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Green bonds are growing bigger and broader

The variety of purposes has expanded beyond alternative energy to green building and sustainable-transport projects. And that's just a start.

As the green-bond market matures, it is developing offshoots. In the last five years, we have seen shifts in the types of projects financed, as well as the emergence of innovative types of bonds and loans linked to environmental, social and governance (ESG) targets. Together, these initiatives may broaden the market, offering more opportunities to investors in search of green investment options and helping fund the transition to a more sustainable economy.

First, some background: Green bonds are fixed-income securities whose proceeds are exclusively and formally applied to projects or activities that promote climate or other environmental sustainability purposes. The market value of Bloomberg Barclays MSCI Global Green Bond Index constituents — a proxy for this market — grew from $60 billion in December 2015 to $372 billion last December.

From alternative energy to efficiency and green building

When the Bloomberg Barclays MSCI Global Green Bond Index was launched in 2015, the largest category of projects funded by far were in alternative energy. Over the past five years, funding has increased for an array of other purposes such as green building and sustainable transport projects. This may reflect an increasing diversity of issuers, as the market has expanded beyond supranationals, banks and utilities to include other types of corporate and public-sector issuers.

Green-bond funding has increased for a variety of purposes (USD bn)

MSCI green bonds chart


Of these categories, sustainable transportation saw the highest rate of growth. We estimate that funding allocated to investments in public transportation, rail and electric vehicles by index-eligible bonds totaled $28 billion in 2019, to reach a cumulative $63 billion since the inception of the market. Funding to electric vehicles, related charging infrastructure and R&D saw growth driven by bonds issued by utilities and real estate investment trusts looking to enhance the green credentials of their properties.

Green-bond innovations

Meanwhile, we saw increasing innovation in this market. In 2019, we began to see funding directed outside the traditional buckets of alternative energy, energy and water efficiency, pollution prevention or green buildings to support "transition" projects, as well as bonds linked to specific targets or that aim to boost market liquidity. Some perspective:

Transition bonds. These bonds fund a movement away from environmentally damaging or "brown" projects (such as coal-based power generation) toward greener projects (such as natural-gas-based power generation), although not toward best-in-class green projects (such as solar photovoltaic power generation).

For example, the European Bank for Reconstruction and Development in 2019 issued a green transition bond (PDF), proceeds of which are used to help conversions from coal to gas and in the manufacture of recyclable plastic. Similarly, Marfrig Global Foods, a beef processor, issued a "sustainable transition bond" (PDF) through which it would purchase cattle from farms that respect its deforestation criteria.

Target-linked bonds. By linking their coupon to the successful achievement of an environmental or social target, these bonds help finance specific green objectives.

For example, Italian utility Enel SpA issued a bond linked to the United Nations Sustainable Development Goals that ties its yield to the achievement of targets, such as the percentage of renewable energy installed. If Enel achieves its defined target by a set date, the coupon remains unchanged, and if not, the coupon is stepped up.

Similarly, Conservation Capital arranged a "rhino bond" in which investors would be repaid their investment plus a coupon only if the population of black rhinos, an endangered species, increases through funding from the bond.

Bond structures that increase liquidity. Denmark’s central bank has been exploring the possibility of splitting a conventional green bond into two parts: a conventional green bond plus a green certificate that could be traded separately.

The purported advantage is that the underlying sovereign bond would be more liquid, while a tradeable "green certificate" would ensure that green expenditures at least match the proceeds from the package. This model is designed to help sovereign states with limited funding to maintain liquidity by not fragmenting their issuance.

Beyond green bonds: ESG-linked loans

In 2019, substantial growth occurred in ESG-linked loans, or those in which companies and their bankers tied terms to ESG performance. These ESG-linked loans totaled about $100 billion in FY 2019, more than double the volume raised in FY 2018.

Examples include the Schuldschein market in Austria, where the margin paid by cellulose-fiber maker Lenzing Group steps up or down by 2.5 basis points (bps) if its ESG rating changes, and utility company Iberdrola, which signed a five-year syndicated credit facility linked to the spread over IBOR to its targeted greenhouse-gas emissions.

ESG-linked loans are fundamentally different from green bonds and serve different needs in the market.

ESG-linked loans versus green bonds

Like green bonds, ESG-linked loans have been growing over the past few years. Several entities have issued green bonds and taken out ESG-linked loans, mostly in the energy and utility sectors, given the pressure that these industries face to move toward a lower-carbon world.

The coronavirus pandemic and its economic impacts may be occupying a great deal of investor attention at the moment, but climate change and sustainability remain high on many investors’ — and companies’ — agendas. Green bonds and their offshoots potentially could offer new opportunities to help make the pandemic recovery greener as well.

This article originally appeared on the MCSI blog.

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