Every so often, market innovation and social imperatives create something exciting that has the potential to make a real difference. As the world’s developing countries and fast-growing cities are facing an increasing financial challenge from climate change, they need ads, airports, buildings, water systems and energy supplies that can stand up to rising global temperatures and extreme weather patterns. The green bond sector is a popular and powerful example of this synthesis. Pension funds, insurers and asset managers are all showing an appetite for such low risk and climate-friendly investments.
Green bonds are debt instruments in which the proceeds are applied exclusively toward new and existing environmental projects. Green bonds are related to climate bonds, which are extension of green bonds. Most green bonds and climate bonds are asset-backed, with investors being promised that all funds raised will only go to certain programs or assets, including renewable energy, energy efficiency, sustainable waste management, sustainable land use, biodiversity conservation, clean transportation and clean water.
It is estimated that approximately US$36 billion worth was labeled as green bonds. In 2014, a record $16.6 billion green bonds have been issued to date, compared with the nearly $14 billion issuance in green bonds in 2013. According to HSBC research. Since 2008, the World Bank has issued more than $6.7 billion in green bonds through 73 transactions and 17 currencies.
Green bonds come from a range of issuers and industries, with transportation the dominant sector. Most issuance is in U.S. dollars, they are also see issued in euros, Brazilian reals and other currencies. Thus far, supranational and agency issuers like the European Investment Bank and the African Development Bank are the market’s dominant players, but non-supranational issuers are also incorporating “green tranches” into their general debt issuance.
The process of investment research, due diligence and risk management remains extremely challenging, as there are many theme bonds but not necessarily labeled as “green”. In addition, though the green bond sector is expanding, compared with the total US$ 100 trillion global bond market, it is still relatively small. Moreover, green bonds are new, with the first World Bank issuance in 2007.
Green bonds offer investors an opportunity to engage in long-term sustainability initiatives, which may become increasingly critical to the health and growth of the global economy. Green bonds may help investors target portfolio objectives even as they help issuers target sustainability and business goals. Investors may include green bonds in a portfolio in accordance with specific environmental and social responsibility guidelines or other long-term objectives. Green bonds are likely to be held by “hold-to-maturity” types of investors or others over the long term, and less by liquidity-focused investors.Additionally, some green bonds can be linked to the performance of an index, like the FTSE4Good Environmental Leaders Europe 40 Index, rather than paying a fixed coupon. In that regard, green bonds could serve a defensive function in portfolios. From a portfolio perspective, green bond yields tend to be relatively low, and their returns tend to resemble those of Treasury securities. The reason is that the cash flow of a green bond is reinvested in green projects that usually have government sponsorship, or in some cases, green bonds may provide some tax exemptions, such as municipal bonds in the U.S. Therefore, valuation of green bond securities generally has not been in line with that of securities of the same entity that were not issued for environmental reason.