According to the Climate Bond Institute, as at December 2020, $1 trillion of green bonds have been issued, with the market expected to continue to grow rapidly as more large corporations issue their own green bonds.

Whilst green bonds have typically been issued by governments and major banks, large corporations, including major development and infrastructure companies such as Lendlease, are now issuing their own green bonds with support from major banks. In March 2021, Lendlease closed a $300m round of 10-year fixed rate green bonds, following on from the successful issue of Lendlease’s $500 million debut green bond in October 2021.

Corporations are issuing green bonds to meet their own Economic, Social & Governance (ESG) targets and objectives, by using green debt to fund projects which contribute to sustainability goals such as lowering carbon emissions and reducing environmental impacts. Lendlease, as an example, have committed to ‘Absolute Zero Carbon’ by 2040. Similarly, investors are becoming more attracted to green bonds to meet their ESG targets and diversify their portfolios to include a range of green investments. Green bonds are becoming more reputable in the market due to certification initiatives, mitigating the risk of “green washing”.

What are Green Bonds?

Green bonds have two distinguishing features:

  • the proceeds are allocated exclusively for projects with environmental and/or climate benefits (understood to be intrinsically coupled with social co-benefits). They follow the Green Bond Principles as set out by the International Capital Markets Association (ICMA) and the proceeds from the issuance of which are to be used for pre-specified types of projects; and
  • provide clear transparency and disclosure on the management of the proceeds.

In general, a green bond, social bond or sustainability bond is a bond (a debt instrument) which can be issued by entities such as corporates (banks and other companies), governments and quasi-governments (councils, municipalities) to finance or re-finance projects. The issuer of the bond (the borrower) owes the bondholder/investor (the creditor) a debt and depending on the terms they have agreed, is obliged to pay back the amount lent within a certain period of time (tenor) and with a certain interest (coupon). Unlike a loan, the bond is a transferable instrument that can be traded on a secondary market if publicly issued.

The development of Green, Social and Sustainability Bonds

Thematic bond markets first developed in a voluntary manner, with the European Investment Bank’s first “Climate Impact Awareness” bond and the World Bank’s first “Green Bond” setting precedents in 2007/2008. Subsequently, improvements in best practice have developed at an international level to guide issuers and deliver consistent markets to maintain investor confidence and avoid the risk of “green washing” (a form of marketing spin or misrepresentation which is deceptively or mistakenly used to persuade the public that an organisation’s products, services, aims and policies are environmentally friendly when they are not).

At the international level, two main voluntary guiding principles for the green bond issuance process have emerged:

  • The Green Bond Principles, co-ordinated by ICMA provide process guidance around transparency on the use of proceeds, project selection process, management of proceeds and reporting.
  • The International Climate Bonds Standards, managed by the Climate Bonds Initiative and developed by a network of technicians, industry players and investors, incorporates the Green Bond Principles and adds science-based criteria to identify assets that are compliant with a sub-two degree world, in line with the Paris Climate Agreement.

In 2017 ICMA also developed the Social Bond Principles and the Sustainability Bond Guidelines which adopt the same pillars around transparency of the Green Bond Principles and add new eligible categories for social financing. The Sustainability Bond Guidelines refer to the eligible assets in the Green and Social Bond Principles (the Green Bond Principles, the Social Bond Principles and the Sustainability Bonds Guidelines are collectively referred to as the “Principles”).

Benefits of Green Bonds for Issuers and Investors

Benefits for Issuers can include:

  • Improve investor diversification;
  • Enhance issuer reputation;
  • Provide an additional source of sustainable financing;
  • Increase alignment regarding the durability of instruments and the project lifecycle;
  • Attract strong investor demand, which can lead to high oversubscription and pricing benefits (as has been observed in relation to certain issuances).

There is increasing evidence of pricing benefits emerging for some issuers, driven by strong investor demand and limited supply. There is also evidence emerging (some of it anecdotal) to suggest that oversubscriptions are being increasingly observed in relation to thematic-labelled bonds (for example the March 2021 Lendlease media release).

Benefits for investors can include:

  • Comparable financial returns with the addition of environmental and/or social benefits;
  • Satisfy ESG requirements for sustainable investment mandates;
  • Contribute to national climate adaptation, food security, public health, energy supply, amongst others;
  • Enable direct investment in the ‘greening’ of brown sectors and social impact activities;
  • Increased transparency and accountability on the use and management of proceeds, becoming an additional risk management tool;
  • Green bonds can help mitigate climate change-related risks in the portfolio due to changing policies such as carbon taxation which could lead to stranded assets. Instead, a green bond invests in climate-friendly assets, such as green buildings, renewable energy, that over time bear a lower credit risk.

The growth of the green bond market has attracted a diversified and more mainstream investor base. The institutional investor community (pension fund managers, assets managers, high-net-worth individuals) with large portfolios including those with sustainability-related mandates, are increasingly seeking green and low-carbon investment opportunities.

Economic Recovery and Green Bonds

Even at a time of a global pandemic market commentators have observed that the demand for green, social and sustainability bonds remains buoyant (with many pointing to oversubscriptions for certain issuances as evidence of this). Both issuers and investors remain keenly focused on green finance as a strategy for ensuring the right investments are put forward to keep environmental and social issues at the top of the agenda.

With interest rates in the developed economies at an all-time low, the demand for yield coupled with the demand for green presents both developed and emerging markets (including companies within these markets) with an unprecedented opportunity to tap new sources of capital at scale coming out of the current pandemic period. It is the hope of numerous market participants that sustainable debt capital, through green bonds, can support a healthy and resilient recovery.