A green bond is a fixed-income asset that is designed to generate funding for initiatives that are beneficial to the environment and promote sustainability. Before purchasing green bonds, prospective buyers should educate themselves on the many kinds of green bonds as well as the benefits and drawbacks of investing.
Green Bonds Definition
A green bond is a kind of fixed-income instrument that is issued for the purpose of funding initiatives that have the potential to have a beneficial impact on the environment. Green bonds, much like other types of bonds, provide investors with a return on their investment and function as a loan from the investor to a corporation, organization, or government body.
There is not one single definition that can categorically say what a green bond is or is not. However, investors should be aware that there are two internationally recognized sets of standards for the issuance of green bonds:
- Climate Bond Standard and Certification: This is a framework of criteria for green bonds, and its primary alignment is with the reduction of greenhouse gas emissions that was created in the Paris Agreement. Bond issuers and investors all across the world utilize this methodology to locate assets that may make a contribution to reducing the effects of climate change.
- Green Bond Principles (GBP): These recommendations for best practice are completely optional, and their purpose is to foster openness and disclosure. As a result, GBP is beneficial to investors because it promotes the dissemination of reliable information that can be used to assess green bonds and the effect they have on the environment.
Types of Green Bond Projects
According to the Green Bond Principles, or GBP, there are five primary categories of projects that may be funded by green bonds. The following are some examples of these main kinds of green bonds:
- Climate change mitigation
- Climate change adaptation
- Biodiversity
- Natural resource conservation
- Pollution prevention and control
Within those broad areas, there are multiple types of green bond projects. The following are examples of green bond projects:
- Renewable energy
- Energy efficiency
- Clean transportation
- Sustainable water and wastewater management
- Eco-efficient technologies and production
- Green buildings
Note: there are bonds that have been issued by state or local governmental organizations that are engaged in environmentally friendly operations but do not adhere to the fundamental standards of the GBP. Bonds that have been issued by an organization that was created for the purpose of managing wastewater, public transit, or buildings that are energy efficient are some examples.
How Green Bonds Work
Green bonds provide funding for initiatives that are beneficial to the environment, such as those that reduce pollution and improve energy efficiency and clean transportation. These bonds function in the same manner as other bonds do in that they pay an investor who has loaned money to the issuer to fund a project an amount that is predetermined and referred to as a coupon payment.
The Climate Bond Standard Board is a third party that confirms the bond will be used to support initiatives that are beneficial to the environment. For a bond to be considered a green bond, it must first get certification from the Climate Bond Standard Board.
Who Issues Green Bonds?
Fannie Mae and the World Bank are two of the most prominent organizations that have issued green bonds. The federal governments of many nations, including the United States, Germany, France, and China, are among the most prominent issuers of green bonds. There is also the possibility of green bonds being issued by municipal or state governments.
Size & Value of the Green Bond Market
The green bond market has seen tremendous expansion ever since the World Bank launched its campaign to address climate change in the year 2008. According to climatebonds.net, the total amount of the green bond market reached $104 billion by the year 2015. This figure was reported in 2015. By the end of the year 2020, the entire amount of the green debt market had surpassed $1 trillion.
Note: Green bonds may be included in the broader category of ESG investing, which refers to a category of investments that conform to a specific degree of environmental, social, and governance norms. This kind of investing is also known as “sustainable investing.”
Green Bond Example
One example of a green bond is the series of transportation revenue bonds that the state of New York and the Metropolitan Transport Authority jointly issued (MTA). Green bonds are a sort of climate change bond that contribute to the funding of clean transportation projects with the goal of lowering carbon emissions.
Pros & Cons of Investing in Green Bonds
Because many green bonds are issued by municipalities, there is a possibility that they may have favorable tax treatment. This feature might make green bonds an appealing investment opportunity, particularly inside a taxable account. This advantageous tax status also acts as an incentive for investors to participate in the financing of projects that are beneficial to the environment.
Pros
- Potential tax benefits: Investors may be able to get income that is exempt from taxation if they purchase green bonds issued by certain government bodies.
- Helping the environment: Investors have the potential to make a profit from their investments while also contributing to the improvement of the natural world.
Cons
- Low yields: The yields on bonds issued by government bodies are often lower than those on bonds issued by corporations.
- Lack of control: There is a possibility that governments already possess the funds necessary to finance a green bond project. It is possible that they will have more money available for other uses if they issue green bonds to fund the same project.
Climate Bonds vs. Green Bonds
It is acceptable to use the terms climate bonds and green bonds interchangeably. Climate bonds are certified by the Climate Bond Initiative as having been issued with the express purpose of preventing or mitigating the effects of climate change. Green bonds are a broader category of debt instrument that can include climate bonds, as well as many other bonds that are issued to benefit the environment.
Blue Bonds vs. Green Bonds
Blue bonds are a kind of environmentally conscious debt security that is issued only for the purpose of funding initiatives that safeguard marine and other aquatic environments. Green bonds are a broad category of financial instruments that are issued to support environmentally-friendly initiatives. Blue bonds are a particular subcategory of green bonds.
Bottom Line
Green bonds are a kind of fixed-income investment that is used to fund initiatives that are designed to be beneficial to the environment. Because green bonds are often issued by government bodies, purchasing them may qualify an investor for favorable tax treatment.
