The lowdown on the thriving green bond
Used to finance environmentally friendly projects, green bonds are popular with investors looking to diversify their portfolio (Getty Images/Andriy Onufriyenko)
Green bonds are a popular pick when it comes to sustainable investing, with more investors aligning their financial activities with priorities that support environmental, social and governance (ESG) issues.
In March, Canada’s first Green Bond Program was introduced, including an inaugural 7.5-year, $5 billion green bond in response to investor demand.
“The federal government now has a foot through the door,” says David-Alexandre Brassard, CPA Canada’s chief economist. “With Canada’s strong credit rating, this creates further investment opportunity in—and brings maturity to—the country’s sustainable finance market.”
Wondering how green bonds work? Here is a breakdown of the basics.
WHAT ARE GREEN BONDS?
Green bonds are fixed-income debt securities that can be issued by governments, organizations or public/private companies, etc. to raise funds for projects that deliver environmental benefits, such as those focused on renewable energy, waste management, sustainable land use, clean transportation and technology, and adaptation to climate change.
Investors are typically institutional or large organizations, such as pension funds, which purchase the bonds in bulk. On the other hand, individual or retail investors typically invest in green bonds through products, such as exchange-traded funds (ETFs) and mutual funds, that include them.
Green bonds are issued and monitored following specific frameworks that align with the Green Bond Principles, introduced by the International Capital Market Association (ICMA). Though these principles are voluntary, they promote transparency, clarity and integrity around sustainable finance projects and how the environmental objectives will be achieved.
Demand for green bonds has soared since their market inception in 2007 when the World Bank issued the first one. In 2021, the global sustainable debt market topped $1 trillion, with green bonds leading with a 75 per cent jump, according to the Climate Bonds Initiative (CBI).
“Though the green bond market supply is still highly dominated by Europe, it is spreading around the world,” says Brassard. “Demand is outpacing supply, meaning green bonds seem to be a viable vehicle for sustained growth to funnel more money toward the ‘green’ transition.”
ARE GREEN BONDS BENEFICIAL?
Sustainable finance products, like green bonds, have a few advantages, beyond contributing to the greater good.
As fixed-income assets, green bonds are more risk-adverse than stocks and less reactive to macroeconomic events, such as economic downturns and geo-political tensions.
As a sustainable-debt instrument, green bonds can be issued at a higher price, yet offer a lower yield compared to the outstanding debt. This is referred to as “greenium”, and means that issuers pay less to finance a green bond compared to a standard bond offering. Strong market performance of green bonds seems to justify the “greenium” paid by investors.
Lastly, with increasing demand and market availability comes access to a wider and more diverse group of investors, helping boost capital for more green projects, while making it easier for investors to align their financial goals with ESG interests.
“Some investors are becoming very serious about the impact their investing has,” says Jeffrey Love, a tax associate with KPMG Law LLP in Canada. “And, because of the demand, some asset managers are trying to design products that appeal to [those investors]. For investors driving their investment dollars towards environmental objectives, this is very important.”
WHAT IS BEING DONE TO ADDRESS “GREENWASHING”?
The issue of “greenwashing” in the context of green bonds is a significant concern and organizations that issue them need to be clear and transparent about how “green” their environmental projects actually are.
“Knowing what you’re investing in and what assurance is behind it, is one of the key challenges right now,” says Love. “Different stakeholders have expressed a criticism over so-called greenwashing if there isn’t sufficient verification in place to ensure securities are green.”
However, as the market matures, expectations from investors, issuers and other stakeholders have changed, with demand for transparency, accountability and disclosure growing, adds Brassard. Investors want more precise definitions and reporting of eligible green project categories, he says.
“Green bonds are the biggest sustainable debt vehicle, which brings a certain degree of scrutiny toward new bond issuance, especially with the high-degree of participation of institutional investors driving demand,” he says. “This lends credibility to the green label of these bonds.”
To combat “greenwashing”, various efforts are underway including standardizing globally how sustainable investments, including green bonds, are issued, measured and reported upon.
“There are different initiatives, but they are piecemeal at this point,” says Love. “The Canadian government, however, has put a lot of effort into addressing these concerns with eligibility criteria, reporting and verification steps when issuing bonds to provide investors with comfort that the bonds they invest in are environmentally bona fide.”
“Mitigating greenwashing risks lies with reliable, trusted and comparable reporting,” adds Brassard, “while being mindful of the associated administrative costs to make the financing tool as efficient as possible.”
MORE ON SUSTAINABILITY ISSUES
Gain insight into navigating the sustainable debt market with CPA Canada and the International Federation of Accountant’s global research study, which analyzes the trends, challenges and opportunities of this evolving sector.
If you’re a CPA seeking to effectively lead ESG initiatives, look to these practical resources and read about the ways that organizations can catch up on sustainability.
Plus, read about Canada’s transition to net-zero and see how the ISSB is progressing on their first two standards proposals and the new Montreal centre.