In the recent years, many financial market operators, including both institutional and retail investors, have been showing interest in sustainable finance. The mankind is facing a serious environmental situation and the financial world is doing its part trying to develop solutions to support the transition to a clean and low-carbon economy. Also the European Commission is working hard to make this transition.
The phrase ‘’sustainable finance’’ actually refers to three different aspects linked to the responsible investing: Environmental, Social and Governance (ESG), but the European Commission is above all focusing on the environmental side for now. In this context, green bonds are becoming more and more popular.
But, what are green bonds?
Green bonds are bonds which are issued to fund new and existing environmental projects, including renewable and clean energy, clean water, sustainable cities and ecosystem protection. In particular, the Climate Bonds Initiative – an international non-profit organization whose aim is to encourage to invest in climate-change solutions – offers eight sectors in its Climate Bonds Taxonomy: energy, buildings, transport, water, waste, nature-based assets, industry and ICT.
Therefore, green bonds represent an interesting opportunity to increase the availability of capital needed for the transition to a sustainable economy.
As regards their financial characteristics, they are – just as the traditional bonds – fixed-income securities: the issuer obtain a fixed amount of capital from investors, repays the capital after an agreed period of time and periodically during this period has to pay interest to the investors.
The green bond market represents a growing market. At the beginning green bonds were issued by supranational institutions, indeed the first green bond was issued by the European Investment Bank (EIB) in 2007. Later on, also local governments entered the market and in 2013 the first corporate green bonds appeared: they were issued by banks (financial corporate green bonds) and private companies (non-financial corporate green bonds).
The green bond market started its real development in 2014 and this was due to development banks (44%), but also to corporate issuers (33%) and to local governments (13%).
In addition, in 2016 Poland issued the first sovereign green bond and from that moment on, several countries (France, Belgium, Fiji, Nigeria and others) have started following its example.
According to a report by Climate Bonds Initiative, green bonds issuance achieved a record of almost $255bn in 2019 and the European Union was the largest international green bond market, having issued a total of $106.7bn.
Data source: Climate Bonds Initiative
In 2019 the proceeds were used above all to finance clean energy projects (31.5%), but also low carbon buildings (29.3%), low carbon transport (20.2%), water (9.3%), land use (3.5%) and waste (3.5%).
Data source: Climate Bonds Initiative
Green bonds surely represent a great opportunity for the financial world, therefore because of them:
- The issuers acquire approval from the public by actively encouraging green projects and build relationships with a new kind of investors, who are interested in investments that develop solutions to environmental problems;
- The investors can participate in the sustainable development of society and can reduce risks, because green bonds play the role of alternative investments.
Clearly, green bonds also provide environmental and social benefits:
- Funding green projects, which aim to reduce greenhouse gas emissions and to prevent the environmental degradation;
- Increasing the awareness of green investments;
- Helping to find solutions to social and economic problems, for example regional reactivation.
Green bonds take with them lots of benefits, however there are still insidious obstacles that the green bond market should overcome.
For example, despite the efforts made by the Climate Bonds Initiative (CBI), the International Capital Market Association (ICMA) and the European Commission, there isn’t a universally accepted definition of ‘’green bond’’ and this causes uncertainty among the investors. Many issuers follow the Green Bond Principles (GBP), promoted by the International Capital Market Association (ICMA) in 2014 as an attempt to make the green bond market more transparent, but these principles are voluntary: it’s a self-regulation and no sanctions are foreseen. In addition, the existing standards such as the GBP focus on the use of proceeds and they don’t take care of the business of the issuers, but it means that oil and gas companies can issue green bonds (e.g. the Spanish ‘’Repsol’’).
The risk of greenwashing, that is the dodgy promotion of some organisations, companies and political institutions which pretend that their products, objectives or policies are environmentally friendly, represent a big barrier to the development of the green bond market. In this field, other examples are represented by countries like Poland and China: Poland is at the forefront of the issuance of sovereign green bonds, but its economy still depends on coal and China plays a key role in the green bonds market, but many investors wonder about how green China really is.
Another problem is that green bond trading is more expensive for the issuers because of reporting and external review costs. In addition, they are not considered liquid investments, because even if issuance has grown quickly, the green bonds deal size remains relatively small and the issuers are mostly AAA-rated, which reduces the choice for the investors. Moreover, there is also the fear that issuers could avoid their commitment (‘’green default’’).
How can we deal with these obstacles?
First of all, the policymakers ought to promote the creation of a globally accepted and compulsory standard for ‘’green bonds’’ to solve the general confusion. In this area, the European Commission is working hard to create a Green Bond Standard, even if these standards will be voluntary and non-legislative.
Next, the governments and policymakers should incentivize the investments in green bonds, help to make the green bond issuance more affordable for the issuers and provide proper contractual protection for investors.