As the temperature in the world is rising, sea levels are soaring and forests are retreating, the world is slowly waking up to the devastating reality of climate change.
The path of sustainability requires all sectors to walk together towards the same final objective: protecting our home.
Little by little many sectors are “going green”, and the financial sector is one of them.
To tackle the issue of climate change by supporting environmentally-friendly projects, green bonds have been issued worldwide and in the last 10 years, they have grown exponentially.
But what are these green bonds? Green bonds are nothing more than a regular bond, a debt security associated with the financing of projects that have positive repercussions in environmental terms. Four main characteristics differentiate green bonds from traditional bonds:
1) selection of the project to be financed or refinanced;
2) the proceeds must be linked to the selected project; the money must be deposited on an escrow account or transferred to a specific portfolio or otherwise tracked by the issuer;
3) a report on the use of the proceeds must be made at least (once a year) indicating the projects for which they are used;
4) there must be a second opinion, i.e. an external auditor must certify documents and objectives.
They are considered attractive to investors because they are straightforward instruments that integrate environmental, social, and governance outcomes into fixed income portfolios. More importantly, green bonds also act as catalysts for deeper sustainable and responsible fixed-income capital markets.
Green Bonds in 2020
In 2020, the issuance of these environmentally-friendly securities slowed down at the beginning of the pandemic in Marchbut that didn’t stop them from reaching a new high in September, totalling more than $50 billion. In the wake of Germany’s first green bond, this trend doesn’t look like it is going to slow down due to the European Union’s plans to sell as much as 225 billion euros ($265 billion) of the securities.
Europe is taking the lead also by setting standards for the issuance of green bonds. Richard Gustard, head of European securities trading at JPMorgan Chase & Co., said, “A widely-accepted standard is good for any financial market. The signs are that both issuers and investors are fully on board with green bonds and it’s going to be an increasingly important part of the market.”
Green Bonds vs. Conventional Bonds
Research shows that companies and governments that borrow using so-called green bonds can save some money. The market for these bonds, which fund environmental objectives such as renewable power, is booming. All that money is driving up the prices and pushing down yields on the bonds, making borrowing slightly cheaper. Analysts around the world are mining bond-market data to understand and quantify what they call “the greenium,” a measurement of how much extra investors will pay for green bonds compared to conventional bonds. For example, one of the greenium hunters, Thierry Roncalli, with his team, found that companies and governments selling green bonds received a premium as large as 0.11 percentage point—modest, but enough to lower borrowing costs. This finding is a sign that the surging demand for environmentally sustainable investments could now be significant enough to influence the behavior of corporations and governments. While a broad bond-market rally has pulled borrowing costs near historic lows, investors with sustainability goals are willing to lend to green projects at even lower rates.
The Future of Green Bonds
In conclusion, if investors want to invest in bonds issued to finance eco-friendly projects, this allows them to gain both exposure to bonds and to contribute to the fight against climate change. Seeing the high growth rates over the last couple of years in this sector, further growth is still to be expected, and most likely followed by an increase in regulations.