Green bonds: A driver for transition requiring a clear, ambitious approach

Green bonds: A driver for transition requiring a clear, ambitious approach
By Thibaud Lemercier and Jerome Kisielewicz
Managing Consultant, Sustainable Finance and Climate Policy
Jan 13, 2022
6 MIN. READ

Since they first launched, green bonds have increased in popularity and scope. Here, two of ICF's experts—Jerome Kisielewicz and Thibaud Lemercier—explain what they are, how they’ve evolved, and their benefits. In this article we also use the term “thematic bonds.” This covers all bonds that specify that the proceeds of the bond will be used for a specific purpose.

What are green bonds?

Typical “vanilla” bonds are issued to raise debt for an organization. A bond is a loan from an investor to a borrower—in this case, the issuer. The issuer then uses that money to fund their organization or their projects. The investor, meanwhile, gets interest on their investment.

In the case of green bonds—a type of thematic bond—the issuer promises to use the proceeds to fund a pre-defined set of activities that have a positive impact on the climate or the environment.

How has the green bond market evolved?

Green bonds were the first thematic bonds to be issued in 2007. One of the first was the EIB Climate Awareness Bond. ICF has since published an evaluation of this bond that you can read here. By 2020, the value of green bonds issued had passed $1 trillion.

We’ve seen many other types of thematic bonds launch, too. These include:

  • Sustainable bonds: used to finance both environmental and social projects
  • Social bonds: used to fund social projects such as affordable housing or gender equality
  • Blue bonds: used to support ocean conservation

Most are based on a similar framework: detailing the activities the issuers will finance with the proceeds, impact reporting, and also what is excluded from the funding.

Sustainability-linked bonds

All of the bonds mentioned above are based on the allocation of proceeds.

However, we’ve also seen the emergence of sustainability-linked bonds in recent years. Here, the money raised isn't linked to a pre-defined set of activities, but to company performance. For example, a typical green bond might fund a solar energy project. But with a sustainability-linked bond, you might instead commit to decreasing your greenhouse gas emissions 20% by 2025. If the issuer achieves these activities then the cost of financing will remain as offered. If they fail, then the cost of financing will increase. Conversely, if the issuer exceeds their performance targets, then investors will enjoy even more favorable terms.

Sustainability-linked bonds are a kind of transition bond—essentially supporting the transition of a company towards improved sustainability performance. We’ve also seen the growth of “thematic transition bonds,” which focus on “hard to abate” sectors such as aviation or the cement industry.

As an example, an airline company might be reluctant to issue green bonds for fear of being accused of greenwashing. But they still want to do better, so they raise a transition bond to finance the purchase of more energy efficient aircraft or another innovation.

The market is constantly innovating and adapting these interrelated bonds to meet the changing concerns of investors and society as a whole. They range from bonds that fund activities around gender issues to others that support biodiversity—our tip for the next big topic in the bond market.

How green is “green”?

With this increased complexity comes increased risk, as there is now greater scrutiny. We're seeing the development of more taxonomies and tools to underpin these green bonds and prevent greenwashing. To understand more about why this is so important, view a recent EU Taxonomy webinar run by ICF’s Thibaud Lemercier here.

In the early days of green bonds, it was relatively easy to see that proceeds were being spent on obviously beneficial activities like a renewable energy project. Today, the picture is much more complex. This is reflected in the ongoing debate in taxonomy around what is actually green. It’s a crucial discussion, as taxonomies should be used by anyone raising bonds around the world as a reference point.

The benefits of green bonds

Beyond the positive impact on the planet and society, what are the benefits of green bonds and other thematic bonds? From a purely economic perspective, a green bond should have better financial terms than a vanilla bond through the so-called “greenium.” Greenium, or green bond premium, refers to the difference in yield between a green bond and an equivalent non-green bond. If the difference is negative, this means the investor is willing to pay a higher price for a green bond than for a vanilla bond leading to a lower cost of borrowing for the issuer.

Recent issuances such as the German twin bonds combining the issuance of a green bond with the issuance of an equivalent vanilla bond contributed to the increasing signs of greenium on the market. But there are at least three other benefits:

  1. The reputational benefits of being seen to invest in causes that society is concerned about
  2. The opportunity to diversify your investor base
  3. The chance to communicate positively about your organization

Our view is that choosing a green financing option is both about having an advantage and avoiding risk. Nowadays, climate concerns and social issues are mainstream. As a result, companies—and even governments—are afraid that failing to address these issues will alienate investors and impact their ability to raise capital. This is because many recovery funds now have extensive low-carbon or sustainability conditions attached. Consequently, any company or government looking to access these funds will need to focus on green issues in order to do so.

The future of the green bond market

What’s next for the market? We believe it will continue to diversify in terms of types of bonds and we’re also likely to see more governments issuing green bonds.

ICF for example recently supported the Italian government with their inaugural €8.5 billion green bond issuance. We have also worked closely with the Italian authorities on developing the green mini bond market to help SMEs to access capital.

ICF is also currently supporting the Region of Andalusia with their sustainable bond issuance. And we’ve also run workshops focusing on how EU regions can raise green and sustainable bonds to finance activities. The European Commission is expected to issue €250 billion green bonds alone over the next few years.

More broadly, there is a shift towards ensuring that investments are aligned with the Paris Agreement or contributing to the UN Sustainable Development Goals. Bonds are often underpinned by the Green Bond Principles, Sustainability Bond Guidelines, or Social Bond Principles (a voluntary set of guidelines promoting transparency, disclosure, and integrity in the market), by new taxonomies, and also increasingly by new regulatory frameworks. Regulations such as the upcoming European Green Bonds Standard will complement and validate the existing principles.

As the thematic bond market evolves, the activities they fund are often less obviously green. At the same time, investors are more educated, regulations are stricter, and there is a higher level of scrutiny. The bottom line is that whatever the future holds for thematic bonds, transparency will be key.

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Meet the authors
  1. Thibaud Lemercier, Managing Consultant, Sustainable Finance and Climate Policy

    Thibaud’s core experience is in climate strategy & policy for financial institutions and public organizations. He has an excellent track record in consulting at international level.  View bio

  2. Jerome Kisielewicz, Managing Consultant, Sustainable Finance + ICF Climate Center Senior Fellow

    Jerome leads work in the field of European sustainable and positive impact finance, combining expertise in climate, renewable energy, and biodiversity finance. View bio

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