As an investor, there are many ways where you can use your money to help reverse the effects of global warming and climate change. If you’re a conservative investor looking for fixed-income investments for capital preservation, investing in green bonds is the way to go.
What are Green Bonds?
According to the Green Bond Principles, green bonds are just like traditional bonds but with a more specific objective to finance environmental projects. It may be for renewable energy production, research and development on improving biodiversity, implementing waste management initiatives, and exploring clean water technologies as some examples.
When it comes to the structure, there’s not much difference between green bonds and traditional bonds. Green bonds can also be issued by both private corporations and governments. They’re also good for capital preservation as fixed-income securities. It’s just designed for investors into responsible investing, especially environmentally conscious ones.
To understand green bonds a bit more, here are the 5 facts that you need to know:
#1 The world’s first green bond was issued in 2007 by the European Investment Bank.
Climate Awareness Bond, the name of the world’s first green bond, was a 5-year green bond dedicated to renewable energy (e.g. solar, wind, hydro, geothermal) and energy efficiency (e.g. building insulation, cogeneration, equipment replacement) projects. It was offered to the 27 member states of the EU from May 29 to June 22, 2007, with a minimum of 5% return on its maturity date (June 2012).
Even before launching this pioneering fund, EIB has already financed over €2.2 billion for the last 5 years. Since then, the EIB has expanded a series of Climate Awareness Bonds (CABs). Between 2007 to 2020, EIB has raised about €33.7 billion in 17 currencies. Because of this, EIB has had a consistent AAA rating.
Source: Climate Bonds Initiative
After EIB’s CAB, the World Bank launched their first green bond a year after in 2008. This green bond set a standard for today’s green bond market. It defined the criteria for eligible green projects and assured investors that these projects will be used to address climate change through a second party opinion provider.
#2 Green bond issuance is a voluntary process.
There are standards on the process of issuing green bonds. However, the process is voluntary. Therefore, green bond issuers are not obliged to report on how their raised capital was spent. Investors should not take things as they are. Just because it says it’s a green bond doesn’t assure that they’ll use it for environmental objectives. Still, due diligence is important.
“The Green Bond Principles (GBP) 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.” — Green Bond Principles (June 2021)
These guidelines were developed in 2014 by financial institutions such as banks and several other bond issuers. The leading organization responsible for this framework is the International Finance Corporation (IFC). IFC also has issued green bonds. In 2020, it has issued 172 bonds in 20 currencies worth over $10 billion.
The GBP is focused on 4 components — use of proceeds, process for project evaluation and selection, management of proceeds, and reporting. To know more about how these guidelines work, you can read more on them here.
#3 Climate Bonds Standard and Certification
When you see that the green bond is “climate bond certified”, that means that the issuer has undergone pre-issuance and post-issuance requirements.
“For investors, the Certification Scheme is a screening tool that labels bonds as Climate Bond Certified. It avoids investors having to make subjective judgements or do expensive due diligence on the green attributes of certified investments. For issuers, the Certification Scheme is a voluntary initiative, which allows them to clearly demonstrate to the market that their bond meets industry standards for climate integrity, management of proceeds, and transparency.” — Climate Bonds Initiative
To know more details on the certification steps, you can read more on it here.
#4 The United States has the most issued green bonds in the world.
The top 3 major contributors to the green bond market in the world are the U.S.A, Germany, and France. The U.S.A leads the national ranking with $51.1 billion, with most issuance from Fannie Mae (about $13 billion). For the year 2020, the cumulative total issuance of the top 20 key players in the green bond market is at $243.8 billion.
Fannie Mae, or the Federal National Mortgage Association (FNMA), has been recognized as the world’s largest issuer of green bonds since 2017. It’s a government-sponsored company that’s focused on greener housing projects. Among its green projects are energy and water efficiency improvement, and green building certifications. However, Fannie Mae is not Climate Bonds Certified so investors will have to practice due diligence.
#5 The majority of green bond proceeds around the world go to renewable energy & efficiency objectives.
According to The World Bank Impact Report 2020, the top 3 sectors that benefit from green bonds are renewable energy & efficiency (36%), clean transportation (27%), and agriculture, land use, forests & ecological resources (15%). Other sectors are shown in the graph below.
This makes sense since conventional energy sources like coal, oil, and natural gas are the direct contributors to greenhouse gas emissions. The transportation industry comes close to second place. Collective efforts around the world are focused on the energy and transportation sectors.
A 2019 study revealed that there’s almost no difference in the yield between non-green and green bonds
Greenium is a term that refers to the yield difference between a green bond and a non-green bond of similar characteristics. In a 2019 study conducted by the Graduate School of Business Stanford University, their primary result is zero greenium.
But to be exact, 84.8% of the matched pairs show zero greenium. Meanwhile, there was a slight advantage for the green bonds at 9.4% compared to the 5.7% favoring the non-green bonds. The study was based on 640 match pairs of identical green and non-green bonds — same date of issuance, maturity, rating, and issued by the same municipality.
As they mentioned in their paper — “These results provide strong evidence that investors are unwilling to sacrifice returns to support environmentally friendly projects, and thus the greenium is equal to zero”.
Investing in Green Bonds
Including green bonds in your investment portfolio helps you hedge against environmental-related financial risks. There are several exchange-traded funds (ETFs) and mutual funds where small investors can buy green bonds.
For example, the VanEck Vectors Green Fund (GRNB) is an ETF that follows the S&P Green Bond Select Index. Another example is the European investment management company, Mirova. As mentioned in my previous post about natural capital investments, Mirova actively works on 6 sustainable strategies. These are just some of the green bond funds that you can tap on.
Aside from green bonds, you may also want to consider ESG investing or investing in sustainable bonds. The financial market is evolving with new ways of investing that benefit the environment. Don’t be surprised to see more variations of ethical investing to come!