A brief guide for understanding what climate bonds are and why they are important.
What is a bond? A bond is a type of loan or IOU which companies, governments, and banks use to finance projects. The issuer of the bond (the borrower) owes the holder (the creditor) a debt and, depending to the terms they agree on, is obliged to pay back the amount lent within a certain amount of time and with a certain interest.
What is a Climate Bond? Climate bonds are used to finance – or re-finance – projects needed to address climate. They range from wind farms and solar and hydropower plants, to rail transport and building sea walls in cities threatened by rising sea levels. Only a small portion of these bonds have actually been labelled as green or climate bonds by their issuers.
What is a Green Bond? Is it the same as a Climate Bond? A Green Bond is where proceeds are allocated to environmental projects. The term generally refers to bonds that have been marketed as “Green”.
In theory, Green Bonds proceeds could be used for a wide variety of environmental projects, or even parks development; but in practice they have mostly been the same as Climate Bonds, with proceeds going to climate change projects.
In some cases, a portion of proceeds have gone to areas seen as environmental but not necessarily related to climate change. For example, proceeds from RaboBank’s green retail bonds in the Netherlands may go to organic farm loans as well as to climate change related areas like sustainable buildings.
Who issues these bonds? Largely corporations and state-owned rail companies, with some from multilateral development banks and some asset-backed bonds.
The pioneer issuers of “labelled” green or climate bonds, where proceeds are allocated to climate projects, have been the World Bank and its sister organisation, the International Finance Corporation, with their Green Bonds, and the European Investment Bank, with their Climate Awareness Bonds.
Who buys climate bonds? The vast bulk of climate bonds have been bought by institutional investors like pension funds and fund managers. In the Netherlands and South Africa banks have also offered green bonds to individuals; and some fund managers have, using World Green Bonds, created special funds that individuals can invest in.
How big is the climate bonds market? The climate/green bond market includes all of those bonds which have been issued to help finance climate-friendly projects. At present, the climate bonds market has an estimated value of $346bn.
There are around $50 billion outstanding of labelled climate bonds and green bonds (as of October 2014).
What types of climate bonds are there? Broadly speaking, climate and green bonds can be categorized according to:
Are climate bonds cheaper than other ones? They are about the same. The difference is that green bonds will attract new investors who are interested in climate friendly projects funded by all types of companies. However, these investors generally want to know that their funds are indeed being spent in a climate friendly way.
What are the benefits of green bonds? They offer the same returns as other bonds, but with the added benefit that funds are only going to climate change solutions. For a lot of people – like the $22 trillion of investors who are members of the Global Investor Coalition on Climate Change – this is important.
They give investors a chance to direct capital to climate change solutions, where at the moment there is little opportunity (“lack of deal-flow”).
Climate bonds satisfy the needs of issuers, bondholders and the environment.
So why aren’t more companies investing in green bonds? Many investors are aware of the problem of climate change, but translating that awareness into investment decisions is usually seen as a major challenge. However, many investors say that given the same conditions in terms of time and investment, they would choose green bonds over brown ones due to the climate change solution opportunities they offer.
This is a matter of perception; while they have generally assumed that climate bonds were high-risk investments, in fact, 89% are investment-grade.
What is the Climate Bonds Initiative and what does it do? The Climate Bonds Initiative is an international not-for-profit which promotes the development of climate bonds. It aims to raise awareness about the existence and benefits of climate bonds and promote investments in them; proposes standards that establish what a green bond is, helping identify and label green bonds so that they may be recognized as such; and develops project models in areas such as energy efficiency, forestry and other climate sectors.
What is the Climate Bonds Standard? The Climate Bonds Initiative has developed environmental standards with which projects must comply in order to achieve the corresponding Certification mark. Investors of these approved programs are therefore assured that their funds are being used for projects which support climate change; and the green bonds associated with these projects are easily labelled and identifiable.