Green Bonds: What They Are & How They Work?

Green Bonds Definition

A green bond is a type of fixed-income security that is issued to fund projects that may have positive environmental benefits. Like any other type of bond, green bonds offer a stated return and represent a loan from an investor to a company, organization, or government agency.

There is no specific definition that states what is or is not a green bond. However, investors should be aware that there are two internationally recognized sets of standards for the issuance of green bonds:

1. Climate Bond Standard and Certification: This is a framework of green bond criteria that are primarily aligned with the lowering of greenhouse gas emissions established in the Paris Agreement. This framework is used globally by bond issuers and investors to identify investments that contribute to addressing climate change.
2. Green Bond Principles (GBP): These principles are voluntary best practice guidelines to encourage transparency and disclosure. Thus, GBP helps investors by promoting accurate information to evaluate green bonds and their impact on the environment.

Types of Green Bond Projects

There are five main types of green bond projects, as mapped by the Green Bond Principles, or GBP. Those broad categories of green bonds include climate change mitigation, climate change adaptation, biodiversity, natural resource conservation, and pollution prevention and control. Within those broad areas, there are multiple types of green bond projects.

Types of green bond projects are:

• Renewable energy
• Energy efficiency
• Clean transportation
• Sustainable water and wastewater management
• Eco-efficient technologies and production
• Green buildings

Note: There are bonds issued by state or local governmental entities involved in environmentally sustainable activities but do not follow the core guidelines of the GBP. Examples include bonds issued by an entity established for the management of wastewater, public transportation, or energy-efficient buildings.

How Green Bonds Work

Green bonds finance environmentally-friendly projects, such as energy efficiency, pollution prevention, and clean transportation. These bonds work like other bonds in that they pay a stated amount called a coupon payment to an investor who is loaning money to the issuer to finance a project.

To qualify as a green bond, it is certified by the Climate Bond Standard Board, which is a third party that verifies the bond will fund projects that benefit the environment.

Who Issues Green Bonds?

Two of the top issuers of green bonds are Fannie Mae and The World Bank. Governments of countries, such as the United States, Germany, France, and China are leading issuers of green bonds. Green bonds may also be issued by local or state governments.

Size & Value of the Green Bond Market

Since the World Bank started its climate change initiative in 2008, the green bond market has grown significantly. By 2015, the green bond market had reached a total volume of $104 billion, according to climatebonds.net. By the end of 2020, the green debt market passed $1 trillion in total volume.

Note: Green bonds may be included in the broad category of ESG investing, or a category of investments that adhere to a certain level of environmental, social, and governance standards.

Green Bond Example

A green bond example is a series of Transportation Revenue Bonds issued by New York with their Metropolitan Transport Authority (MTA). These green bonds are a type of climate change bond that help to finance clean transportation projects intended to reduce carbon emissions.

Pros & Cons of Investing in Green Bonds

Since many green bonds are issued by municipalities, they may have tax advantages, which can make these bonds attractive for investment, especially within a taxable account. This favorable tax status also serves as an incentive for investors to help finance projects that benefit the environment.

Pros

• Potential tax benefits: Green bonds issued by certain government entities may provide tax-free income for investors.
• Helping the environment: Investors have the opportunity to earn income from an investment while benefitting the environment.

Cons

• Low yields: Bonds issued by government entities often pay lower yields than corporate bonds.
• Lack of control: Governments may already have the money to fund a green bond project. If they issue green bonds for that same project, it may free money up to do other things.

Climate Bonds vs. Green Bonds

Climate bonds and green bonds may be used interchangeably. Climate bonds are specifically issued to prevent or mitigate climate change and are certified by the Climate Bond Initiative. Green bonds are a broader category of debt instrument that can include climate bonds, as well as many other bonds that are issued to benefit the environment.

Blue Bonds vs. Green Bonds

Blue bonds are issued specifically to finance projects that protect the ocean and other water ecosystems. Blue bonds are a type of green bond, which is a general category of debt instrument issued to finance environmentally-friendly projects.

Bottom Line

Green bonds are fixed-income investments that finance projects intended to benefit the environment. Since green bonds are often issued by government entities, they may provide tax benefits to an investor.