As the green-bond market matures, it is developing offshoots. In the last five years, we have seen shifts in the types of projects financed, as well as the emergence of innovative types of bonds and loans linked to environmental, social and governance (ESG) targets. Together, these initiatives may broaden the market, offering more opportunities to investors in search of green investment options and helping fund the transition to a more sustainable economy.
First, some background: Green bonds are fixed-income securities whose proceeds are exclusively and formally applied to projects or activities that promote climate or other environmental sustainability purposes. The market value of Bloomberg Barclays MSCI Global Green Bond Index constituents — a proxy for this market — grew from $60 billion in December 2015 to $372 billion last December.
From alternative energy to efficiency and green building
When the Bloomberg Barclays MSCI Global Green Bond Index was launched in 2015, the largest category of projects funded by far were in alternative energy. Over the past five years, funding has increased for an array of other purposes such as green building and sustainable transport projects. This may reflect an increasing diversity of issuers, as the market has expanded beyond supranationals, banks and utilities to include other types of corporate and public-sector issuers.
Green-bond funding has increased for a variety of purposes (USD bn)
Of these categories, sustainable transportation saw the highest rate of growth. We estimate that funding allocated to investments in public transportation, rail and electric vehicles by index-eligible bonds totaled $28 billion in 2019, to reach a cumulative $63 billion since the inception of the market. Funding to electric vehicles, related charging infrastructure and R&D saw growth driven by bonds issued by utilities and real estate investment trusts looking to enhance the green credentials of their properties.
Meanwhile, we saw increasing innovation in this market. In 2019, we began to see funding directed outside the traditional buckets of alternative energy, energy and water efficiency, pollution prevention or green buildings to support “transition” projects, as well as bonds linked to specific targets or that aim to boost market liquidity. Some perspective:
Transition bonds. These bonds fund a movement away from environmentally damaging or “brown” projects (such as coal-based power generation) toward greener projects (such as natural-gas-based power generation), although not toward best-in-class green projects (such as solar photovoltaic power generation).
For example, the European Bank for Reconstruction and Development in 2019 issued a green transition bond (PDF), proceeds of which are used to help conversions from coal to gas and in the manufacture of recyclable plastic. Similarly, Marfrig Global Foods, a beef processor, issued a “sustainable transition bond” (PDF) through which it would purchase cattle from farms that respect its deforestation criteria.
Target-linked bonds. By linking their coupon to the successful achievement of an environmental or social target, these bonds help finance specific green objectives.
For example, Italian utility Enel SpA issued a bond linked to the United Nations Sustainable Development Goals that ties its yield to the achievement of targets, such as the percentage of renewable energy installed. If Enel achieves its defined target by a set date, the coupon remains unchanged, and if not, the coupon is stepped up.
Similarly, Conservation Capital arranged a “rhino bond” in which investors would be repaid their investment plus a coupon only if the population of black rhinos, an endangered species, increases through funding from the bond.
Bond structures that increase liquidity. Denmark’s central bank has been exploring the possibility of splitting a conventional green bond into two parts: a conventional green bond plus a green certificate that could be traded separately.
The purported advantage is that the underlying sovereign bond would be more liquid, while a tradeable “green certificate” would ensure that green expenditures at least match the proceeds from the package. This model is designed to help sovereign states with limited funding to maintain liquidity by not fragmenting their issuance. (…)
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