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Green Bonds

Guide to Understanding Green Bonds

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Green Bonds

How Green Bonds Work (Step-by-Step)

Green bonds are fixed-income bonds issued to fund projects with a net positive impact on the environment and climate change. The fixed-income instruments fall under the ESG investing umbrella term, i.e. a form of sustainable investing that considers environmental, social, and governance (ESG) factors.

Green bonds bridge capital-raising and investors’ desire to fund projects with environmental and sustainability benefits.

The overarching purpose is to benefit the environment and climate, with the primary issuers consisting of the private sector and multilateral institutions.

  • Financing Component: If an issuer seeks to finance a project deemed beneficial to the environment or climate, green bonds can be issued to secure funding.
  • ESG Component: In exchange for the capital, the financing comes with a commitment to use the proceeds for environmentally-friendly projects.

Green Bonds Benefits to Investors: Government Incentives

Tax Credit, Direct Subsidy and Tax-Exempt Bonds

For bond investors, green bonds can help allocate their money into projects that align with their values, hence the long-term “mission” is built within the instrument.

Like standard corporate bonds, these ESG-oriented bonds offer a stated return yet contain a pledge to utilize the funds to finance existing (or new) green, sustainable projects. Besides providing investors with the option to invest in projects promoting the environment and sustainability, the bonds can potentially come with tax incentives in the form of:

  • Tax Credit Bonds: Instead of receiving interest payments, bondholders receive tax credits; thus, issuers do not have to pay cash interest.
  • Direct Subsidy Bonds: The green bond issuer receives rebates from the government to subsidize their interest payments.
  • Tax-Exempt Bonds: Bondholders do not have to pay income taxes on interest from their green bond holdings, which in turn enables the issuer to negotiate lower interest rates.

Generally, these tax incentives specifically apply to municipal bonds, as opposed to all “green” bonds, so no unique tax treatment should be expected for non-government issuances in most cases.

Green Bonds Market: Who are the Issuers?

EIB and World Bank Group (WBG) Green Financing Arrangement Example

The types of issuers can range from supranationals and development banks to local/municipal governments and corporate entities.

Historically, the largest issuers have been supranationals such as the European Investment Bank (EIB), World Bank Group (WBG), and International Finance Corporation (IFC), the private sector division of WBG.

Most notably, the first “green” financing arrangement was issued by supranationals: the EIB (2007) and WBG (2008).

But in recent years, corporates such as Apple and Amazon have been receiving significant media coverage for their green bond issuances, with more non-financial corporates anticipated to follow suit in the coming years.

Green Bond ETFs and Mutual Funds: How to Buy?

Despite accessibility typically being restricted to institutional investors, individual retail investors can still gain indirect exposure via exchange-traded funds (ETFs) and mutual funds in their portfolio, such as the following vehicles:

  • VanEck Investment Grade Floating Rate ETF (FLTR)
  • iShares Floating Rate Bond ETF (FLOT)
  • Invesco Global Clean Energy ETF (PBD)
  • Calvert Green Bond Fund (CGAFX)
  • Invesco WilderHill Clean Energy ETF (PBW)
  • First Trust Global Wind Energy ETF (FAN)
  • Invesco Solar ETF (TAN)
  • VanEck Vectors Low Carbon Energy ETF (SMOG)
  • SPDR S&P Kensho Clean Power ETF (CNRG)
  • TIAA-Core Impact Bond Fund (TSBIX)
  • Domini Social Bond Fund (DFBSX)

Green Bonds Principles Frameworks

Climate Bonds Standard and Green Bond Principles (GBP)

As of the present date, there is not necessarily a universally accepted, global standard on what constitutes a “green” bond.

In part, this is due to how relatively new the asset class is and the scope of projects the bonds could fund. The meaning of “sustainable” and “environmentally-friendly” can be relatively subjective and is continuously expanding.

Currently, two widely recognized frameworks frequently referenced in practice are the following:

  1. Climate Bonds Standard: An internationally recognized certification for identifying and labeling green investments that meet the criteria for approval.
  2. Green Bond Principles (GBP): Guidelines for “best practices” established by a consortium of banks in 2014 to promote more integrity within the market.

Climate Bonds Standard Certification

Climate Bonds Standard Certification (Source: Climate Bonds Brochure)

Use of Proceeds List: Types of Projects Financed Examples

Green bonds are closely tied to the ongoing shift towards environmental, social and governance (ESG) projects, given their stated commitment to fund only sustainable projects.

As part of the agreement, the proceeds can only finance projects related to renewable energy (e.g. wind, solar, hydro), recycling, clean transportation, and other ESG initiatives.

More specifically, examples of projects financed are as follows.

  • Renewable Energy
  • Energy Efficiency
  • Pollution Prevention & Control
  • Public Transportation
  • Green Buildings
  • Energy Conservation
  • Sustainable Water & Wastewater Management

Green Bond Principles (GPB)

In 2014, the International Capital Market Association (ICMA) established the “Green Bond Principles” to provide guidelines on gauging the sustainability of their investments.

The GBP outlines the best practices for green bond issuances and serves as a framework for issuers to abide by and for investors to expect.

“The GBP, updated as of June 2021, are voluntary process guidelines that recommend transparency and disclosure and promote integrity in the development of the Green Bond market by clarifying the approach for issuance of a Green Bond. The GBP recommend a clear process and disclosure for issuers, which investors, banks, underwriters, arrangers, placement agents and others may use to understand the characteristics of any given Green Bond.”

– ICMA (Source: Green Bond Principles (GBP))

The guidelines recommend raising the bar for transparency and disclosure requirements for more integrity within the market.

The Green Bond Principles do not explicitly define “green,” but rather, the decision is left to the discretion of the issuer, who subsequently communicates their project’s specific purpose to investors.

  1. Use of Proceeds: Clear outline of how the funds will be spent and the types of eligible green projects, e.g. renewable energy, transmission, building energy efficiency, and pollution prevention.
  2. Process for Project Evaluation and Selection: Communication expectations of the green bond issuer to investors, such as the project’s mission, objectives, and metrics tracked to measure the impact.
  3. Management of Proceeds: Explanation of how the funds generated by the bond are to be handled, with details on the verification process by a third-party auditor.
  4. Reporting: Up-to-date information regarding the progress and impact of the green bond for purposes of public reporting – i.e. typically, the issuers release an impact report with periodic updates.

The GBP raises awareness of the importance of transparency and communication, which ultimately helps bring more capital into the market over the long run and supports continued development as a result of the higher bar for integrity standards among participants.

JP Morgan Sustainable Bond Framework Components

JP Morgan Sustainable Bond Framework

Sustainable Bond Framework (Source: JP Morgan Green Bond Annual Report)

Green Bonds Market Trends and ESG Outlook (2022)

In recent years, corporations and financial institutions have been increasingly under pressure from investors and regulators to improve their ESG scores and sustainability efforts.

Corporates can raise capital for their ESG initiatives with a net positive impact on the environment and climate while simultaneously highlighting their commitment to protecting the environment and sustainability.

The global market is projected to reach a $1 trillion milestone by the end of 2022 (or in 2023), according to a survey conducted by the Climate Bonds Initiative.

“The long-awaited $1 trillion milestone is now a market reality, whether at the end of 2022 or in 2023. But the climate crisis grows. It’s time to lift our sights and aim higher. $5 trillion in annual green investment by 2025 must be the new mark for policy makers and global finance to achieve.“

– Sean Kidney, CEO, Climate Bonds Initiative

Green Bonds Market Size

Global Green Bonds Market (Source: Climate Bonds)

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