligible projects or assets with environmental benefits.
In 2013, the Green Bond Principles (GBP) clarified the steps to issue a Green Bond. Through these principles, the International Capital Market Association (ICMA) provides voluntary guidelines for the broad debt market to ensure transparency and traceability.
There are 4 core principles to follow :
A Green bond is a use-of-proceed debt.
The use of the debt security funds should be allocated to green projects identified by the issuer. The green projects should contribute to environmental objectives and be included in the green project categories defined by the GBP such as Renewable energy, clean transportation, green buildings, eco-efficient products and processes, etc.
The process for project evaluation and selection should be available.
The Green Bond issuer should clearly communicate to investors how the selected projects fit within the green projects categories. He could specify, for instance, some exclusion criteria and internal processes (committee, etc) to select eligible projects.
The fund allocation must be accurately tracked.
The issuer should demonstrate that the funds allocated and unallocated from Green Bonds to green projects are correctly managed. The reporting should be done regularly to share the allocation balance to investors.
Reporting is key in measuring the impacts of projects
The issuer should share updated information on the impacts from the green projects financed. The report can provide a list of all projects or group them into a project category portfolio.
Today, Green bonds enable the debt markets to play a key role in financing issuers through green MTNs, Commercial Paper, Schuldschein, Asset-backed securities, RCFs, etc. According to the ICMA principles, all debt instruments are needed to increase the capital allocation to such projects.
By expanding the green offering on all debt markets, private and public issuers will receive greater support from investors in financing green projects.
Who has issued Green Bonds ?
Multilateral development banks (MDB), such as the European Investment Bank (EIB) and the World Bank, were the only Green Bond issuers from 2007 to 2012.
The market really emerged in 2013 when the first corporate green bonds were issued, followed by first sovereign issuers like France and Poland.
Today, the Green Bond market reached an all-time high with more than $1 trillion in cumulative green debt issued in just over a decade. This is one of the most significant developments to finance the low-carbon investments opportunities.
Some prominent issuers
Vasakronan AB, Sweden’s largest property company issued one of the first Green bonds in 2013 and the first Green Commercial Paper in 2018 on the market. The green debts’ funds were allocated to low-carbon and low-energy real estate assets. This offers capital markets with further opportunities to actively pursue a lower environmental impact.
ENGIE, a French energy company, to this date has issued more than 12 billion euros of green debts to finance the production, storage and distribution of renewable energy and the energy efficiency of their infrastructures. The eligible investments are mostly capital, operating and R&D expenditures.
All issuers may finance, in whole or in part, new or existing projects or assets that are eligible for the Green Bond Principles.
What challenges does the Green Bond market face?
The deal flow of Green Bonds remains very insufficient to meet the investment demand needed to stay below the 2°C global warming target. Trillions are needed annually to finance the global sustainable transition. In 2020, the Green Bond market reached US$269 billion in issuance according to the Climate Bond Initiative.
The green bond market is currently experiencing several challenges :
- There is a lack of transparency and harmonization for impact and allocation reporting, which makes it difficult to assess and compare the green bonds performance and impact as a whole or in a portfolio.
- This could lead to a risk of greenwashing for issuers and investors when the impacts and projects financed are not sufficiently transparent.
- There is also a lack of common standardization to specify what is eligible to Green Bonds and how to measure the impacts.
- There is a knowledge gap on the instruments and developments in sustainable finance. This constitutes a major barrier to the participation of issuers, banks and investors in these sustainable markets.
What are the benefits of Green Bonds ?
The primary benefit is that Green Bonds are transforming financial services and the way their participants do business. They promote greater transparency on how issuers and investors use their funds and evaluate their impacts. Indeed, financial markets are starting to behave differently.
Green Bonds are a powerful communication tool for issuers and investors to inform all stakeholders about the impacts and progress made in terms of environmental sustainability.
By issuing green debt, they are telling the market that they finance labeled activities with environmental benefit. This will also attract new investors interested in the issuer’s sustainable strategy.
Green Bonds are not a loss for financial players, nor do they significantly benefit from an additional reward. But the big difference between vanilla bonds and green bonds lies in climate risk management, both from a corporate and portfolio perspective.
The physical and transitory risks of climate change will determine which issuers and financial players are the least exposed to climate risks.
This will be a decisive factor for debt market players seeking to finance activities in the short and long term. Climate risks are investment risks, according to BlackRock CEO, Larry Fink in his 2021 annual letter.
What’s next for the green bond market ?
Transition bonds are now issued in the green bond market. Green bonds finance only green sectors while transition bonds are intended for highly polluting sectors (mining, cement, chemicals, etc.) to finance sustainable projects and reduce their CO2 emissions.
Alongside debt product diversification, we observe international initiatives that produce taxonomies (project classifications), including the EU and China taxonomy.
The aim is to define green projects more precisely and to create a standardized set of reports and best practices.
