Green bonds are used to finance sustainable projects all over the world. You might not have the possibility to invest in a green bond directly, but you have a chance to invest in green bond funds. Green bonds have recently become very popular.
As companies are searching to finance more green projects and investors are looking for ways to green up their portfolios, green bonds are offering the answer to many issues. Here is what they are and how they work.
What Are Green Bonds?
Green bonds present a type of debt issued by public and private institutions to fund themselves. Unlike other credit instruments, that allow you to lend money, green bonds commit the usage of money received to a project related to climate change or an environmental project.
This is a fixed-income investment. It can be issued by companies, organizations, and governments. Such green bonds may be helpful for financing renewable energy (solar, wind, and hydro), clean transport, recycling efforts, as well as sustainable forestry.
On 5 July 2007, the European Investment Bank (EIB) launched a very special issue for the first time: green bonds. Why are they so popular these days? They can be defined by their aim: to finance projects that contribute to reaching the Sustainable Development Goals – number 7 (affordable energy) and number 13 (climate change).
Main Uses of Green Bonds
Green bonds are utilized for green projects that influence positively the environment. For example:
- Clean transportation
- Energy efficiency
- Renewable energy
- Waste management
How Green Bonds Work
What should a company do if it wants to finance a green project? It may issue green bonds to assist in securing funding. Investors purchase the bonds and the government or the company pays them back over time together with the interest.
Keep in mind that individuals can’t become such investors – green bonds are purchased in bulk by large organizations like pension funds.
What can you do as an individual? You may invest in mutual funds and exchange-traded funds that include green bonds, such as the iShares Global Green Bond ETF or the Calvert Green Bond Fund. Investing in one of these funds will give you a chance to gain access to green bonds and deal with them. Institutional investors rather than individuals may access green bonds themselves.
Green Bonds Principles
The “Green Bond Principles” were established in 2014. They were created in order to gain some insight into the sustainability of the investments. Here are the main principles:
- Process of Project Evaluation and Selection. It explains the project’s aims and what the issuer of the green bond should communicate to investors.
- Use of Proceeds. It explains how bond finances may be spent. This also outlines eligible green projects, such as energy efficiency in buildings, renewable energy production and transmission, sustainable land management, and pollution prevention.
- Management of Proceeds. This principle shows how one should handle the finances created by the bond.
- Reporting. This principle demonstrated how the progress and impact of green bonds should be recorded. Issuers should release a report on the impact of a green bond with certain details.
Types of Green Bond Projects
International Finance Corporation or IFC is the World Bank Group’s institution that is concentrated on the private sector. This organization has played an important role in launching and building the world’s green bond market, moving from being an issuer of the green bond to being an investor.
“The growth of green bonds in the capital markets has been explosive and is increasingly attracting attention from investors”, states Denise Odaro, IFC Head of Investor Relations.
There are five main types of green bond projects, as stated by the Green Bond Principles:
- Climate change mitigation
- Climate change adaptation
- Biodiversity
- Pollution prevention and control
- Natural resource conservation
There are numerous kinds of green bond projects within these broader types including:
- Energy efficiency
- Renewable energy
- Eco-efficient technologies and production
- Clean transportation
- Sustainable water and wastewater management
- Green buildings
Who Issues Green Bonds?
The World Bank and Fannie Mae are the two top issuers of green bonds. Governments of countries, such as the USA, China, France, and Germany are leading issuers of green bonds. State and local governments may also issue them.
Pros and Cons of Investing in Green Bonds
Many green bonds offer tax advantages since they are issued by municipalities. It makes them an attractive type of investment, especially within a taxable account. They serve as an incentive for investors to help fund projects that help the environment. Here are the main advantages and downsides of green bonds.
Pros:
- Helping the environment. Investors have a chance to earn income from this investment and also help the environment.
- Prospective tax benefits. Particular government institutions issue green bonds and they can offer tax-free income for investors.
Cons:
- Lack of control. Governments that have enough finances to fund a green bond project can issue green bonds for the same project and free the money up for other needs.
- Low yields. Green bonds issued by government companies generally pay lower yields compared to corporate bonds.
Should You Invest in Green Bonds?
Green bonds present a suitable investment opportunity as they help investors put their funds where their values are. Green bonds have a particular mission built into this investment itself. It is similar to investing in social, environmental, or governance investments.
More than that, green bonds offer tax incentives such as tax credits and tax exemptions. It helps investors avoid paying income tax on the interest they earn and issuers avoid paying interest on their issuances.
Examples of Green Bonds
- Apple financed 17 green bond projects in 2020. These projects aimed to prevent 921,000 metric tons of carbon emissions from being released each year. Besides, the projects included a solar power development outside Fredericksburg, Virginia.
- Walmart closed its first green bond in 2021. The company announced that it will allocate a sum equal to its net proceeds from the $2 billion offering to projects on waste recycling, energy efficiency, and water conservation.
- Volkswagen funded a green bond project in September 2020 to help finance e-charging station infrastructure and electric car manufacturing.
The Bottom Line
Green bonds are fixed-income investments that fund projects mentioned to benefit the environment. They often provide tax benefits to investors as they are issued by government entities. Individuals may not have a chance to invest directly in green bonds, but they may invest in green bond funds.
