Green bonds explained

Home › Investments > What are green bonds?

As the need to tackle climate change becomes ever more urgent, governments and companies are increasingly offering forms of sustainable finance to fund eco-friendly projects and meet their climate goals. Investors can buy green bonds to support these initiatives. Here, we take a look at how green bonds work and what makes them appealing to investors.

Green bonds are a type of debt security that governments and companies (private or public) can issue to raise capital for environmental projects. In exchange for the money, the issuer promises to pay out interest (coupons) and return the principal amount at maturity, just like investing in regular bonds. The difference is that green bonds are specifically used to finance projects aimed at sustainability, such as renewable energy, clean transportation, or energy-efficient buildings. As such, they belong to the category of impact investing.

The attraction for investors is twofold: they can support climate-friendly initiatives and ideally earn a return on their investment. Because the capital raised must be put entirely towards eligible sustainability projects, it is the responsibility of the green bond issuer to provide transparency, for example by reporting on where the capital has been used.

The funds from green bonds can be used on renewable energy projects like wind farms, solar parks, hydroelectric plants, and biomass facilities. They also support sustainability initiatives at a country level, such as clean transportation and sustainable land management.

There are two main types of green bonds: government green bonds, known in Ireland as sovereign green bonds, and corporate green bonds, issued by companies, banks, and other financial institutions. Both types aim to invest in projects that have a positive environmental impact, though corporate green bonds tend to focus more on sustainability efforts in the private sector.

The World Bank was one of the pioneers in green investment bonds, issuing its first one in 2008. As of October 2024, it has raised approximately $19 billion across 28 currencies to fund global climate projects*.

The Irish Sovereign Green Bond (ISGB) is issued by the government to fund environmental projects. It was launched in 2018, raising €3 billion at first, and by 2020, that total grew to €6 billion.

Eligible projects include:

• Built environment/energy efficiency
• Clean transportation
• Climate change adaptation
• Environmentally sustainable management of living natural resources and land use
• Renewable energy
• Sustainable water and wastewater management

To keep things transparent, the government publishes annual reports and data showing how the capital is being spent and the impact it’s having on the environment. The government’s green bond is part of Ireland’s plan to reach its goal of cutting CO₂ emissions by 80% from electricity generation, buildings, and transport by 2050.

Because green bonds are a relatively new form of investment, first issued in 2007, the frameworks that govern them are still evolving. However, many issuers follow the Green Bond Principles (GBP), which are a global set of standards.

There are four core principles in the GBP that govern the issuance of green bonds:

1. Use of proceeds: Capital raised must be solely spent on projects that benefit the environment.
2. Project evaluation and selection: Issuers must have a clear process for choosing projects that meet environmental criteria. This is essential for fostering transparency.
3. Management of proceeds: The funds must be carefully tracked and allocated to the selected green projects, with a clear system in place for managing them.
4. Reporting: Issuers must provide regular updates to investors on how their funds are being used and the environmental impact of the projects.

Aside from global standards, companies in Europe will soon be able to prove their adherence to a new EU Green Bond Standard (EUGBS), which will come into effect in late 2024. The EUGBS is voluntary, but the goal is for “European Green Bonds” to be treated as a premium label that investors will be able to recognise as high-quality green bonds with the highest standards of transparency.

Investing in green bonds can be an effective way to support the shift to a low-carbon economy while also potentially making a return. Some green energy bonds come with detailed reports on the CO₂ emissions avoided, giving investors a clear idea of the environmental impact their money is making. As sustainability becomes an increasingly vital goal, these bonds could ultimately lead to the creation of jobs and, in turn, boost the economy.

That said, green bonds do come with drawbacks. A significant concern is “greenwashing”, which is where a project is marketed as more environmentally friendly than it really is. It might be worth double-checking the broader activities of the company issuing the green bond. For example, if a major fossil fuel company starts offering green bonds for its solar energy ventures, it doesn’t change the fact that its main business may still be harming the environment.

Green investment bonds may offer lower returns than other fixed-income investment types, as they tend to be in high demand. When demand is high, issuers can offer lower interest rates, which may not be as attractive to some investors. Researching the market and comparing rates can help when deciding whether to invest. You might even be able to get a more competitive return by comparing savings vehicles such as fixed term deposits.

In Ireland, you can buy green bonds through brokers or financial advisers who provide access to bond markets. They can help you find suitable green bonds based on your investment goals. Alternatively, online platforms can present a more affordable option.

For those looking for diversification, green bond funds are available from various asset managers. These funds pool investments from multiple investors to buy a range of green bonds.

Several Irish banks also offer access to green bonds, either directly or through investment products. These options tend to be designed to meet the bank’s own sustainability goals in line with their corporate green bond frameworks. Notable options include the Bank of Ireland, ESB, and AIB.

Green bonds work similarly to regular bonds. A corporation issues the bonds, sells them to investors, and uses the funds to finance sustainable or environmentally-friendly projects. In return, investors earn money from green bonds in two ways. Firstly, they receive periodic interest payments, called coupons, usually paid twice a year. Secondly, they get back their initial investment when the bond matures, which typically ranges from a few years to several decades.

One key point to consider is the “green premium”, or “greenium”. This refers to the fact that green bonds are often priced higher than regular bonds, which can result in smaller coupon payments. However, there are signs that the greenium is decreasing**, which could make these bonds more cost-effective for investors as time goes on.

The information provided here is for informational and educational purposes only and does not constitute financial advice. Please consult with a licensed financial adviser or professional before making any financial decisions. Your financial situation is unique, and the information provided may not be suitable for your specific circumstances. We are not liable for any financial decisions or actions you take based on this information.

Like any investment, green bonds carry risks, especially during periods of market volatility or geopolitical uncertainty. At the same time, green energy bonds are often issued by governments or reputable institutions, which some might argue make them relatively low-risk compared to other investment types. Similarly, the regulatory reporting and overall transparency required for companies to issue green bonds in the first place can be a plus point. Investors get to see exactly how their funds are being used.

However, a major concern is the nature of the projects funded by green bonds. Many bonds are used to expand existing projects or initiate new ones similar to those already in progress. This raises questions about the true environmental impact of some projects – are they genuinely contributing to sustainability, or would they have happened anyway without the funding?

Greenwashing is a significant risk, too. Since there’s no universally accepted definition of what makes a bond “green”, some bonds may not fund genuinely sustainable projects. Investors are encouraged to do their homework and carefully assess whether the bond issuer’s activities are in keeping with the green claims that they make.

And because the green bond market is still maturing, it can lack the liquidity offered by other areas. This could be an issue for investors who need to buy or sell quickly, and they might face losses. Until the market is experiencing steady growth, green bonds may be better suited to longer-term investors rather than those seeking immediate access to their funds.

While green bonds give you the chance to support projects that make the world a greener place, they do come with limitations. Once you invest in a green bond, your money is typically tied up for the term of the bond, so you won’t have easy access during that time. Green bonds often don’t allow you to top up your investment after the account is opened, so you’ll need to commit the full amount upfront.

If you’re looking for a more flexible way to grow your savings while still benefiting from competitive interest rates, you might want to consider other options, such as savings accounts available on the Raisin Bank marketplace. With our demand deposit accounts, you can enjoy the freedom to deposit and withdraw funds as needed. Plus, your savings are protected up to the applicable limits if the bank were to fail, giving you peace of mind that your money is safe.

*https://treasury.worldbank.org/en/about/unit/treasury/ibrd/ibrd-green-bonds

**https://www.irishtimes.com/special-reports/2023/03/30/improved-returns-make-green-bonds-increasingly-worth-banking-on/