Investing for the future: your guide to green bonds, blue bonds, and beyond
Green finance involves directing financial resources towards environmentally sustainable projects, such as green bonds, carbon finance, and blue bonds, to promote positive environmental and social outcomes. This growing sector aims to support initiatives like clean energy, emissions reduction, and social development, while fostering responsible governance and helping countries meet climate goals.
What is green finance?
Every day, trillions of dollars are put into investments around the world. Green finance refers to the practice of directing financial resources towards environmentally sustainable projects and initiatives.
This can take the form of green or sustainable bonds, carbon finance, social bonds or blue bonds among others. All of them aim to encourage investments that align with sustainability principles, contribute to positive environmental and social outcomes, and foster responsible corporate governance practices in one way or another.
Green bonds and loans
Capital put into green bonds and loans is directed towards financing new or existing projects with a positive environmental impact. These include efforts to develop clean energy sources, improve energy efficiency, and reduce greenhouse gas emissions.
The instruments are issued by governments, companies and multinational development banks with an interest in green projects. Issuers need to demonstrate how their processes meet commonly accepted eligibility criteria such as the International Capital Market Association’s Green Bond Principles.
There are two types of green bonds. Labeled green bonds are certified as green by their issuer and subject to screening processes, including external reviews. These bonds typically have lower yields than their unlabeled counterparts, which are not earmarked for specific projects despite being fundamentally aligned with environmental goals.
However, studies of US corporate and municipal bonds have shown that green bonds trade at a yield premium relative to non-green bonds. This is sometimes referred to as the “greenium”. Investors also typically receive a public relations benefit, as they are viewed as being on the “right side” of climate change.
Sustainability bonds and loans
Unlike green bonds, sustainability bonds and loans are not directed towards a single project. Instead, their proceeds are also used to finance a broader array of environmental and social developmental activities.
This could be investing in projects that tackle issues like global warming. to funding enterprises that work to support marginalized groups including migrants, the unemployed, and people with disabilities.
In addition, sustainability bonds can be secured and tied to the collateral value of an asset, such as real estate. They can also be unsecured, where investments are backed by the creditworthiness of a government or a company.
Carbon finance
A growing mechanism for ethical investing is carbon finance, which places a financial value on carbon emissions. Countries and companies can offset their own emissions by paying for carbon-lowering initiatives around the world.
This includes projects by organizations such as the United Nations High Commission for Refugees (UNHCR). In one instance, refugees in Rwanda, who used inefficient and unsustainable firewood for cooking, were provided with fuel-efficient stoves. Over a ten-year period, the stoves would allow refugees to reduce their carbon dioxide emissions by 30,000 tons per year, UNHCR estimates.
The two main carbon pricing policy instruments are carbon taxes and emissions trading systems. A carbon tax places a fee on the carbon emissions content of fossil fuels, and the market determines the resulting quantity of emissions reductions.
Meanwhile, emissions trading systems place a cap on the total quantity of emissions. The systems also allow the market to determine the price for tradable emissions allowances.
The Paris Agreement has set a target of keeping global warming to no more than 1.5°C. This requires signatories to reduce their emissions by 45% by 2030 to reach net zero by 2050. Carbon finance is viewed as a tool for countries to meet their goals, as carbon dioxide accounts for around three quarters of the world's greenhouse gas emissions.
Even so, setting up a carbon market can be challenging, as carbon has no intrinsic value. As a result, the value of carbon is dependent on authorities enforcing limits on emissions.
There are carbon trading schemes currently running in the European Union, United States and across Asia, with varying emission limits and prices. There is room for the emergence of a global market that can help the world decarbonize more effectively.
Social bonds
These bonds address social problems through investing in projects such as affordable housing, healthcare and education. There have also recently been bonds focused on mitigating the social issues arising from the COVID-19 pandemic.
Issuers of social bonds follow a set of voluntary guidelines, to report the effectiveness of their projects and maintain transparency. The instruments have the potential to make a positive impact on vulnerable communities around the world.
Blue bonds
Instead of land-based projects, blue bonds focus on marine and coastal conservation. Examples of these include initiatives to protect the marine ecosystem and fund sustainable fisheries.
Around USD175 billion is needed every year to conserve the world's oceans, according to estimates. However, only USD25 billion is contributed annually, resulting in a funding gap. At the start of 2023, blue bonds accounted for less than 0.5% of the global sustainable debt market.
One reason is that blue bonds tend to be issued by low-income countries with poor credit ratings, dampening investor interest.
Blue bonds also lack standardized definitions and metrics for issuers and investors to rely upon. However, in 2022, the International Finance Organization, the private-sector arm of the World Bank, published a set of guidelines for the asset class. This could support higher take-up rates
Green project finance
Lastly, green project finance directs funds from public, private and not-for-profit stakeholders to sustainable development priorities.
It supports environmental investments, energy efficiency and renewable energy financing. This differs from traditional project finance, where money is directed to initiatives which do not necessarily benefit the environment.
Perhaps the biggest advantage of green project finance for investors is that it contributes to a more sustainable climate and environment, while delivering returns.
The road ahead
Tools for ethical investing continue to be refined as the ecosystem for sustainable finance develops.
With the world still a distance away from meeting its climate goals, green finance is seen as a way to bring countries, businesses and investors a step closer to environmental targets.
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