What Is a Green Bond?
As the world increasingly focuses on addressing climate change and other environmental challenges, green bonds have become popular for investors to align their financial goals with their values and contribute to positive change. Green bonds are a type of fixed-income investment used to fund projects with a positive environmental impact. Like traditional bonds, green bonds offer investors a stated return and a promise to use the proceeds to finance or refinance sustainable projects, either in part or whole.
These bonds are issued by public, private, or multilateral entities to raise capital for initiatives that contribute to a more sustainable economy and generate identifiable climate, environmental, or other benefits. Projects funded by green bonds include renewable energy, energy efficiency, clean public transportation, pollution prevention and control, conservation, sustainable water and wastewater management, and green buildings that meet internationally recognized standards and certifications.
Key Takeaways
- A green bond is designed to support specific climate-related or environmental projects.
- Green bonds may have tax incentives that make them more attractive to investors.
- The phrase “green bond” is sometimes used interchangeably with “climate bonds” or “sustainable bonds.” However, these are not synonyms.
- Green bonds are part of a larger trend in socially responsible and environmental, social, and governance (ESG) investing.
Understanding Green Bonds
Green bonds are meant to encourage sustainability and support climate-related or other environmental projects. They help finance projects ranging from energy efficiency to sustainable agriculture and forestry to protecting aquatic and terrestrial ecosystems. They also finance the cultivation of environmentally friendly technologies and climate change mitigation.
Like other bonds, the green variety often has tax incentives in the form of credits and exemptions, making them more attractive than comparable taxable bonds.
Green bonds are often verified by a third party, such as the Climate Bonds Standard Board, which certifies that the bond will fund projects that provide environmental benefits.
History of Green Bonds
As recently as 2012, the value of all green bonds issued was just $2.6 billion. But in recent years, the market has boomed as governments introduce new requirements to tackle climate change, and many investors want investments that meet their ESG goals.
Bloomberg reports that sales of green bonds climbed to a record $575 billion in 2023. Of that total, $190 billion of green bonds were issued by governments during the year.
Demand is expected to increase in the coming years, thanks to cheaper borrowing costs made possible by the expectation of falling interest rates and European regulations to improve the transparency, comparability, and credibility of the green bond market.
Green bond funds developed in the 2010s, broadening the ability of retail investors to participate in these initiatives. Allianz SE. (ALV.DE), Axa S.A., State Street Corporation (STT), TIAA-CREF, BlackRock Inc. (BLK), AXA World Funds, and HSBC Holdings PLC (HSBC) are among the investment companies and asset management firms that have sponsored green bond mutual funds or exchange-traded funds (ETFs).
2008
The year when the World Bank issued the first so-labeled green bond for institutional investors.
Real-World Example of Green Bonds
The World Bank is a major issuer of green bonds. In 2022, the last year for which data is available, it reported $40.8 billion in bonds issued, $28.2 billion in funds disbursed, and $33.1 billion in new lending committed. Previously, the bank had reported issuing $14.4 billion in green bonds from 2008 through 2020. The funds went to projects for energy and efficiency (33%), clean transportation (27%), and agriculture and land use (15%).
One of the bank’s first green bond sales financed the Rampur Hydropower Project, which provided low-carbon hydroelectric power to northern India’s electricity grid. Financed by issuances of green bonds, it produces almost 2 megawatts per year, preventing 1.4 million tons of carbon emissions. In 2022, its combined projects lowered carbon emissions by 8.4 million tons.
Types of Green Bonds
While all green bonds represent a form of debt financing for an environmental project, the specific characteristics of each instrument may differ based on its issuer, what the proceeds are used for, and the recourse of bondholders to the issuer’s assets in case of a liquidation, among other factors. The following are types of green bonds available on the market:
- “Use of proceeds” bonds: These instruments are dedicated to financing green projects, but should the issuer liquidate, the lenders have recourse to the issuer’s other assets. They have the same credit rating as the issuer’s other bonds.
- “Use of proceeds” revenue bonds or asset-backed securities: These securities may finance or refinance green projects, but the collateral for the debt comes from streams of revenue collected by the issuer, such as taxes or fees. States and municipalities often opt for this type of setup when issuing green bonds.
- Project bonds: These are limited in scope to a particular underlying green project, meaning that investors have recourse only to assets related to the project.
- Securitization bonds: These gather a group of projects into a single debt portfolio, with bondholders having recourse to the assets underlying the complete set of projects.
- Covered bonds: These debt instruments finance a group of green projects known as the “covered pool.” In this case, investors have recourse to the issuer, but if the issuer can’t make debt payments, then bondholders have recourse to the covered pool.
- Loans: Financing for green projects may be secured (backed by collateral) or unsecured. With unsecured loans, lenders have full recourse to the borrower's assets. For secured loans, lenders can access the collateral.
How To Buy Green Bonds
Investments in green bonds often come from institutional investors, mutual funds, hedge funds, and endowments that can afford to invest large sums in debt instruments. However, many mutual funds and ETFs offer exposure to the green bond space for retail investors who want to align their portfolios with their environmental sensibilities and values.
For example, the iShares USD Green Bond ETF (BGRN) tracks the performance of an index comprising investment-grade bonds that finance environmental projects. While the ETF focuses only on U.S. dollar-denominated debt, it includes bonds from non-U.S. issuers and U.S.-based borrowers.
While ETFs like BGRN are readily available through a brokerage account or online platform, retail investors who want to buy individual green bonds have a slightly more complex situation. Your broker may allow you to invest in individual bonds, but when purchasing green bonds from corporate issuers, you may be subject to minimum deposits, maintenance fees, and commissions. Government-issued green bonds may also be available to buy through your broker or directly from the issuer.
What's a Major Challenge When Buying Green Bonds?
When buying green bonds, you might have several challenges. Transparency and reporting can create a bit of homework, as you'll want detailed information about the use of proceeds and the environmental impact of funded projects. Also, the green bond market is still developing, and some bonds may have lower liquidity than traditional ones, making it harder to buy or sell at desired prices and times. The lack of a universal standard in the green bond market can create confusion about what qualifies as a green bond, and there are no binding regulations for the nongovernmental standards often used.
How Are Green Bonds Different From Blue Bonds?
Blue bonds are sustainability bonds used to finance projects that protect the ocean and related ecosystems. They might support sustainable fisheries, protection of coral reefs and other fragile ecosystems, or reducing pollution and acidification. All blue bonds are green bonds, but not all green bonds are blue bonds.
How Are Green Bonds Different From Climate Bonds?
“Green bonds” and “climate bonds” are sometimes used interchangeably, but some authorities use the latter term specifically for projects focusing on reducing carbon emissions or alleviating the effects of climate change. The Climate Bonds Initiative has set standards for certifying climate bonds.
How Do I Know If a Green Bond Is Actually Green?
Despite efforts like those of the Climate Bonds Initiative, there is no universally recognized standard for determining the environmental friendliness of a bond. Sometimes, debt instruments may be marketed to investors as “green” even if their positive environmental impact is dubious at best. Examples of greenwashing—making exaggerated or misleading ecological claims—highlight the need for investors to carry out due diligence regarding potential green bond purchases. In addition to the Climate Bonds Initiative, other companies provide assessments of bond issuers’ environmental claims, including Bloomberg L.P., rating agencies such as Moody’s, and other specialized firms.
The Bottom Line
Green bonds are debt securities designed to finance environmentally friendly projects. Green bonds may offer tax advantages, providing incentives for investing in sustainable projects that do not apply to comparable types of bonds. Investors seeking assets that align with their environmental values should be sure to verify the claims of sustainability made by bond issuers.
