Green Bonds – What They Do, and Evidence from Academia

Green Bonds – What They Do, and Evidence from Academia

Governments and corporations issue green bonds to fund projects with positive environmental impacts, such as developing renewable energy, improving energy efficiency, controlling pollution, providing clean transportation, constructing or retrofitting green buildings, improving wastewater management, and supporting climate change adaption. According to the Climate Bonds Initiative, annual issuance of green bonds more than tripled in the five-year period from 2017 to 2021.

To get more specific, the International Capital Market Association (ICMA) defines these eligible Green Projects categories, (shown in no particular order, including but not limited to…). In our humble opinion, these projects merit support because they help to sustain and improve quality of life. Failing to support these things would be like ignoring the “Check Engine” light on your car’s dashboard. You don’t enjoy spending money on auto maintenance, but ignoring the problem is not a sustainable long-term strategy when you need your car to get you where you need to go every day, for years to come. Eventually the damage done by not spending the money now will destroy the car, leaving you with a pile of scrap metal. Green projects can help to save the earth and its inhabitants (all of us) from that fate.    

International Capital Market Association (ICMA) – Green Projects Categories
Renewable energyIncludes production, transmission, appliances, and products
Energy efficiencyApplies to new and refurbished buildings, energy storage, district heating, smart grids, appliances and products
Pollution prevention and controlIncludes reduction of air emissions, greenhouse gas control, soil remediation, waste prevention, waste reduction, waste recycling and energy/emission-efficient waste to energy
Environmentally sustainable management of living natural resources and land useCovers environmentally sustainable agriculture and animal husbandry; climate smart farm inputs (e.g., biological crop protection or drip-irrigation); environmentally sustainable fisheries, aquaculture, and forestry, and preservation or restoration of natural landscapes
Terrestrial and aquatic biodiversity conservationApplies to projects that protect coastal, marine and watershed environments
Clean transportationIncludes electric, hybrid, public, rail, non-motorized, multi-modal transportation, infrastructure for clean energy vehicles, and reduction of harmful emissions
Sustainable water and wastewater managementIncludes sustainable infrastructure for clean and/or drinking water, wastewater treatment, sustainable urban drainage systems, river training, and other forms of flood mitigation
Climate change adaptationRefers to efforts to make infrastructure more resilient to impacts of climate change,  and information support systems such as climate observation and early warning systems
Circular economy adapted products, production technologies and processesIncludes the design and introduction of reusable, recyclable and refurbished materials, components and products; circular tools and services, and/or eco-efficient products
Green buildingsThose that meet recognized standards or certifications for environmental performance

Many of the largest green bond issues come from governments and municipalities, including the largest one so far, a $12.1 billion sovereign issue from the Netherlands that will fund green building upgrades, low carbon transport, marine renewable energy, and solar and water infrastructure projects. Banks are also active in this space, including Barclay’s in the U.K., which issued a $65 million green bond to finance marine renewable energy, solar, and wind projects. For those who are interested in perusing the universe of green bond issues, the Climate Bonds Initiative offers this searchable database.

The legal documents (bond indenture, etc.) for green bonds require the issuer to use the proceeds for the stated purpose only, so it would be engaging in fraud to do otherwise. In other words, an issuer cannot simply slap a “green” label onto a regular bond issue in the hopes of convincing investors to accept a lower coupon rate (which the evidence says doesn’t happen anyway, at least not for corporate issuers – see “Academic Research” below) or to try to polish its sustainability image. 

For further assurance, certification according to the Climate Bonds Standard has become “de rigueur” in this market. Certified climate bonds must conform to criteria that are consistent with the 1.5 degrees Celsius target in the 2015 Paris Agreement. To obtain certification, a prospective issuer must use an Approved Verifier, who provides assurance that the bond meets the Climate Bonds Standard’s requirements. The Climate Bonds Standard Board provides final confirmation of all Climate Bond Certifications.

Academic Research

Seeking information on this topic (or any topic, for that matter) should go beyond the top results of a Google search. To go a step further, we often look at academic research on the subject (and if you are not yet familiar with Google Scholar, we apologize in advance for introducing you to a bottomless pit of interesting research that could make your head swim, or inspire you to get a PhD, or both). Keep in mind that just because an article was published in an academic journal does not mean it is useful, but the incentives for doing this type of research are not purely commercial, and that can be comforting. 

An article on MIT’s Climate Portal summarizes three interesting research findings in an analyses of the boom in green bond issuance: (1) when firms announce plans to issue certified green bonds and financed projects, their stock price increases—this is unlike stock price reactions following announcements regarding conventional bond issuance; (2) firms’ do not obtain less costly financing (e.g., lower interest rates) on certified green bonds—green and conventional bonds pay investors roughly the same interest, all other things being equal; (3) It is critical to obtain certification for green bonds. Green bonds that are “self-labeled” are not associated with a reduction in carbon emissions; nor do they generate a positive stock market reaction. 

Given that corporate green bonds represents only a small fraction of total bond issuance, what drives issuers to choose this approach, and what are the costs of issuing green bond? One of the studies cited in the MIT article (Flammer, 2021) concludes that by issuing (certified) green bonds, companies credibly signal their commitment toward the environment. A research paper titled “Determinants of Firms’ Choice between Green and Conventional Bonds: Why is the Corporate Green Bond Market Still so ‘Green’?” (Dutordoir, Li, and Neto, 2022) looks at conventional and green bonds issued by firms in the U.S., Western Europe, and China between 2012 and 2021 and finds that firms are more likely to issue green bonds than conventional bonds when the costs of disclosure are fairly low and reputational gains from being seen as green are fairly high, and they have a strong focus on innovation. 

Does issuing green bonds lower the cost of capital or otherwise benefit shareholders? The evidence is mixed. Tang and Zhang (2020) study returns following green bond issuance by firms in 28 countries over the period from 2007–2017. They show that stock prices positively respond to green bond issuance but do not find a consistently significant premium for green bonds. This suggests that the positive stock returns that occur around green bond announcements are not fully driven by lowering the cost of debt. Nonetheless, the authors show that institutional ownership, especially from domestic institutions, increases after the firm issues green bonds, and stock liquidity significantly improves. Overall, these findings suggest that issuing green bonds benefits existing shareholders.

The results reached in any research on sustainability-related probably need to be updated fairly soon after the article is published because the field is growing so quickly – witness the huge growth in green bond issuance in 2021 alone—those issues were not part of the study cited above. On that note, we invite you to bookmark “Google Scholar” and OWL ESG’s Insights page on your browser and visit them often. For more information about how OWL’s data can help you to keep up with developments in the sustainability landscape, contact us.