In 2013, the International Finance Corporation (IFC) packaged and issued a new financial instrument – a so called “green bond” – which was identical in price and returns to other IFC bonds, so provided no extra perks, the only difference was that the IFC promised to invest the money received for this bond in climate friendly projects. The bond sold out in one and a half hours, and was 3 times oversubscribed. A few days later Korea’s Export-Import Bank issued its first green bond for renewable energy, energy efficiency and water projects the Korean Government had planned. The day after the $500m green bond sold out, an email was sent to the network of bankers working in capital markets around the world, with the header “green is the new black”.

The green bond market, which was non-existent ten years ago, has taken off. In 2017 there was a 92% growth in green bonds listed on the London Stock Exchange and a 78% increase in the money raised. Growth in the market has consistently outstripped expectations of financiers who initially doubted the promise of a market that offers no extra benefits to investors beyond being good for the environment. In 2017, the green bond market reached $221billion, in 2018 it is expected to reach $250 billion.

Climate Bonds Initiative (CBI), an NGO which promotes and tracks the expansion of the green bonds market, believes that its growth potential is even greater. Beyond the green bonds in the market that were labelled as such in 2017, CBI identified an additional $674 billion of “climate aligned bonds” that have not been formally labelled and traded as green. This makes up a total universe of $895 billion climate aligned bonds in 2017, made up of 3,493 bonds from 1,128 issuers across seven climate themes. Even with these staggering figures, demand for green bonds is currently outstripping supply – which allows CBI to be confident that a target of $1trillion market of bonds invested in climate solutions is achievable by 2020.

Wider relevance

The emergence and rapid growth of the green bond market over the last five years provides an example of one way to help finance the transition to a low carbon global economy. Green bonds are no different to regular bonds, in that they provide secure, low risk, long term investments that can be part of a diverse investment portfolio. Green bonds, like other bonds, are credit rated, can be traded, and occur in many different currencies. They are similar to any normal bond in structure and terms, with similar pricing and benefits – the only difference is that the proceeds go to finance, or re-finance, climate change projects – such as renewable power plants, retrofitting of buildings, or green infrastructure such as flood defences. Of course, bond markets are part of a much larger development in the size and influence of the global financial markets, which has been problematic for many reasons, and even green finance can be subject to the problems of financialisation.

But rapid transition does require the redirection of finance from ‘bads’ to ‘goods’, and the emergence of the green bonds market comes as good news because historically it has been difficult to channel finance towards projects which are climate friendly, about reducing emissions, and more climate proof, about adapting to climate breakdown. According to the International Energy Agency, in the energy sector alone, cumulative investment of $53 trillion is required by 2035 to avoid dangerous climate change. New Climate Economy estimates that $93 trillion is required across the whole economy by 2030. So, it is clear that currently there is a huge investment gap that is preventing us from building the green infrastructure the world needs to support a low carbon future. Green bonds provide an opportunity to partially bridge that gap and support the rewiring of our economies to support green investments over fossil fuels.

Green bonds are similar to other themed bonds issued in the past – to finance the building of the railways in Britain in the 19thth century or to support the war efforts of the early 20th century. They provide a means for governments to direct finance to climate action, whilst also sending a political signal of the importance of investment in this area for the public interest. Green bonds have already shown their potential to support climate action in diverse countries across the world. The first green bonds were issued in Europe and the United States, but have since been issued in 40 countries from every continent. China currently has the largest green bond market of any country in the world.

Green bonds can also be issued by a diverse range of actors. The market was piloted by development banks, but increasingly national governments, municipalities and corporates are issuing green bonds to finance their climate friendly activities. Initially most investments were channelled towards the re-financing of renewable energy projects, however, issuance is increasingly diversifying to support a wider range of climate friendly activities. According to CBI’s count of the total issuance to date, renewable energy and green buildings make up 64% of the total, followed by transport 14% and water 10%. Waste management, adaptation and land use each account for 3-5%.

Context and background

The expansion of clean energy and green infrastructure around the world has been limited because the cards of the global financial deck are stacked against it – these sectors suffer a lack of access to finance and high cost of capital. Renewables present a number of issues for financiers. Often the actors are relatively new and comparatively small enterprises, meaning that they cannot leverage corporate finance based on their track-record as a company, but must rely on project-finance. This can present a further challenge as there is often a lack of information or knowledge about the risks of renewable projects, which severely affects their credit-worthiness. Given the higher perceived risk, debt usually comes at a higher cost. By contrast, the fossil fuel industry is made up of large players, with long track-records of financial stability and high profits – meaning that they have traditionally been favoured in the market by investors as a safe bet.

Developing countries face even greater challenges in leveraging finance for clean energy and green infrastructure projects. Renewable energy projects in developed countries are usually financed with up to 90% debt. In developing countries, however, the inability to raise sufficient debt means that a renewable project developer may need to raise up to 30-40% of the project cost in equity contributions – a target so high that it often leads to the failure of such projects to achieve financial closure.

In recognition of the challenges faced by developing countries in fronting the costs of a low carbon future, and given the industrialised world’s historic responsibility for climate change, the Paris Climate Agreement included a commitment from developed nations to channel $100billion annually to developing countries to support their climate mitigation and adaptation efforts through the Green Climate Fund. In 2017, however only $2 billion was approved by multilateral climate funds to be channelled to developing countries. For countries in both the global South and global North, additional sources of financing to make the transition to a low carbon future are desperately needed.

Enabling factors

The key to the rapid growth of the green bond market has been the growing recognition by financiers and the general public of the long-term financial risk that climate change presents to investments. Influential players like the Bank of England have defined climate as financial risk and recommended the greening of the financial system. For particular types of institutional investors – such as pension funds, sovereign wealth funds and insurance funds – these risks have become too acute to ignore. Institutional investors have a duty to ensure that their portfolios are relatively low risk, to keep people’s savings secure in the long-term. For a pension fund that has to be confident it will be able to pay out to its savers in forty years’ time, it no longer makes financial sense to bank on fossil fuels. The Institute and Faculty of Actuaries has recently highlighted the risks to pension fund portfolios if they remain unchanged on current trajectories of climate change.

A 2015 UNEP inquiry into the disconnect between the current global financial system and a more sustainable future argues that we have “an historic window of opportunity to develop a sustainable financial system”. There is evidence suggests this is happening. A 2013 survey found that nearly one third of institutional investors expect to increase their renewables investments. At the Paris Climate talks, institutional investors representing a market of $11.2 tn committed to growing the green bonds market, and the insurance sector, which makes up one third of the world’s investment capital, committed to multiply their green investments by 10 by 2020. Institutional investors have approximately $80 trillion under management, 50% of which is held in the form of bonds – these sums can in large measure explain the explosion of green bonds in recent years, and indicate the exponential growth potential of the market.

National government actions have also been crucial to incentivising the rapid growth of green bonds markets. Poland and France were the first countries to issue sovereign green bonds in late 2016 and early 2017, and later in 2017 Fiji and Nigeria became the first issuers amongst developing economies. The sovereign is usually the highest rated institution in the country, so can kick start a national market by providing liquidity and scale, and attracting other corporate issuers. To provide transparency and support the growth of the market, several nations have also developed country level green bonds guidelines. China issued guidelines for listed companies in 2016, and in the same year it outstripped the USA as the country with the highest issuance of green bonds.

Finally, the relatively flexibility of the labelling system has supported the rapid growth of the market – as so far issuers have been able to self-identify their bonds as green. The lack of rigid criteria for labelling or clear obligations for reporting has allowed the market to grow rapidly, but has been accompanied with concerns about the risks of greenwashing. Reporting that proves that the finance is being channelled as promised has not been comprehensive – for bonds issued before April 2016, 74% have post-issuance reports publicly available. The Green Bonds Principles are voluntary guidance that was launched by a group of banks in 2014 to bring clarity and transparency to the process of issuance, disclosure and reporting. The Climate Bonds Standards and Certification Scheme provides a more formalised approach that aims to ensure consistency. Steps are also being taken by governments, for example at the EU level, to develop a common standard and classification system.

Scope and evidence

  • In 2017 there was a 92% growth in green bonds listed on the London Stock Exchange and a 78% increase in the money raised.
  • The labelled green bond market has increased from $11 billion in 2013 to $221billion in 2017. So far in 2018, $94.3 labelled green bonds have been issued, and issuance is expected to reach $250 billion.
  • In 2012, CBI tracked the $174 billion of climate aligned bonds. Just five years later, in 2017 this figure had increased 5 times, with a total universe of $895 billion of climate aligned bonds made up of 3,493 bonds from 1,128 issuers across seven climate themes.
  • Of the total green bond issuance to date, renewable energy and green buildings make up 64%, followed by transport 14% and water 10%. Waste management, adaptation and land use each account for 3-5%.
  • In 2015 institutional investors representing a market of $11.2 tn committed to growing the green bonds market, and the insurance sector, which makes up one third of the world’s investment capital, committed to multiply their green investments by 10 by 2020.

Lessons for a rapid transition

  1. Don’t underestimate the demand for green financial products. Green bonds have been repeatedly over-subscribed. As they grow they need to beware the dark sides of financial markets.
  2. They have the ability to buck trends. Green bonds tap into growing investor interest in ‘green finance’. This is significant because historically it has been difficult to channel finance towards projects which are climate friendly and more climate proof
  3. There is scope for positive contagion.  The first green bonds were issued in Europe and the United States, but have since been issued in 40 countries from every continent. Part of this has been enabled by the fact that already well-established rules of the bond market could be applied. Government support has also been critical.

References

Boulle, B., Frandon-Martinez, C., Pitt-Watso, J (2016) Bonds and climate change: The state of the market 2016. https://www.climatebonds.net/files/files/CBI%20State%20of%20the%20Market%202016%20A4.pdf

Boulle, B., Meng, A., Frandon-Martinez, C., McAvinue, R., Triparthy, A., Giuliani, D., & Elliot, C. (2017). Bonds and climate change: The state of the market 2017.  https://www.climatebonds.net/files/files/CBI-SotM_2017-Bonds%26ClimateChange.pdf

Giuliana, D. and Sonerud, B, (2018). Sovereign Green Bond Briefing. Climate Bonds Initiative. https://www.climatebonds.net/resources/reports/sovereign-green-bonds

LSE Public Lectures (2016) Green Bonds: a solution to finance the future? http://www.lse.ac.uk/lse-player?id=3370

Ng, T. H., & Tao, J. Y. (2016) Bond financing for renewable energy in Asia. Energy Policy, 95, 509–517. https://doi.org/10.1016/j.enpol.2016.03.015

UK Parliament (2017) Green finance: mobilising investment in clean energy and sustainable development https://publications.parliament.uk/pa/cm201719/cmselect/cmenvaud/617/61707.htm

United Nations Secretary-General Climate Change Support Team (2015) Trends in Private Sector Climate Finance Report. Retrieved from http://www.un.org/climatechange/wp-content/uploads/2015/10/SG-TRENDS-PRIVATE-SECTOR-CLIMATE-FINANCE-AW-HI-RES-WEB1.pdf

UNEP Inquiry (2015) The Financial System We Need. http://unepinquiry.org/wp-content/uploads/2015/11/The_Financial_System_We_Need_Policy_Summary_EN.pdf

UNEP Inquiry (2017) Green Finance Progress Report, Retrieved from https://wedocs.unep.org/bitstream/handle/20.500.11822/21608/Green_Finance_Progress_Report_2017.pdf?sequence=1&isAllowed=y

Chappatta, C.. Green-Bond Market Needs to Get Tough to Blossom, Brian Chappatta, Bloomberg Opinion, 18 July 2018 https://www.bloomberg.com/opinion/articles/2018-07-18/green-bond-market-needs-to-get-tough-to-blossom