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    GSAM Insights

    UNDERSTANDING GREEN BONDS

    February 13, 2023  |  5 Minute Read

     

    The green bond market is one of the fastest-growing, most dynamic segments in fixed income. In the last five years, green bonds have experienced a major transformation from a niche impact segment to a potential opportunity for every fixed income investor.

     

     

    What is a Green Bond?

     

    Green bonds are debt instruments that finance projects with environmental benefits. Issuers can be companies, governments or agencies that commit to using the proceeds exclusively for financing climate- or environment-related projects, assets or activities. This commitment is what sets green bonds apart from traditional bonds.

     

    The financial characteristics of green bonds such as structure, risk and returns are similar to those of traditional bonds. Their credit quality ranges from investment grade to non-investment grade, although most corporate green bonds are investment grade. The credit profile of a green bond is the same as that of a traditional bond from the same issuer, and in terms of pricing there is no significant difference between a green and non-green bond.

     

    The liquidity of green bond issuers varies across sectors and regions given the rapidly growing global market. So, in regions where liquidity options are more limited, investors' ability to sell may be impacted.

     

    Green bond holders have the same recourse to the issuer. Essentially, they are standard bonds with an additional green element. Green bonds come in short- or long-dated maturities and have various types of coupons and yields.

     

     

    Who Decides if a Bond is Green?

     

    Green bond issuers self-label their bonds as green based on guidance from regulators, stock exchanges and market associations. A number of organizations have developed sustainability standards and labels to give additional transparency on the environmental quality and performance of a product, process or service.

     

    The use of such labels as reference for assessing the greenness of an investment has been a practice in the green bond market for years, according to the International Capital Market Association (ICMA). Issuers often include these standards in their frameworks to qualify environmental use of proceeds. One of the most widely used standards – the Green Bond Principles – was published by ICMA in 2014.

     

    One concern in the green bond market is “greenwashing” – the risk that the environmental ambition of a green bond is not fulfilled or is overstated. Investors should pay particular attention to bond documentation, the green impact of a bond (including alignment with green bond standards) and the sustainability strategy of a bond issuer.

     

     

    Where Does The Money Go?

     

    Designated green bond projects are meant to deliver clear environmental benefits that can be assessed and, where feasible, quantified by the issuer. The Green Bond Principles contain project categories that are broad in scope, but they all contribute to environmental objectives such as climate change mitigation and adaptation, natural resource conservation, biodiversity conservation and pollution prevention and control.

     

    Without a globally-accepted specific definition of green projects, most issuers currently commission independent reviews of their green bond investment frameworks and/or specific issuances for the benefit of investors. The Green Bond Principles also encourage a high degree of transparency and recommend an external review to supplement the issuer’s project evaluation and selection process.

     

     

    The Green Bond Principles Use of Proceeds

    The eligible green project categories, listed in no specific order, include:

    Renewable energy

     

    Energy efficiency

     

    Pollution prevention and control

    Environmentally sustainable management of living natural resources and land use

    Terrestrial and aquatic biodiversity conservation

    Clean transportation

    Sustainable water and wastewater management

    Climate change adaptation

    Eco-efficient and/or circular-economy-adapted products, production technologies and processes

    Green buildings

    Source: ICMA.

     

    What Are Some Examples of green bond Issuance?

     

    In 2007, the European Investment Bank – the European Union’s lending arm – issued its first Climate Awareness Bond. A year later, the World Bank introduced its first green bond. These two issues created the blueprint for today’s green bond market and the framework for defining projects eligible for green bond financing.

     

    The People’s Bank of China issued its own green bond guidelines in 20151 to stimulate issuance, and China has now become one of the world’s largest markets. Poland issued their first sovereign green bond in December 2016. And in 2017, a number of US municipalities also launched sizeable issues to finance local transportation and water projects.

     

    The Dutch government’s first green bond issue in 2019 was focused on funding projects that help it adapt to climate change. Given that much of the Netherlands lies below sea level and is therefore vulnerable to climate change, the projects are related to things like reinforcing flood defenses, monitoring and managing water levels and optimizing water distribution.

    More recent examples of green bond projects include a €5 billion 20-year bond issued by Spain in September 2021 to promote clean transport. Since transport is a major contributor to global greenhouse gas emissions, green bonds are a useful way to finance electrification of the sector.

     

    In March of 2022, a €1.75 billion 20-year green bond was issued to develop and finance the Grand Paris Express, a 200-kilometer subway project that seeks to link the periphery of Paris to the city center, meeting a growing need for sustainable mobility. The project is a key part of the goal to make Paris a carbon-neutral city that is fully powered through renewable energy by 2050.

     

    And Germany issued a new green bond offering in August 2022 for €5 billion, with a 5-year maturity. The net proceeds will finance green expenditures such as clean transportation projects, renewable energy, and sustainable agriculture and forestry.

     

    And Germany issued a new green bond offering in August 2022 for €5 billion, with a 5-year maturity. The net proceeds will finance green expenditures such as clean transportation projects, renewable energy, and sustainable agriculture and forestry.

     

     

    Conclusion

     

    We believe green bonds will be an increasingly important tool for financing the investment needed to advance the energy transition and build a sustainable economy. And as the green bond universe grows and becomes more diversified, we see green bonds becoming a key component of fixed income allocations, providing investors with an opportunity to make a positive environmental impact while generating similar potential returns as traditional bonds.

     

     

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    1In August 2022, China issued a new green bond framework, the China Green Bond Principles, to align with international standards and to unify China’s onshore green bond markets.

     

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    Date of First Use: December 1. 2022 299364-OTU-1707436

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