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Green Bonds Finance Climate-friendly Projects

The success of the engineering team together to develop water power in the dam to generate electricity.

Some investors may be surprised to find out that green bonds have been around for more than 10 years. While the early issuance numbers started with just a few bonds, cumulative green bond issuance surged past the $1 trillion mark at the end of 2020, marking a 60 percent increase from 2015, according to the Climate Bonds Initiative.

Also called climate bonds, green bonds are used to finance climate-friendly projects around the world. Their issuance is poised to expand further in 2021 as the planet shifts its focus to rewarding companies and governments financing green and other sustainability projects.

Last year alone, there was a record issuance of $270 billion in green bonds. The scope  of these bonds is also expanding into social, sustainability, sovereign, transition, and other environmental, social, and governance (ESG) areas.

When a company issues a green bond, that money is specifically targeted toward a green project. Take Google as an example. Last year, the company issued $5.75 billion in sustainability bonds, the largest corporate issuance of its kind ever. The money will be used for a variety of sustainability projects (environmental and social), including energy efficiency at Google’s data centers, clean energy investments into solar and wind, green buildings and preventing food waste, clean transportation via electric vehicles and bicycles, and circular economy and design across operations, products and supply chains. 

The social aspect of Google’s sustainability bonds includes a commitment to racial equity including by financing small businesses in Black communities, affordable housing in the Bay Area, and support for small businesses and COVID-19 response.

While Google has been carbon neutral since 2007, a company doesn’t have to be 100 percent green to issue green or sustainability bonds. Many companies can make use of green bonds to finance specific green projects. Not-so-green firms can also finance their transition into more sustainable operations by issuing transition bonds. The market for a variety of ESG bonds is clearly growing and so are the types of bonds.

Who certifies green bonds?

Climate Bonds Initiative (CBI) is the organization that certifies bonds and loans prior to their issuance. They are then called Certified Climate Bonds. CBI uses strict standards and a certification scheme to ensure that bonds and other debt instruments meet the criteria aligned with the Paris Climate Agreement to limit global warming to less than 2 degrees Celsius.  

In its Sovereign Green, Social, and Sustainability Bond Survey 2021, CBI noted that 22 national governments had issued such bonds as of last November. Goals for this financing included national climate plans, mitigation of social inequalities, emission reduction, and net-zero goals.

The survey concluded that a key motivator behind increased issuance is, in part, due to more options and diversity in the investor base for the bonds. It also increased transparency around the projects attracting more investors.

For retail investors interested in not just putting their money into equity ESG ETFs, there are now more and more green or ESG bond funds available to choose from. Examples include Nuveen ESG U.S. Aggregate Bond (NUBD), iShares Global Green Bond (BGRN), VanEck Vectors Green Bond (GRNB), and iShares ESG U.S. Aggregate Bond (EAGG).

“We continue to see bond issuance grow very quickly in that space,” said Tony Rodriguez, head of fixed income strategy at Nuveen. “We think that’s going to continue and won’t slow down. We think that it makes sense from an investment perspective.”

He said that they integrate ESG analysis across the full credit spectrum at Nuveen, “whether it’s high-yield, corporate or structured bonds. We see continued flows into those strategies and globally continued focus into ESG-focused products.”

Rodriguez said that green bonds tend to be “competitive” to “more attractive” from a total return point of view compared with traditional, non-green bonds.

“I think the view had been that you were giving something up, that you were paying a premium and you were maybe therefore not accessing areas of the market that had great potential returns,” he noted. “We don’t think that you need to sacrifice return to be in ESG investment strategies.”

He explained that the cost could be higher in the long run for companies that are not integrating ESG into their operations. From a total return perspective, avoiding some of these downsides could be key.

“You gain greater credit protection from companies and issuers that are leaders from an ESG perspective,” Rodriguez said. “When companies take their ESG responsibility seriously and manage effectively for those risks, we think they reduce their risk relative to competitors. And we think that will be one of the bigger drivers of outperformance.”

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