Q&A: green bonds

The green bond market remains small compared with the overall global fixed-income market

Zoe Knight, Head, Climate Change Centre of Excellence, HSBC, explains green bonds.

What is a green bond?

It works in the same way as a traditional bond. The key difference is that its proceeds are specifically earmarked for investment in projects that have environmental benefits. The emergence of green bonds reflects a wider shift towards taking sustainability into account when investing. The green bond market remains small compared with the overall global fixed-income market – but it is growing rapidly.

What is sustainable investment?

It first became popular in equities, where stock market indices based on ethical and sustainability criteria were launched around 15 years ago. More than 1,200 institutional investors, representing around USD45 trillion of assets under management, have signed up to the UN-backed Principles for Responsible Investment. They have pledged to incorporate environmental, social and governance factors into investment practices. Many investors are now focusing on fixed-income products. In particular bonds are often used to raise capital for projects in areas such as energy efficiency and clean energy.

The emergence of green bonds reflects a wider shift towards taking sustainability into account when investing

How popular is it?

HSBC Global Research estimates that USD74 billion worth of bonds broadly aligned to the low-carbon economy were issued in 2012. Green bonds are hard to define but are currently just a small segment of that.4 The first explicitly labelled “green bond” was issued by the European Investment Bank in 2007 and the market has since expanded by a compound annual growth rate of 55 per cent. Green bonds worth more than USD18 billion were issued in the first six months of 2014, compared with USD11 billion during 2013.

Bonds linked to other sustainability-related themes have also been developed. In 2006 the first “social bond” was launched to fund vaccination programmes in developing countries. Subsequent social bonds have focused on areas including education, health, female entrepreneurship, labour standards and human rights as well as local community projects.

Zoe Knight

Zoe Knight, Head, Climate Change Centre of Excellence, HSBC

What are green bonds used for?

There is no consensus on what a green bond’s proceeds can or cannot be used for. However, green bonds have been used to finance projects in three main areas:

  • Low-carbon energy, particularly renewables but also carbon capture and waste-to-energy projects
  • Energy efficiency in buildings, industry and transport
  • Environmental and land use, covering areas such as agriculture, forestry, water and waste as well as climate change adaptation

Who is issuing and investing in them?

Major international financial institutions, including the European Investment Bank, World Bank and the International Finance Corporation, have led the way. They have issued green bonds to provide financing for the low-carbon economy. More recently government agencies and municipal governments have followed, while major companies have also begun to issue their own green bonds to fund low-carbon projects and to diversify their investor bases. Demand is also increasing. Large institutional investors – who initially adopted a cautious attitude towards green bonds – are now increasing their exposure. Some have been declaring investments publicly to highlight their commitment to climate finance and sustainability.

What are the Green Bond Principles?

They were launched in January 2014 to provide a set of voluntary standards for the issuers of green bonds. Designed to help build the transparency and credibility of the green bond market, they are supported by a group of international banks, including HSBC. They cover areas including:

  • Defining how a bond’s proceeds will be used
  • Evaluating and selecting suitable projects
  • Managing the proceeds and reporting on their use
  • Independent verification and review of green bond criteria

What next?

The green bond market is still in its infancy. But demand is clear from the take-up by institutional investors – one recent corporate green bond issue was six times oversubscribed. Both the number and size of green bonds being issued continue to increase. Some investors have raised questions over what qualifies as a green bond and whether some are simply repackaging existing finance, rather than raising new capital. As the market grows, we anticipate a greater focus on whether green bonds are delivering tangible environmental benefits. The establishment of the Green Bond Principles was a first step towards demonstrating the integrity of the market; the next stage will be to define criteria for investment themes in renewables and energy efficiency.