What is a Green Bond and How does it Work?

Sustainable finance has grown in popularity as climate change and corporate sustainability become more important for companies seeking long-term business success and customer loyalty. However, between impact investing, socially responsible investing, and green financing – it can be difficult for companies to choose which type of sustainable investment is right for them.

What are green bonds, how do they work, and why might they be the right option for a company looking towards ethical investments?

Green bonds are a fixed-type of income, and are used to help raise the funds necessary to implement new environmental projects dedicated towards reducing climate change or other activities beneficial for the environment. Green bonds started around twenty years ago and function in the same way as traditional bonds – except they have the added benefit of creating positive environmental change. Green bonds are sometimes referred to as climate bonds or sustainable bonds. 

The main goal of green bonds is to support environmental projects dedicated towards reducing climate change or other environmentally beneficial causes. Green bonds pertain to the values expressed in  socially responsible investing and ESG investing – where the primary incentive is not a lucrative financial return, but the satisfaction of knowing that the investment is aiding a worthwhile cause, in this case, by benefiting the environment. 

The market for green bonds is growing by the day, with the financial amount of green bonds having been issued reaching almost $270 billion in 2020 – with the U.S. leading in green bonds having issued $50 billion dollars worth of green bonds in a single year. Green bonds are continuing to grow in popularity given they don’t require additional expertise in contrast to traditional bonds.

Green bonds work in the exact same manner as other bonds distributed by the government or corporate. In general, a bond is a numerical representation of an agreement between a “borrower” and a “lender” – where the “borrower” is meant to return the money to the “lender” at an interest rate. This is how people who choose to invest using bonds receive a financial return.

The borrowers will issue green bonds for various projects, but the difference between green bonds and traditional bonds – is that green bonds are selected purposefully for projects that will contribute towards positive environmental change or in the fight against global warming.

Given green bonds function in the exact same way as traditional bonds, except for the environmental benefits – green bonds are inherently just as financially successful and more impactful than traditional bonds.

There are a multitude of benefits to green bonds: such as creating positive environmental change, helping to improve biodiversity, aiding in the restoration of an ecosystem, and reducing carbon emissions that pollute the planet. Green bonds do not only serve as beneficial for the environment, but choosing green bonds over traditional bonds can also result in tax benefits for the owner of the green bond. Therefore, in a similar way to many of the tax reduction opportunities expressed in the Inflation Reduction Act of 2022, where Biden encourages Americans to opt for the purchase of electric cars or to install solar panels – green bonds provide an added financial incentive over traditional bonds. 

All in all, similar to impact investing or socially responsible investing – green bonds provide similar financial returns with the added benefit of working to improve the current environmental circumstances. 

Think of green bonds as buying a daily necessity of some kind – such as a packet of sponges or laundry detergent. Imagine paying for the price of two sponges in a pack, and then you get the third additional sponge for free at no additional cost. This is precisely what the benefits of green bonds are: instead of solely improving financial security and reserves – green bonds also help to improve the environment with no added effort necessary. 

Green bonds can also help companies meet their ESG requirements, improve risk management in other economic activities amongst the marketplace, and best of all – green bonds can encourage other environmentally friendly investments to be made and become the new norm in the future. 

However, there are many different types of bonds that are similar to green bonds, and it can get confusing what classifies as a green bond.

In addition to green bonds, there are two bonds that are often interchanged with green bonds – called blue bonds and climate bonds.

Blue bonds are sustainable bonds dedicated to financing projects towards protecting the ocean or other marine life and ecosystems. For instance, blue bonds can be used for projects towards cultivating more sustainable fisheries, protecting fragile ecosystems in the ocean such as the Great Barrier Reef, and reducing pollution that impacts ocean ecosystems and marine life. Blue bonds fall under the umbrella of green bonds, but not all green bonds can be considered blue bonds – as not all green bonds specifically tackle ocean life and ecosystems.  

Another type of green bond, often used interchangeably with green bonds, are climate bonds. Climate bonds are bonds that are specifically meant to reduce emissions and mitigate the negative impacts of climate change.

While there is no full-proof way to determine if a bond is indeed a green bond, there are a couple of ways to classify the environmental impact of a bond. For instance, bonds or investments that are marketed to potential investors may not actually qualify as a green bond or green investment – and may in turn only be another example of greenwashing. However, bonds that fall under certain initiatives, such as the Climate Bonds Initiative – may be considered a true green bond.  

If green bonds provide the same benefits as other ethical investments, what makes green bonds worthwhile?

Ethical investments are any investments that financially support industries that are dedicated to creating environmental, social, or economic change. For instance, an ethical investment could be a green bond tied to the research and development of renewable energy resources, or an investment made to provide education to children in developing countries. Both of these circumstances aid in positive environmental or social change – making them ethical investments. 

That being said, it’s difficult to determine the difference between ethical investments and green bonds given that they both have the same primary goal. In short, the main difference between ethical investments and green bonds is that the goal of ethical investments is to create change amongst society in addition to benefiting the economy and the environment – whereas green bonds are more focused on contributing to projects developing new technologies and action plans to reduce carbon emissions and protect the environment. 

For instance, a financial investment that is dedicated towards improving the environmental health and safety of employees at a company would be considered as an ethical investment – as the main end result of this investment would be a change in the surrounding community or society. On the other hand, an investment made towards research towards new developments for carbon capture and storage systems would be more likely to be considered as a green bond – as carbon capture and storage systems help to reduce the amount of carbon dioxide emissions in the air and are ultimately beneficial for the environment.   

Both green bonds and ethical investments are committed to an outcome that creates change, instead of being solely focused on receiving a good financial return.

There are several different types of green bonds: including project green bonds, securitization green bonds, covered green bonds, and green loans. All green bonds ultimately function in the same way: green bonds are like loans with interest rates, to be returned to the initial investor who provided the loan, and the funds are used to financially support a specific environmental project. 

One hypothetical example of a green bond is imagining that a constructor wanting to build a new property with sustainable infrastructure seeks a green bond through an issuer, such as the Work Bank – which is a real-life green bond issuer. The constructor will be able to use those finances to make advances in the construction of the project – which is both beneficial to the constructor and the investor of the green bond. The end outcome is both financial gain for the investor and the constructor, as well as encouraging the development of eco-friendly buildings and technology that contribute to positive environmental change. 

A real-world example of a green bond is the entire country of Austria, which purchased a green bond worth 4 million euros back in May 2022. It is estimated that at the end of the issuance of the green bond, Austria will accumulate a whopping 250 million euros. This demonstrates how a green bond is good for both the environment and a receiving good financial return.

Securing a green bond wouldn’t be possible without the determination of companies or governments that want to create sustainable change through their loans. Ultimately, these companies and governments are responsible for issuing green bonds – and can provide them to any individual or party in need of funds to finance a sustainable or eco-friendly project. 

Therefore, these individuals or groups seeking green bonds must seek companies or governments with the ability to issue them a green bond in the first place. Ultimately, it is the decision of the company or government to issue the green bond – so the best course of action for any individual seeking a green bond is to thoroughly prepare the presentation of their project for several prospective investors, in order to increase their chances of receiving a green bond. 

Investments for green bonds also come from institutional investors, such as hedge funds, mutual funds, and endowments – but these institutional investors are still not responsible for the distribution of the green bond. 

Those presenting their sustainable project to potential green bond issuers should demonstrate how they intend to use the funds provided for them with the green bond, such as by specifically outlining how the future project will help to increase energy efficiency or reduce emissions. Next, the company or government potentially issuing the green bond can determine if it is a project they are interested in issuing a green bond for – where the company or government then has a chance to elaborate on their opinion on the sustainable project. Then, the process of how the funds for the green bond will be generated and distributed can be discussed. Finally, a reporting schedule will be drafted in order to ensure that the green bond is a success for both the investor and the party receiving the green bond. 

All in all, green bonds are just like traditional bonds – except they are dedicated towards creating environmental change. If you’re looking for an investment and help the planet at the same time: a green bond may be exactly what you’re looking for.

If reading this article about green bonds and how they work has made you interested in reducing your carbon emissions to further fight against climate change – Greenly can help you!

Greenly can help you make an environmental change for the better, starting with a carbon footprint assessment to know how much carbon emissions your company produces.