Green bonds: the future of sustainable finance?

As part of its Green Deal for Europe, the European Commission has announced its intention to mobilize almost 1,000 billion euros by 2030 to support Europe's environmental transition policy. The aim is to reduce European GHG emissions by 55% compared with 1990 levels, and to achieve carbon neutrality by 2050.

This financing plan calls on both public and private funds. Of the €1,000 billion, the EU aims to issue €250 billion in green bonds by 2026 via its NextGenerationEU program.

But there's nothing new or specifically European about green bonds. They've been around since the beginning of the 21st century. Although they weren't yet called green bonds, the first of them are thought to have been issued in 2001 by the City of San Francisco to finance a solar power project.

How do they work? What role do they play in financing the European and global environmental transition? How do you know if a green bond is really green? 

What are green bonds?

First of all, let's recall what an obligation is.

This is a debt security issued by companies or governments and traded on the financial markets. It enables these players to borrow money from individual or professional investors to repay their debts or invest in new projects.

Investors are remunerated through the payment of interest until the money invested is repaid. The share of risk (and reward) is inversely proportional to the quality of the issuer, and therefore to its ability to repay the investor at the end of the contract between the issuer and the bondholder.

Green bonds operate on the same principle as conventional bonds, but are designed to finance projects in the sustainable economy. They are now considered to be one of the main vectors for financing sustainable investments by companies and governments, and have been booming since the 2015 Paris Agreements.

Who can issue green bonds?

Green bonds can be issued by a wide variety of players: public or private companies, governments, local authorities, international institutions...

The first so-called green bonds were issued in 2007 by the European Investment Bank, followed in 2008 by the World Bank.

On the government side, France and Poland were forerunners in the field, issuing their first sovereign green bonds in 2017 to finance their transition to a low-carbon economy . Today, more than 62 countries around the world have issued sovereign green bonds, and the number is rising all the time.

The breakdown of issuance by issuer category varies greatly from year to year, although governments are still leading the race. In 2022, the public sector accounted for 39% of issuance, financial players for 32% and corporates for 29%.

A booming market

Green bond issuance is booming. Many players see it as an opportunity to finance a costly ecological transition, but also as a response to investors' increasingly stringent demands in terms of the sustainability of their investments.

By January 1, 2023, they will have raised over $2.5 trillion worldwide , and despite a slight slowdown in 2022 due to the crisis and inflation, their cumulative volume of funds raised is growing at a steady pace. Sustainable bonds (green bonds, social bonds and sustainability linked bonds) currently account for around 7% of the global bond market.

They are also a way for many countries to meet the sustainable development objectives set out in the 2015 Paris Agreements. More and more emerging countries are issuing sovereign green bonds to finance their energy transition, including India, Fiji, Egypt, Thailand and Mexico. The record is Chile, which has issued nearly $34 billion in sovereign green bonds.

France is not to be outdone. In 2022, it was the world's biggest issuer of sovereign bonds, having raised more than €42 billion since the launch of its first green OAT (Obligation assimilable au Trésor) in 2017.

The European Union in general is the world's largest issuer of green bonds, accounting for 43% of green bonds issued worldwide to date. Proof of their success is the fact that, by 2022, sustainable bonds in Europe will account for 25% of the volume of new euro-denominated issues.

Regulation still in progress

The boom in green bonds in recent years has led to a number of abuses in the use of these financial instruments. While their number has exploded, their reliability has also proved increasingly variable.

Some green bonds are green in name only. Indeed, until now, the definition of what a green bond was essentially depended on its issuer, who could therefore make a totally subjective assessment of what a "green" project was. For example, some bonds have been used to finance airport runways in Hong Kong. 

In the case of sovereign bonds, the social and environmental responsibility of certain issuing countries, such as Saudi Arabia and Russia, also often raises questions.

There is still little scope for monitoring the use of funds and the actual sustainability of the projects financed, undermining the credibility of these green bonds.

Some countries, notably in the European Union, have begun to regulate the term "green bond", but without coordinating their efforts. As a result, a wide range of legislation coexists in different countries, and in the context of a totally globalized financial market, green bonds are traded without the same definition, constraints or obligations.

A number of initiatives have therefore been put in place, from the creation of institutions such as the Climate Bond Initiative, to labels such as the SRI label, and finally common regulations such as those just introduced by the European Union.

The Climate Bonds Initiative

The Climate Bonds Initiative is a non-governmental organization dedicated to promoting and supporting the development of green bonds worldwide. Its backers include foundations, public and private organizations, as well as the United Nations.

The Climate Bonds Initiative was the first organization to set up a certification system based on a taxonomy to identify truly "green" bonds and thus combat greenwashing.

It works alongside governments, financial players and investors to develop a favorable framework for the issuance and promotion of green bonds.

According to the Climate Bonds Initiative, $5,000 billion a year will be needed from 2025 onwards if we are to effectively combat the risks of climate change and achieve the target of limiting global warming to 1.5 degrees set by the Paris Agreements. This is almost 10 times the amount currently raised through the issuance of green bonds each year.

Green bond and European taxonomy

Since the Paris Agreements, the European Union has implemented an active policy to develop sustainable finance within the framework of the Green Deal for Europe.

The development of green taxonomy and the implementation of the SFDR were the first milestones. The primary objective was to improve the transparency of companies' activities and the investment strategies of financial players.

The issue of green bonds has become increasingly important as they have developed in the various countries of the EU, whether sovereign bonds or green bonds issued by institutions or private companies. Green bond issuance is also part of the European Green Deal's financing plan, notably via the NextGenerationEU program, which aims to achieve an issuance volume of around 250 billion euros by 2026.

The aim of such legislation is to harmonize existing regulations and provide investors with a common understanding of green bonds. As the world's leading issuer of this type of debt security, the European Union needed to be able to provide a clear definition of what was considered "green".

On October 5, 2023, Members of the European Parliament adopted the first draft regulation on green bonds. It must now be examined by the EU Council.

This regulation links the issuance of green bonds to the European taxonomy, which classifies activities according to their "sustainability" based on a list of strict criteria. It will enable investors to ensure that the bonds issued support projects considered green by the taxonomy.

The aim is to create a favorable framework for the issuance of these bonds, and to support their strong growth. This standard will remain optional for issuers, but will provide formal proof of the sustainability of the projects financed. It will also be open to issuers from non-EU countries wishing to benefit from the framework offered by this regulation.

To qualify for the EuGB (EU Green Bonds) label, a bond must meet several criteria: 

• all funds must be used to finance a project considered sustainable according to the European taxonomy
• issues will be audited by an external examiner registered with ESMA (European Securities and Markets Authority)
• issuers will be subject to a list of reporting obligations

Conclusion

Green bonds are an effective tool for developing sustainable finance worldwide. They can be an excellent way of mobilizing new funds for the ecological transition of governments and businesses, as their success in emerging economies has shown.

The regulatory process currently underway within the European Union will provide a better framework for this booming market, and reassure investors about the sustainability of the projects financed via these debt securities.

However, despite the growing success of green bonds since the Paris Agreements, their growth is still too low to provide the funds needed for this large-scale project. Today, it would be necessary to increase the number of issues by a factor of 10. The gradual establishment of a market conducive to their international development must now take into account the need to accelerate their large-scale issuance.

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Sources : 

• "Sustainable finance: where do European green bonds stand?", Actu-Juridique.fr, 10/10/2023
• "Word from the News - Green bond", Banque de France, March 2022
• "Green Bonds", WWF
• "How green are green bonds?"Natixis Investment Managers, 24/03/2023
• "High-flying greenwashing around a new green bond for Hong Kong Airport", Reclaim Finance, 04/01/2023
• "Green bonds face new questions over authenticity", Financial Time, 29/11/2021
• "Sustainable Debt Market - Summary H1 2023", Green Bonds Initiative, August 2023
• "$500bn Green Issuance 2021: social and sustainable acceleration: Annual green $1tn in sight: Market expansion forecasts for 2022 and 2025"Green Bonds Initiative, 31/01/2022
• "Next GenerationEU: European Commission successfully launches first green bond issue to finance sustainable recovery", European Commission, 12/10/2021
• "Sustainable" bonds account for a quarter of bond issues in Europe", Les Echos, 21/11/2022
• "Green, Social, and Sustainability (GSS) Bonds - Market Update - January 2023", The World Bank, January 2023
• "From India to Indonesia, green bonds help countries turn the corner on sustainable development", The World Bank, 10/04/2023
• "European green bonds: Council adopts new regulation to promote sustainable finance", European Council, 24/10/2023