What is a green bond?

Green bonds, which are also often referred to as climate bonds, are fixed-income financial devices specifically designated to raise money for sustainable and climate-oriented projects.

These projects are aimed at energy efficiency, sustainable agriculture, fishery, forestry, clean water, clean air, pollution prevention, preventing ecosystems and sustainable water management. In addition, mitigating climate change and environment-friendly manufacturing technologies are also financed as part of the projects.

Green bonds are exempted from tax, making them more attractive in comparison with other taxable bonds. Furthermore, the tax incentives encourage shifting to renewable resources and thus helps in dealing with climate change.

The World Bank, the City of Johannesburg, Toyota Financial Services, the Regency Centers Corporation, Export Development Canada, the Environmental Defense Fund, and the Commonwealth of Massachusetts have issued green bonds. 

What are the principles of green bonds?

In terms of principals, the issuance of such bonds are known to follow the standards of Green Bond Principles (GBP).

These principles are intended to be used by the issuers to seek guidance on the key components while launching a green bond, assisting the underwriters and assisting investors by providing necessary information to evaluate the credibility of the green bond.

There are four green bond principles:

• Use of proceeds: It is vital that the use of proceeds must be utilized to finance or re-finance green projects. GBP has explicitly pre-defined the categories under which the projects can be labeled as green.
• Selection: It is encouraged that they publish a high level of transparency in the issuer’s objectives, policy, and strategy. It includes the project's environmental objectives, the process to manage any upcoming ecological or social risk, and the process that determines the green eligibility of the project.
• Management of proceeds: The GBP describes the collected funds are managed in a sub-account and are attested by the issuer in an internal process. It also recommends a high level of transparency in managing the proceeds.
• Reporting: Green bonds are required to report the allocation of proceeds on the green projects. It is written in the annual report with the list of projects and the allotted funds for each project.

Frequently Asked Questions (FAQs)

1. How can green bond issuers evaluate their projects?

According to the green bond principles, issuers can use external assurance to verify their project’s alignment with the principles.

Third-party consultations: Experts can assist in the establishment of the procedures selection. These third-party reviews are confidential and should be made public only at the issuer’s discretion.

Audits: Auditors can independently audit the project processes and the allocation of proceeds.

Third-party certifications: The issuers utilize these certifications to get assurance on green credentials. As of now, there are no well-established standards for evaluating, but there are some third-party certifications like Centre of International Climate and Environmental Research Oslo, Leadership in Energy and Environmental Design, etc.

Ratings: Several credit agencies and stock exchanges have engaged in developing their metrics to determine how greener an underlined project is.

2. What are the advantages of issuing a green bond?

The issuance of green bonds adds to an organization’s reputation, as it is addressing and committing to rectifying environmental damages. Green bonds portray an organization’s will and inclination to protect the environment that is negatively impacted by business activities.

The issuance of green bonds helps in building environmental sustainability and provides tax benefits.

Increased access to investors who are willing to invest in green activities and projects.

3. How has the market developed for green bonds?

Green bond indices: Since the formation of the green bond market, the green bond indices are introduced to assist in benchmarking and liquidity. Some of the green bond indices are Barclays, MSCI, Standard & Poor’s, etc. Each of the indices has different criteria for inclusion in its index.

Green exchanges: There are a number of stock exchanges like the Luxembourg Stock Exchange and London Stock Exchange Group that have set up some green exchanges as well. These exchanges have their own eligibility criteria and might require a third-party’s assurance.

Green assessment: Recently, credit rating agencies have formed a framework to assess how green a project is. For instance, S&P Global Ratings introduced its Green Evaluation tool in 2017, which evaluates how green a project is based specifically on that project. Moody’s Investors Service also launched a Green Bond Assessment framework in 2017.

Expanding jurisdictions: Lately, there are jurisdictions that are expanding on the issuance of green bonds.

4. What are some of its limitations?

Disagreements regarding what qualifies as ‘green projects’ is common.

These bonds cannot rise in under-developed financial markets.

A majority of investors are interested in green bonds only if they make financial sense in terms of returns.