How have green bonds and green finance emerged?
The bond markets have in recent years witnessed the emergence of a specialist new product referred to as ‘Green Bonds’. Green finance was developed therefore by the financial markets to direct capital towards activities designed to mitigate climate change and improve the environment. The United Nations Framework Convention on Climate Change, the UNFCC and the Paris Accord are international environmental treaties adopted to make the world more green.
What is green finance?
‘Green’ refers generally to any financing where the money borrowed is used to reduce carbon emissions, fight pollution or clean up the environment. Together ‘Green’ and ‘Social’ funding are often referred to as ‘Sustainability Bonds’ in the capital markets where the money raised might include contributing to fighting global warming and addressing social problems.
Which principles do green bonds adhere to?
‘Green Bond Principles’ were first published in 2014. The essential element that sets green finance apart from other types of borrowing concerns what is done with the money borrowed. In the case of ‘Green Bonds’, everything hinges on the ‘use of proceeds’ statement. The issuer has to specify what it will do with the money and justify it being for ‘Green’ purposes. Therefore the internationally agreed Green Bond Principles rely upon four ‘pillars’ and a fifth key supporting element.
- The issuer of the bonds clearly identifies how it will use the money
- How the issuer selects and evaluates relevant projects
- Explains how the money raised by the Green Bond is effectively ring-fenced by the treasury team
- How a borrower subsequently reports on the use of the money, noting and quantifying the impact in appropriate terms
Finally, the Fifth element is an external review.
How has the reporting, external review and verification process been categorised?
As the market has grown, different types of organisations have offered to provide external reviews. These fall into the following broad categories:
- Consultants offering second opinions
- Verification in the form of a green audit
- Certification in the form of a label
Who regulates green bonds?
The finance industry has done a good job working together to agree and enforce important principles. This is done by an Executive Committee (‘ExCom’) of the Green Bond Principles, made up of major market players drawn from the ranks of bond market investors, issuers and arrangers.
What are issuer and investor expectations?
Issuers hope to enjoy a reputational uplift from being seen to contribute towards the fight against global warming. Green bonds ensures some investor diversification, some greater certainty of execution success in the current market and a more stable investor base. We can expect this market to grow and develop quite quickly.