An Introduction to Green Bonds

One of the most talked about financing instruments of today is perhaps the green bond. A green bond is defined as “a debt security that is issued to raise capital specifically to support climate related or environmental projects.” (World Bank, 2015). A typical bond involves the issuer selling the bond to an investor, with the promise to repay the principal debt plus a premium when the bond matures. The structure of green bond is the same as that of conventional bonds except that the proceeds of green bonds are used exclusively to finance projects that deliver environmental benefits. 

While the term climate bond is often used interchangeably with the green bond, the former is actually a sub-set/sub-category of the latter or an extension of the green bond concept. (Mackenzie & Ascui, 2009).  

 Unlike those of green bonds, the proceeds of climate bond are used exclusively to finance projects that address climate change, such as for reduction of carbon emissions or adaptation to climatic shocks.

As there are no uniform global standards for green bonds, various principles and certification programs have been developed, the most common ones being Green Bond Principles and the Climate Bond Standards, both of which are voluntary.  

Green Bond Principles (GBP) focus on transparency, disclosure and integrity of information in the issuance of a Green Bond. As per the principles, the evaluation and selection criteria of the bonds, the process of management of the proceeds and the impact of the investments from the proceeds including environmental benefits should be conveyed to the investors. However, details of what really qualifies as “green” are not specified and are left to the discretion of investors (Talbot, 2017). 

 

Developing nations also have characteristics that make it particularly difficult to proliferate green bonds: 

• Capital markets of developing countries are often underdeveloped, equity based, and lacks debt instruments, which impedes proliferation of green bonds. 

• Knowledge gap and lack of technical expertise act as impediments to proper monitoring and assessment of the proceeds of green bonds to ensure their alignment with the Green Bond Principles (Banga, 2018). 

• Inadequate institutional support, particularly due to lack of collaboration between different ministries that have different priorities often slows down the process of issuance of green bonds and acts as a hindrance to the market development. 

• Minimum value requirements: For green bonds to be attractive to investors and be indexed, they need to be worth USD 250 million or more (Chiang 2017). In developing countries like Bangladesh, many green projects of small size are implemented which do not comply with the minimum size desired by investors.  

• High transaction costs associated with getting green bond certification, particularly when it needs to be proven that the bond issuer is creditworthy is a major barrier (Tuhkanen, 2020), as potential issuers often have to resort to international rating agencies, which, along with issuance costs such as underwriter and issue manager fee, third party evaluation fee, auditing fee etc. drive costs up. 

• Currency conversion: In recent years green bonds have predominantly been issued in the Chinese Renminbi, the US dollar (26%), and the Euro (Climate Bonds Initiative, 2018), and many developing countries are yet to explore the possibility of issuing bonds in foreign currencies to raise capital from global financial markets, and even if does so, they would be exposed to currency risks (Banga, 2018).  

As the market for green bonds is growing globally, climate vulnerable countries have started giving them serious attention because of their potential to mobilize finance from the private sector. For instance, in April 2021, Bangladesh – one of the most climate vulnerable countries of the world - approved its first green bond valued at around $12 million USD, the proceeds of which will predominantly be used to micro credit operations of the recipient NGO Sajida Foundation (TBS report, 2021).  

Amidst the buzz around green bonds, several key issues are getting overlooked which require more critical analysis. Firstly, there is the concern of additionality i.e., whether the green bonds are leading to additional climate financing as some of the interventions financed by green bonds would have happened regardless. 

Moreover, the voluntary nature of certifications and the absence of clarity regarding what classifies as green leads to the risk of greenwashing, with green bonds being used to fund non green interventions such as fossil fuel powered utilities. For instance, the $500 million green bond issued by Exim bank of India was partially used to finance a railway line to supply coal to the notorious Rampal coal plant of Bangladesh – the proposed location of which was in proximity of the Sundarbans Mangrove forests (Brightwell, 2016). 

Furthermore, the absence of standardization of green bonds call into question the sustainability of many of these instruments and their ability to generate returns, as the lack of transparency due to non-uniform disclosure requirements can dissuade potential investors from entering the bond market. The wide range of certification schemes globally with no universal framework or monitoring and reporting lead to lack of harmonization of disclosure requirements and the use of proceeds (Weber and Saravade, 2019). 

On a more fundamental level, the focus on “alternative financing instruments” such as green bonds deters from the no strings attached grant funding demands for economic and non-economic loss and damage of vulnerable countries such as Bangladesh which have contributed little to global warming but are not only bearing the brunt of climatic impacts but are also being expected to pay for it (Huq, 2020) 

• Banga, Josué, “The green bond market: a potential source of climate finance for developing countries,” Journal of Sustainable Finance & Investment 9(18), (2018). Available at: Researchgate 
• Brightwell, Ryan, “How green are green bonds?” Climate 2020 (2016). Available at: Climate 2020

• Chiang, J., “Growing the US Green Bond Market -Volume 1: The Barriers and Challenges,” California Treasury (2017). Available from the California Treasury.

• “Green Bonds, the state of the market”, Climate Bonds Initiative (2018). Available here.

• Huq, Saleemul, “Loss and damage from natural disasters made worse by climate change,” The Daily Star (2020). Available at: The Daily Star 

• Kevin M. Talbot, “What Does "Green" Really Mean?: How Increased Transparency and Standardization Can Grow the Green Bond Market,” 28 Vill. Envtl. L.J. 127 (2017). Available here.

• Mackenzie, C & Ascui, F, “Investor Leadership on Climate Change: An analysis of the investment community's role on climate change, and snapshot of recent investor activity.” United Nations Global Compact, (2009). Available here.

• The Business Standard (TBS), “Bangladesh launches first green bond,” (2021). Available here.  

• The World Bank, “What are green bonds?” (2015). Available at: The World Bank  

• Tuhkanen, H. “Green Bonds: A Mechanism for Bridging the Adaptation Gap?” SEI Working Paper, Stockholm Environment Institute (2020). Available at: The Stockholm Environment Institute.

• Weber, Olaf, Saravade, Vasundhara, “The Role of Standards in the Green Bond Market,” Centre for International Governance Innovation (2019). Available at: JSTOR.