By Cal Spranger

Socially responsible investing isn’t just for stocks anymore. One of the fastest growing areas of sustainable investing is in the bond market. Since their introduction in 2007, green bond issuance has increased exponentially, and green bonds have become part of the lexicon of environmental finance.

What are green bonds?

Green bonds are bonds whose proceeds are specifically earmarked for projects and activities that promote climate and other environmentally sustainable purposes. Proceeds from green bonds should be used to fund projects with clear environmental benefits, with the following broad categories provided as guidelines:

• Renewable energy
• Energy efficiency (including efficient buildings)
• Sustainable waste management
• Sustainable land use (including sustainable forestry and agriculture)
• Biodiversity conservation
• Clean transportation
• Clean water and/or drinking water

History of green bonds

Though the first green bond was issued in 2007 by the European Investment Bank, it was not until 2013 that the concept began to gather significant traction. Since then, the green bond market has been growing at a 30% annualized rate (Source: Bloomberg New Energy Finance, Green Bonds: 2016 in review).

Today, green bonds are issued by supranationals (i.e. World Bank, European Investment Bank), commercial banks, local and national governments and corporations. Though Europe is the dominant region, accounting for 38 percent of all outstanding bonds, the U.S. market has been rising in prominence. Tech giant Apple broke records in 2016 when it issued $1.5 billion in bonds dedicated to financing clean energy projects across its global operations. While Apple’s participation in the green bond market may open the floodgates for other corporate issuers, much of the U.S. issuance has been in the tax-exempt market. Municipal green bond issuers range from the Commonwealth of Massachusetts to the City of Spokane.

Challenges with green bonds

The remarkable growth of the green bond market has not come about without a number of challenges, many of which are not yet resolved. The most significant obstacle facing the green bond market is gaining consensus regarding what constitutes a green bond. Currently, green bonds are a self-labelled title, with no legally binding guidelines to ensure investors of the legitimacy of the issuer’s claims. Huge strides were made when thirteen investment banks began drafting formal issuer guidance in January 2014 called the Green Bond Principles (GBP). GBP are a voluntary set of recommendations intended for the broad use of the market. They provide issuers with guidance on the key components in launching a credible green bond. Today, the number of supporters has grown to more than 200 institutions representing both participants and stakeholders. To further develop the green bond market, an efficient third-party certification process may be needed.

The value of green bonds

From an investor viewpoint, the yields on green bonds are comparable to those of non-green bonds. As with conventional bonds, the usual market forces determine green bond yields: economic strength, credit quality, maturity term, redemption features, liquidity, savings rates and inflation. It is important to reiterate that the “green” signifies how proceeds are spent, not how the bonds are secured or repaid. Ultimately green bond investors are exposed to the credit risk of the issuer, rather than the risk of the project the bond is funding. The performance of the green project does not alter the probability of coupon or redemption payments on the green bonds. In summary, you have the same credit risk as you would have with a regular bond of the same issuer.

Green bonds have plenty of social value, including the enhanced awareness of environmental issues and projects to mitigate them, as well as the reputational benefits to both issuers and investors in green bonds. Economic value mainly comes from supporting companies and development institutions to gather funding for large environmental projects.

Whether motivated by climate change or the desire for clean air and healthy ecosystems, a growing number of investors want to see their money going toward environmentally sustainable projects. Green bonds are an emerging sector of the bond market that enables investors to support their goals with the security and stability of high-quality fixed income. While still a niche market, we expect its rapid growth to continue as investors seek out investments that align both their financial and personal objectives.