What are green bonds? How did climate bond initiative come into the picture? What factors are driving impact investing portfolios? And how can investors ensure that their portfolios create positive impact?
We are seeing a drastic shift in the investment landscape, in terms of investors’ preferences toward impact investing. Simply put, investors are concerned about creating a positive environmental or societal impact through their investments. Assets tied to ESG (Environmental, Social, and Governance) strategies of businesses surpassed USD8.2 trillion in the US alone in 2016. What is staggering is that this value represents a 33% increase compared to 2014. It is clear that investors are keen to park their funds in anticipation of a brighter impact investing. This demand surge has come out in the form of green bonds. The green bond market stands at USD200 billion, doubling the amount of growth over the last couple of years.
What are green bonds?
Fossil fuel-produced energy (in the form of natural gas, coal, and oil) contributes massively to climate change. These byproducts are leading generators of toxins, which pose health hazards and environmental risks. Such an adversely changing climate has created the need for investors to recognize cleaner and reusable energy. Consequently, the alarming situation is triggering the importance of green bonds. Federally qualified organizations or municipality institutions issue such tax-exemption bonds for development of brownfield sites. Such organizations are fast realizing the positive impact of green bonds on the climate. Hence, enterprises are increasingly allocating funds for such bonds.
The World Bank has projected that cities will invest USD100 billion through 2050 to prevent climate change from affecting livelihood. Similarly, the United Nations has also estimated an annual investment of USD1 trillion by emerging economies toward sustainable infrastructure development.
Factors driving explosive growth of green bonds
The explosive growth of bonds began in 2013 and the issuance of corporate green bonds spurred its arrival. There has been no looking back since 2013. Corporate giants and commercial banks fueled the growth of green bonds, as depicted in the graph below:
Organizations with green bonds can foster qualified investment capabilities to their assets as they can reach out to investors, who are seeking long-term plans. Such plans usually bring in low-risk investments coupled with margins for climate change, sustainable and impact investing projects. These investors can mobilize the private sector climate finance, which remains the biggest objective of green bonds.
For instance, the World Bank issued a 10-year green bond worth USD600 million which includes investors like Deutsche Bank Treasury, Swedish pension funds AP2 and AP4, Mirova and Nikko Asset Management among others. Deutsche Bank planned to invest EUR1 billion in another such green bond. Such decisions to set up dedicated portfolios for impact investing are crucial toward driving expansion in green bonds issuance.
The success of green bonds is contributing to the growing awareness within the investment sector. The result of seven years of work by the World Bank Treasury is crystal clear after the issuance of the first green bond in 2008. Large institutional investors were seeking liquid investments contributing to eco-friendly projects. Consequently, the World Bank has been consistently supporting impact investing vision with an issuance of around USD8 billion green bonds in 18 currencies globally. Ranging from around 80 transactions, green bonds by the World Bank are helping investors finance a range of environment-friendly projects. Such impact investing projects include geothermal power development in Indonesia, sustainable urban transportation in India, sustainable forest management in Mexico, and disaster-risk management in the Dominican Republic among others.
Current green bond market scenario
Soaring hopes and success stories clearly indicate the substantial optimism involved in the green bonds initiative. However, without any fixed criteria for the fulfillment of investment in green bonds, there have been a few incidents where ‘green money’ has been leveraged to fund illicit and controversial projects. Hence, the International Capital Markets Association (ICMA) has formulated a framework for the Executive Committee of the Green Bond Principles (GBP). Recognized by the investors, the framework has streamlined the issuance and investment in green bonds. The framework is restricted to a criterion for projects, quantifiable environmental benefits, and impact evaluation process.
At present, the market practice of green bonds has been complex due to the inadequate formulation of documentation by investors. In this regard, SG Analytics’ ESG team can help investment visionaries with research to validate their green bond mission for a green future. The GBP properly guides the green bond market to harmonize the mission. The guidance is resulting in distinct impact investment portfolios – a new regime of eco-success.
Opportunities for investors in green bonds
Continuing from the best quarter ever in 2016 (October-December), the green bond market has witnessed even bigger success with an issuance of USD20 billion in the first quarter of 2017. Enel and Iberdrola represented around 48% of the total issuance of global green bonds in the first quarter of 2017. This success rate has given rise to another specific bond to counter climate change – Climate Bonds Initiative (CBI). So, what exactly is CBI? Climate bond is a broader universe; however, it is triggered by green bonds. While the green bond is a labeled market with guarantees for investors in any sector, climate bonds are issued by restrictive companies purely active in environmental sustainability.
According to the CBI, January 2017 witnessed an issuance of green bonds worth around USD11.2 billion. Adding to the emerging success, green bonds worth over USD5 billion were issued in February and March 2017. Buoyed by the surge in the issuance of green bonds, companies like Apple and Repsol are pumping in billions to support the promise of a greener tomorrow. Earmarking more than USD1.5 billion, Apple is dedicated to financing clean energy projects across its global business operations. The company is looking forward to a positive impact that involves green building, annual water saving worth 20.2 million gallons, annual energy saving worth 37 million kWh, and annual prevention of greenhouse gas emissions of 0.20 million metric tons. Hence, as per the current market scenario of green bonds, companies that are instrumental in driving a positive change, are also succeeding by saving more.
Effective climate change solutions for successful issuance of green bonds
Financing environmental solutions are technically tough because of the expertise required and solution-centric research. It has also turned out to be tough due to the deficiency in access to finance and investment research. Geared toward climate change mitigation, corporate entities seek to fund from federal grants powered by substantial research metrics. Funding sources like state grants and philanthropic agencies are usually in silos. Hence, businesses need to adopt a strategic approach to secure grants for green bonds.
The most effective climate change solution strategy for any business would depend on the following roadmap:
- Assessment of current market environment for green bonds and its potential use associated with climate change mitigation objectives.
- Improvement in applicability measures of green bond issuance funds.
- Involving key market players including private sector for fostering demand tailored to corporate social responsibility (CSR).
- A strategic roadmap for efficiently deploying green bond funds wherever needed.
- Execution of a pilot program based on key management functions.
Certainly, a strategic approach to adopting the ‘green movement’ should be the road ahead for the global commercial landscape. However, businesses, which are ready to capture a major market share of green bonds, will need to focus on the core functional ESG resources. Given the rapid expansion of the green bond market, being at the helm of a strategic approach could make enterprises having an overwhelming feeling. Nonetheless, honing CSR skills is an imperative for enterprises. Enterprises can effectively carry out CSR strategies with a diagnostic study of the adequate implementation of green bonds.
Unlocking the future: Green bonds for a green planet
With the grossing number of companies realizing the importance of impact investing, green bonds could make a huge difference on environmental balance and reduce climate change risks. After the climate bond initiative, it is possible that a new format of green bonds could emerge to incent emitters of deadly pollutants. Green bonds are gradually evolving as the bridge between the investor community and a greener tomorrow.
The growing investor community seeking measurable improvement in the ecology has started realizing the potential of green bonds. However, the maturing green bond market would need a demand-supply balance. Moreover, new business models, credit enhancements and dynamic research are playing a key role in the development of this green project. Avoiding catastrophic climate change will require even strong vision and initiatives, with extensive government support. California Gov. Jeffy Brown recently announced his bravery with the objective of combating climate change even if President Donald Trump rolls back environmental regulations. By 2030, California aims to reduce emissions by 40% below the mark they were in 1990 – this augurs well for businesses seeking green bonds in the US. Additionally, India has also lined up ambitious targets for building renewable energy sources – 100 gigawatts solar power are expected to be in place by 2022.
While the future road of green bonds is not known, history suggests that there’s always a transition point between eras, and change occurs at the precipice. Green bonds are the path to a sustainable tomorrow, emboldening businesses to be bold, think long-term, and above all, to act. Are investors ready to build a greener tomorrow?
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