What is Green Bond?
Green bonds are a special type of financial markets bonds that has all the characteristics and pay-out structures of fixed income financial instruments, but their end use is dedicated to environmental and climate change projects such as that aimed development of renewable energy resources, pollution minimization, etc.
Origin of Green Bonds
- The history of such bonds can be traced back to the City of San Francisco, where the voters approved a revenue bond known as “Solar Bonds” to finance renewable energy.
- Certain development banks like the European Investment Bank issued an Equity index-linked bond in 2007, which was followed by World Bank launching green bonds in 2008, which had a plain vanilla bond structure.
- In 2013 corporates started participating in the issuance of such bonds.
Demand for Green Bonds
- As per the Climate & Development Knowledge Network, there is a demand of at least $12 trillion.
- United Nations estimates the funding gap close to $2.5 trillion needed in order to achieve Sustainable Development Goals.
- Public balance sheets (Government spending, Sovereign Funds) do not have the capacity to fund these amounts needed, and thus, 80%-90% of the funding has to come from private investments, and thus, these Green Bonds become an attractive vehicle to serve this purpose.
- Approximately 1500 investors across the world have made their commitments to the responsible investment public. The total assets under their management are $45 trillion.
Examples of Green Bond
- USA: Tesla Motors Inc. issued $600 million convertible bonds in May 2013.
- NIGERIA: The nation has started the process of issuing a $ 64 million green bond which is aimed at local investors. The proceeds would be used to finance low emission projects such as solar power, deforestation, transport, etc.
- Export-Import Bank (EXIM) issued 5-year $500 million green bonds. The proceeds of these funds are to be used for funding Green projects in countries in the Indian Subcontinent (other than India) like Bangladesh and Sri Lanka. This bond had received a rating of BBB- by Standard & Poors and Baa3 by Moody’s.
- Yes Bank: Issued green bond of $54 million that was completely bought by the International Finance Corporation (IFC).
- London Stock Exchange (LSE): LSE, in order to provide investors with clearer access to green projects via green bonds, has launched a range of green bonds segments.
Some of the advantages are as follows.
- Issuance of Green bonds enhances the reputation of the issuer as an organization or firm which is committed to helping address environmental challenges. With the environmental impacts of businesses grabbing more and more negative light, such a bond helps in showcasing the will and inclination of the firm to act for environmental protection.
- Providing access to a certain set of investors who only invest in environmental projects. Such investors have grown in number, and so has the pool of funds earmarked for such investments. These bonds are particularly exciting for such a set of investors.
- Helps in achieving green mandates such as the likes of UN’s Principle for Responsible Investment (PRI)
- As the end-use of the bonds have positive environmental externalities, they also tend to have attractive tax benefits. Kenya’s Capital Market Authority green bond tax incentive, which was implemented in 2017
- Overall, such a bond also acts as a catalyst in the development of the local Financial Markets, which can help funding projects beyond environmental focussed projects.
- It usually tends to find the end-use of the raised capital in Emerging Markets (EM), while the raised money is primarily from investors based out of developed nations. Thus, the funding gap in EMs is addressed to a certain extent.
- Issuers are benefitted as the bond proceeds help their capital structure. Like issuers are permitted to use a certain percentage of the proceeds to repay bank loans and invest in working capital. These proceeds can also be used to replaced high-cost debt in existing green projects in the case issuer is meeting the minimum credit rating and has demonstrated good operation performance in the past.
Some of the disadvantages are as follows.
- In the past, such bonds have attracted criticism to the extent the end use of the money raised from such bonds did not go far enough to be classified as green.
- Green bonds cannot flourish in an under-developed financial market. The market should have a system to structure major projects.
- A lot of Global Funds have raised concerns that the issuance is not diversified enough in terms number of the issuer or the countries the project is based in. In such a case, they are not confident of launching a fund fully dedicated to Green Projects, as this will lead to too few bonds being chased by too much demand.
- A major set of investors are only interested in green bond investment if they make financial sense in terms of returns for the amount of risk assumed. This for any bond boils down to the credit rating of the bond, and an investor will not go ahead with the decision of investment just because it is Green if the credit rating is not favorable.
- Many investors are more comfortable investing when the issuing company as a whole is sustainable and not just the project.
- Lack of liquidity has also been a major limitation of green bonds. Institutional investors weigh liquidity as an important factor, and green bonds are not known to offer enough liquidity when compared to other popular investments that are highly sought after among institutional investors.
Green bonds are on the rise, and with an increase of sensitivity towards the impact of economic growth on the environment across the globe, more and more investors will be attracted to investing in such instruments, which will lead to more issuers taking advantage of the situation and raise capital for green projects.
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The rise in green bonds will also address causes like low liquidity, which will excite more institutional investors to lay aside their apprehension and come forward and participate in. At the same time, the regulators and credit rating agencies need to ensure that while on the one hand, a conducive environment is provided for self-sustenance of green bond issuance, credit rating gives a fair and accurate assessment of the risk on these bonds in addition to the end-use being green projects.
This has been a guide to what Green Bond is and its definition. Here we discuss Origin, demand, and examples of green bonds along with advantages and disadvantages. You can learn more about financing from the following articles –