Green bonds: how do they work for companies and investors?

Green bonds are becoming increasingly popular as a way of investing in sustainable projects.

These bonds offer investors the opportunity to support projects that contribute towards a more sustainable future while also generating income.

In addition, green bonds help companies finance their environmental objectives and improve their reputation as leaders of sustainability.

In this article we’ll take a detailed look at what green bonds are, how they work and why they are becoming so popular in the global finance market.

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What is a green bond?

A green bond is a debt security issued by public and private organisations in order to finance sustainable and environmental projects.

These bonds attract investors who are interested in supporting projects that have a positive impact on the environment, such as renewable energy, energy efficiency and biodiversity conservation. Green bonds have a similar structure to conventional bonds, but the proceeds may only be used on specific green projects.

Who can issue green bonds?

Any body that is able to issue securities – including governments, companies, corporations, not-for-profit organisations and other institutions – can issue green bonds.

Issuing green bonds is a way for these entities to finance environmentally sustainable and socially responsible projects while also attracting investors who are interested in supporting these kinds of projects.

It’s important to highlight that the issuance of green bonds is regulated and subject to certain rules and standards, such as those established by the Institute of International Finance (IIF) regarding sustainable development, as well as others from similar bodies.

Which projects can be financed with green bonds?

Green bonds can be used to finance a wide range of sustainable and environmental projects, including:

Renewable energy: such as wind farms, solar farms and hydroelectric energy projects.
Energy efficiency: projects that aim to reduce energy consumption and increase the efficiency of buildings, industries and transportation.
Conservation of terrestrial and aquatic biodiversity: projects designed to protect wildlife and habitats.
Pollution prevention and control: projects that help reduce greenhouse gases, prevent and reduce waste and decontaminate land.
Green infrastructure: such as urban parks, drinking water and sewage systems, and sustainable transport.
Sustainable development: projects with the goal of improving living conditions in communities, including homes, access to basic services and employment.

These are just a few of the types of projects that can be funded using green bonds. The ultimate goal is to use the proceeds obtained from the issuance of these bonds to support projects that have a positive impact on the environment and society as a whole.

How do green bonds work?

Green bonds work just like any other bond. An entity issues green bonds and sells them to investors; it uses the proceeds it receives to finance sustainable and environmental projects. In exchange, investors receive interest and the entity’s commitment to reimburse the borrowed capital by a certain date.

However, green bonds have certain features that set them apart from conventional bonds:

Purpose: green bonds are linked to specific projects with a positive environmental and social impact.
Transparency and accountability: green bonds are usually subject to greater transparency and accountability in order to ensure that the proceeds are used correctly.
Certification and standards: green bonds are often certified and evaluated by independent bodies in order to guarantee their sustainability.

The process of issuing and purchasing green bonds is similar to that of any other bond, but the focus in this case is on projects that positively impact the environment and society. Investors may choose to invest in green bonds as a way of supporting these projects while also gaining financial returns.

Green Bond Principles

The Green Bond Principles (GBP) set out a voluntary framework that promotes transparency and disclosure, thus underpinning the integrity of the green bond market.

These principles are designed to be widely used in the market and provide issuers with guidance on the key aspects of launching a credible green bond. In addition, they aid investors by promoting the availability of the information necessary to evaluate the environmental impact of their green bond investments, and they assist underwriters by offering vital steps that will facilitate transactions that preserve the integrity of the market.

The GBP recommends that issuers provide clear and detailed information on the procedure and the publication of their green bonds so that investors, banks, underwriters, arrangers and placement agents, and anyone else involved, can understand the characteristics of any green bond.

The Green Bond Principles emphasise the importance of transparency, accuracy and integrity of the information that will be disclosed and reported by issuers to all stakeholders.

The four core components for alignment with the GBP are:

Use of proceeds.
Process for project evaluation and selection.
Management of proceeds.
Reporting.

The key recommendations for heightened transparency are: Green bond frameworks and external reviews.

What are the requirements for issuing a green bond?

There are several sets of standards in the industry, of which the International Capital Markets Association’s Green Bond Principles are just one example. However, the need for consistency in the market has given rise to the creation of global regulations.

In order to issue a green bond, the issuer must state the use of the proceeds, detail the process for project evaluation and selection, explain how it manages the proceeds and report on the progress of the bond, similar to the Green Bond Principles.

There must be a policy governing the use of the proceeds and a taxonomy classification system.
The prospectus needs to include the chosen projects with a focus on environmental sustainability, eligibility and exclusion criteria; the identification of any social and environmental risks; and review and monitoring mechanisms.
The transparency policies for managing the proceeds must also be detailed, including when the bonds lose their green status, the people responsible for independent studies of the fulfilment of sustainability objectives and principles, the commitment to perform said studies, the periodic disclosure mechanisms (optional) and the disclosure methods.

These are just some of the aspects that issuers must take into consideration when issuing a green bond.

How to issue a green bond (step by step)

Issuing green bonds can be a tedious process. It’s difficult to say precisely how much time is required to prepare and issue a green bond, as it greatly depends on the internal organisation of the issuer and the complexity of the green bond framework and subsequent offering. However, if we disregard the work involved in defining the bond, the preparation and execution could take somewhere between eight and 12 weeks.

The following steps need to be taken:

1. Search for eligible assets (pillar 1 of the GBP).

2. Choose an underwriter.

3. Design the criteria for the green bond and the project selection process (pillar 2 of the GBP).

4. Record the bonds.

3. Detail the processes and controls for using/managing the proceeds (pillar 3 of the GBP).

5. Disclose information.

6. Obtain bond credit rating.

7. Allocate the proceeds.

8. Reporting: allocation and impact (pillar 4 of the GBP).

A more detailed step-by-step guide can be seen in this video:

In conclusion, green bonds are an important financial tool for boosting sustainability. With growing demand from investors and increased awareness regarding the importance of investing in environmental solutions, we’ll likely see a boom in the number of green bonds issued in the future.

However, it’s vital to ensure that these instruments meet the proper sustainability standards and that issuers make good use of the money raised.

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