What’s behind the rise and rise of green bonds?

Companies and governments are for the first time raising significantly larger amounts of capital in the debt markets for environmentally sustainable initiatives than they are for fossil fuel projects. What’s behind the rise of green bonds and what does the future hold?

According to Bloomberg, approximately $350bn was generated through the sale of green bonds and loan agreements in the first half of this year, surpassing the financing for oil, gas, and coal-related activities, which amounted to less than $235bn. Bloomberg’s data indicates that the ratio was approximately $300bn for environmentally friendly projects versus $315bn for fossil fuels during the same period last year.

Despite the rise of green bonds, there remain uncertainties about the actual utilisation of funds. For example, the German utility company RWe has raised $1bn by selling green bonds this year. April Merleaux, research manager at Rainforest Action Network, told Bloomberg that the company is also Europe’s biggest greenhouse gas emitter and a major coal developer.

Those uncertainties are outlined by a recent study of the European Central Bank’s (ECB’s) bond investments. The report shows that green bonds issued by carbon-intensive companies amounted to more than €3.5bn, while the bank fails to differentiate between green bonds issued by low-carbon and high-carbon emitters. The ECB has also announced it is abandoning the reinvestment programme, in addition to its strategy to decarbonise its corporate bond portfolio.

One of the driving forces behind the surge in green bonds is the demand for new revenue streams with investors willing to pay extra for a bond with a sustainable impact, also known as a ‘greenium’.

Speaking to Green Central Banking, Neha Kumar of the Climate Bonds Initiative explains that “most green bond issuances are based in the ‘developed world’ as investors have sought new avenues of raising capital. The demand for green bonds has seen a huge rise in the last decade, but developing economies are increasing too. However, progress is slow.”

According to the latest data, the US has issued a total of $380bn, China $287bn, and India $21.6bn. The majority of China’s issuances are domestic green bonds which have been the target of greenwashing claims, although China’s Green Finance Committee recently declared $35bn worth of green bonds meet the EU standards.

In 2016, Fiji became the first emerging market to issue a green bond, raising $50mn for climate resilience. Since then, 19 emerging market governments have issued green, social and sustainability bonds. Kumar says that “there is a high demand for local currency issuances in developing economies, but investors are not yet ready to take on the risk that comes with this”.

“Only eight or nine countries have issued green bonds in local currencies and this is a big issue,” says Kumar. There are two sides to issuing bonds in dollars; “when India, for example, issues bonds in dollars, it exposes the issuer to market volatility, but this issue is outweighed by the sheer wealth of demand in US and Euro-denominated investors. Cumulative issuance data shows that 72% of green bonds have been issued in either Euros or US dollars which makes it much more difficult to issue in local currencies.

While progress is evident, there are challenges in promoting local currency issuances in developing economies. Investors often hesitate to take on the risks associated with these markets, which may limit the growth of green bonds in these regions. To cater to the growing demand for climate mitigation projects, a shift towards blended finance (combining public and private funding) has been observed.

However, compared to climate mitigation, adaptation and resilience projects are not as financially lucrative in the short term, which has hindered private finance in this area. To overcome this obstacle, there is a need for a more comprehensive framework and standardisation for adaptation and resilience projects, similar to the climate bond standard for mitigation efforts.

In light of the increasing importance of adaptation and resilience, green bonds are expected to play a crucial role in financing blended finance projects. Sovereign green bonds, in particular, have gained prominence as they offer third-party verification and certification, which can foster growth in the green bond market.

Several countries are already making strides in this direction, with India and Australia launching their debut sovereign green bonds, and the EU developing a voluntary green bond standard to enhance market practices.

The future of green bonds may seem promising as the global focus on environmental sustainability intensifies, presenting opportunities for environmentally friendly projects to flourish with the support of responsible investors. However evidence of greenwashing,  backtracking on decarbonisation strategies and the disparity between developed and developing economies still pose challenges.