What are Green Bonds?
A green bond is a fixed income debt instrument in which an issuer (typically a corporation, government, or financial institution) borrows a large sum of money from investors for use in sustainability-focused projects. Green bonds work similarly to a traditional bond issuance, except the funds are slated for use in energy efficiency, renewable energy, or other projects that meet certain sustainability requirements, often formalized in a green bond “framework” developed by the issuer. Green bonds typically involve one or more third-party firms to underwrite, certify, and monitor the bond issuance.
Green Bonds may be a good fit if your organization...
- Needs to raise a large amount of funds (typically $25+ million) for capital-intensive projects that can achieve measurable sustainability-based impacts, such as greenhouse gas reduction or green building certification.
- Wants to increase visibility into your company’s green investments.
- Wants to attract investors aligned with the goal of making profitable environmental, social & governance (ESG) investments.
- Can leverage a strong credit rating to raise low-cost capital
- Can capture tax benefits and incentives for green bonds.
To compare Green Bonds to other financing options that might be a good fit, answer a few questions about your organization.
How it Works
The main difference between green bonds and traditional bonds is that the issuer publicly states how it will use the proceeds to fund sustainable projects, allowing the bond to be marketed to investors as green. While there are no universal requirements for a green bond, the Green Bond Principals (GBPs) and Climate Bonds Standard (CBS) are popular voluntary guidelines that advise on the appropriate use of funds, project selection process, and reporting.
The projects considered for green bonds are typically described in a pre-issuance report detailing how the financed projects will achieve the issuer’s desired impact. An external party can prepare this report to one of four levels:
- Second party opinion on the bond’s general alignment with the GBP;
- Verification against stated business or environmental criteria, such as science-based goals;
- Certification against an external standard like the Climate Bond Standard; or
- A score/rating against an external methodology, much like a credit rating.
Issuers often develop a green bond “framework” in support of their environmental and sustainability objectives and then apply this framework to issue multiple bonds. With no governing body for green bonds, it is possible for issuers to self-label green bonds and perform internal impact verification.
As a debt instrument, the terms of the green bond rely on the strength of the balance sheet of the issuer, with the best rates available to issuers with a strong credit rating. For this reason, the most common types of green bond issuers are large, often publicly traded corporations or municipalities. While there are public listing venues available for green bonds, such as the Luxembourg Stock Exchange (LuxSE), successful green bond sales often involve negotiation directly with investors.
After selling bonds to raise capital, the issuer is responsible for managing the use of proceeds to meet the objectives of the green bond. Projects can be funded directly, with the issuer purchasing equipment or hiring contractors to carry out projects. Issuers can also use proceeds to pay for service agreements, such as Energy Services Agreements (ESAs) or Energy Service Performance Contracts (ESPCs) in coordination with an energy service company (ESCO).
Green bond issuers also typically release regular public post-issuance reports. These reports are required by many of the voluntary guidelines, including the GBP and CBS. Most reports are annual and account for the use of proceeds (i.e. where the funds are going) and the progress achieved towards the green bond’s stated objective. These post-issuance reports are distributed to investors and can be released publicly.
Given the administrative costs associated with investor management and third-party verification, projects funded through the sale of green bonds tend to be large and ambitious in scope. For this reason, projects financed in this way frequently include renewable energy generation projects or the portfolio-wide installation of efficient building technologies.
Advantages and Disadvantages
The sale of green bonds can generate significant capital at low rates to enable capital-intensive projects or portfolios of smaller projects.
Unlike financing mechanisms that are attached to a specific property or project, green bonds give issuers more discretion in the use of proceeds, provided this complies with the bond’s requirements.
Post-issuance reports allow issuers to track the impact of projects funded by green bonds while also complying with the GBPs and CBS guidelines.
Issuers can set the repayment period as appropriate, enabling them to support a wide range of projects, including those with longer payback periods.
Green bond sales can generate significant publicity for organizations tackling ambitious projects. Additionally, post-issuance reports allow companies to market the impacts achieved through use of bond funds.
Without a governing body enforcing standardization across green bond offerings, each issuer must structure their own bond terms, including deciding on the desired method of impact monitoring.
Green bond issuers frequently need to engage and negotiate directly with investors to make sure enough capital is raised through the sale of green bonds. There are frequently reporting requirements to investors during the repayment period to demonstrate the use of funds and project impact.
The issuance process requires engaging and coordination with many parties, including credit underwriting and bond reviewers, a burden that can impact the economic impact of smaller bond sales. Establishing a reusable framework can decrease this burden on subsequent bonds.
In the U.S., green bonds are typically issued for $10 million to $100 million, though they are frequently used to raise larger sums. The bonds issued for less than $10 million are typically utilized by municipal organizations.
State of the Market
The green bond market has experienced significant growth in the last several years, with positive year-over-year growth every year since 2011. Per the Climate Bonds Initiative, in 2019 $51.3 billion was issued in the U.S. alone, with a total of $257.7 billion deployed internationally. Fannie Mae remains the single largest green bond issuer in the world, accounting for 9% of 2019 issuances.
Green bonds are utilized worldwide by a variety of entities including developmental banks. In the U.S. market, most issuers are either corporations or municipal entities like city governments. Municipal issuers tend to use bonds to raise comparatively smaller amounts of money, on the order of $5 million to $20 million, as appropriate for their geographic footprint. Recent examples of large corporate green bonds include:
- A 24-year, $500 million bond by Goldman Sachs Renewable Power, certified by Sustainalytics, for use in solar generation
- A 5-year, $650 million bond by PNC Financial Services Group under its green bond framework for use in generation and building energy projects
- A 10-year, $1 billion bond by Verizon Communications Inc., a non-financial corporate entity, for use in a variety of projects including generation, storage, building technology, and land use.
Learn More About Green Bonds
Department of Energy — Bonding Tools
Climate Bonds — https://www.climatebonds.net/
ACEEE — Green Bonds Toolkit
NRDC — How to Issue a Green Muni Bond
Retail Industry Leaders Association (RILA) — Green Bonds Factsheet
International Capital Markets Association — Green Bond Principles
Green Bonds At-A-Glance
|Basic Attributes||Project Types?Which project types can be financed using this option?||Energy Efficiency, Renewable Energy, and Other Generation|
|Applicable Sectors?Which economic sectors does this option commonly serve?||
Common: Commercial & Industrial, Government, Multifamily, Affordable Multifamily. Less Common: Non-profit, Private Universities, Schools, Hospitals
|Geographic Scope?Is the financing option available throughout the U.S., or limited to certain areas that have the appropriate policies and programs in place?||Nationwide|
|Building Ownership?Does this option work well for projects in leased space, owned space, or both?||Owned or Leased|
|Typical Project Size?What range of project sizes does this option typically serve?||Any (note typical minimum issuance is $10 million)|
|Contract Structure||Contract Complexity?How complex is the financing option from the customer’s perspective, in terms of the size and complexity of the financing contract, the number of parties involved, and other factors?||High|
|Parties Involved?Which types of organizations are typically involved in executing the financing option?||Customer, Lender, Underwriter, Contractor, Third-party, Certifier and/or Monitor|
|Payment Type?Are customer payments fixed over time or might they be variable based on factors such as energy savings or utility rates?||Typically fixed, but sometimes with flexibility for variable payments|
|Performance Risk?Which party bears the risk that the installed equipment may not perform as expected?||Borne by issuer|
|Tax & Balance Sheet||Budget Source?Do customer payments made on this financing option typically come from an operating budget ("opex") or capital budget ("capex")?||Capex|
|Balance Sheet Treatment?According to industry best practices, does the financing option typically appear as a liability on the customer’s balance sheet, or is it off-balance sheet?||On balance sheet|
|Tax Deductions?Which amounts can a customer typically deduct from its taxes under this financing option? In some cases all payments are deductible, and in other cases only interest and depreciation are deductible.||Yes, for municipal issuers|
|Equipment Ownership?During the financing term, is the efficiency equipment typically owned by the customer (internal) or by an outside party such as the lender or contractor (external)?||Internal|
|Collateral Source?Which customer assets can the lender use as collateral to secure repayment?||Listed in bond terms, sometimes mortgage or other assets (recourse loan)|
|Contract Terms||Typical Duration?How long does a typical financing contract last?||3-25 years|
|Typical Close Time?How long does it typically take to secure financing once you start speaking with providers?||6-9 months|
|Market Attributes||Market Size?What is the total cumulative dollar value of projects financed under this option?||Upwards of $100 billion|
|Time in Market?How long has this financing option been available in the market?||Since 2000s|