Green bonds are bonds whose proceeds are earmarked for environmentally friendly (green) projects. Despite the specific purpose green bonds were created for, they are a surprisingly flexible source of funding for organizations looking to finance green initiatives. Like ordinary bonds, green bonds can be structured multiple ways to fulfill the specific needs of both borrowers and lenders.
Because green bonds combine flexible financing with an environmentally friendly image, their use has exploded in the past several years.
According to the Climate Bond Initiative (CBI), this upward trend has continued apace with $41.8 billion worth of green bonds issued in 2015, and $34.5 billion issued in 2016 to date.
Green bonds historically have been issued by international financial institutions, and green projects were classified as such by the World Bank’s environmental department. Accordingly, the amounts issued were small—in the tens of millions—and investors were few and far between.
The green bond market began a dramatic shift in 2013. In November 2013, Électricité de France (EDF), a French energy group, raised €1.4 billion from green bonds, which many mark as the point at which corporations became the primary issuers of green bonds. EDF’s issuance was soon followed by Toyota raising $1.75 billion to help finance the sale of car loans for hybrid and electric vehicles. In 2014, Unilever issued a £250 million bond earmarked for reducing their operations’ waste, water use and greenhouse-gas emissions. This marked a shift in the corporate green bond market: whereas the EDF and Toyota bonds were for new specific green projects (renewable energy and electric vehicles respectively), Unilever’s bonds were designed to reduce the environmental footprint of its ordinary activities, expanding the scope and flexibility of green bonds from the borrower’s perspective.
Investors quickly began to take notice of this shift in the market. The first investors to show serious interest in green bonds were public-sector institutions, such as state-run pension funds. In November 2013, Zurich, an insurance firm, said it would invest $1 billion in green bonds and appointed BlackRock, an investment-management giant, to run its portfolio. Other money managers soon started getting in on the action; in 2012, 95% of investors were owners of assets (mostly the aforementioned pension funds). Now more than half are asset managers.
The enthusiasm for green bonds has continued to grow as investors are increasingly focused on integrating social and environmental objectives into their investment process and green bonds help them meet these objectives. According to the CBI, most green bond issuances are oversubscribed.
We are now entering a third wave in the green bond phenomenon, as municipal and local governments are beginning to take notice of the advantages green bonds provide. Cities and states are increasingly turning to green bonds to make up for the shortfall in federal infrastructure spending and to simultaneously accomplish their goals of creating environmentally sustainable infrastructure for the 21st century.
In May 2016 alone, the New York Metropolitan Transportation Authority (MTA) issued a $588,305,000 green bond, the New Jersey Infrastructure Trust issued a $29,320,000 green bond and the San Francisco Public Utilities Commission (SFPUC) issued a $240,580,000 green bond.
The SFPUC issuance is earmarked for a range of green projects, such as making their waste treatment plants more energy efficient and preparing their stormwater management and water conservation programs for the effects of climate change.
According to Bloomberg, the municipal market is the wild, wild-west for green bonds, as issuance of the bonds grows rapidly despite no industry-standard criteria for what constitutes a green bond.
However, there are some private companies and organizations such as CBI and Sustainalytics, an Amsterdam-based firm, offering certification. For example, the New York MTA sought in February to have their first green bond offering certified under standards set by the CBI. The standards set by these organizations are extensive and designed to promote confidence and growth in the market.
Green bonds are far from a mature financial instrument, and there will be some growing pains as standards begin to be put in place and the boundaries of what constitutes a green project are tested. But the promise is clear. Green bonds are an innovative way to address one of the most pressing issues of our time.