Once a niche market, "green bonds" — debt instruments designed to raise capital to finance climate-related or otherwise environmentally beneficial purposes — have proven increasingly popular with investors. In the first half of 2014, for instance, approximately $20 billion in green bonds were sold, a figure that is expected to nearly double by year's end — explosive growth for a niche financial instrument that just two years ago accounted for only $3 billion of the $80 trillion bond market.
The first "green" bond labeled as such was issued in 2008 by the World Bank's International Bank for Reconstruction and Development. At the time, it was a product specially tailored to satisfy demand from Scandinavian pension funds looking to invest in environmentally friendly fixed-income products. The bond, which was developed in close collaboration with Skandinaviska Enskilda Banken and the inaugural group of investors, supported a pre-defined set of climate change mitigation and adaptation projects. Since then, growing investor demand has helped to broaden the pool of environment-related bond issuers, as well as the criteria used to define the objectives of said issues. This, in turn, has led to some confusion as to what exactly makes a bond "green."
Lacking a universally accepted definition, the original issuance process developed by the World Bank Group often is used as a guiding benchmark. All World Bank projects are designed to achieve concrete development results and pass environmental, social, and governance due diligence filters. The subset of projects that address climate change — including projects to help reduce greenhouse gas emissions and mitigate the adverse effects of a warming climate — are reviewed by environmental specialists to determine whether they meet the World Bank's eligibility criteria, which were developed with the help of academics at the Center for International Climate and Environmental Research (CICERO). If they do, the future proceeds of the bond are allocated to the selected projects. Projects supported in this manner have included solar and other renewable energy installations, waste management infrastructure, and reforestation initiatives. The progress and outcomes of all projects financed by the World Bank are monitored periodically. In the case of green bonds, the World Bank Treasury monitors the progress of each project and provides a summary and impact report to investors interested in learning more about the expected social and environmental outcomes of the project or projects their investments are supporting.
As the market for this kind of debt has grown, different issuers have adopted different definitions of “green” to suit their particular needs and have taken different approaches to implementing the various steps of the process. Consider two of the more recent issuers: the State of Massachusetts and the government of British Columbia. While Massachusetts closely modeled its project selection after the World Bank's framework, British Columbia's North Island Hospitals Project uses as its criteria LEED Gold certification standards and energy and greenhouse gas targets established by the American Society of Heating, Refrigeration and Air-Conditioning Engineers. As a result, investors in those instruments will draw their own conclusions as to whether the investment's "green" designation meets their own and stakeholders' expectations.
The good news is that the green bond space is evolving rapidly. Earlier this year, for example, a group of banks, working with the World Bank and other issuers and investors, developed the Green Bond Principles as a way to provide "guidance to issuers and encourage transparency and disclosure." These voluntary guidelines have been helpful in creating awareness about the green bond issuance process, especially expectations with respect to disclosure.
Elsewhere, the Climate Bonds Initiative and its partners are providing investors with information about green bond standards in different sectors. And the recent introduction of several green bond indices, including one from MSCI/Barclays, has helped establish clear guidelines for the inclusion of green bonds in other indices based on financial parameters (size and maturity), the issuer's ESG score, the issuer's definition of "green," selected project categories, reporting on the use of proceeds, and expected impact.
As the field of impact investing continues to grow, the green bond market is moving in the right direction, with issuers increasingly willing and eager to communicate to investors the expected social and environmental outcomes of their investment and connecting them more directly to the projects they are supporting. We look forward to a day in the near future where green bonds become mainstream and mobilize new capital for environmental progress.
Jenna Nicholas is a consultant to the World Bank Treasury and CEO of Phoenix Global Impact, a social impact consulting firm.
Laura Tlaiye is the Sustainability Advisor at the World Bank Treasury and is responsible for selecting and reporting on projects supported by green bonds. She has over twenty years of experience in project and management experience in the areas of climate change and sustainability.