Green Bonds: What They Are and How to Invest in Them

Green bonds are debt instruments used to raise money for new and existing environmental and sustainability projects while providing investors with regular returns, similar to ordinary bonds. Green bonds may help fund climate change mitigation and adaptation, renewable energy, conservation, waste management, transportation, and more.

To qualify as actual green bonds, these investments have to be certified by a third party, like the Climate Bonds Standard and Certification Scheme. Further, green bonds may offer investors certain tax benefits versus other kinds of bonds.

What Is a Green Bond?

A green bond is a type of fixed-income security that pension funds or institutional investors can buy. Individual investors can add green bonds to their portfolio by purchasing ETFs or mutual funds that include green bonds. They are issued by corporations, governments, and financial institutions to raise money for specific sustainability and environmental projects. The World Bank is one of the largest green bond issuers.

A green bond is similar to other types of bonds, but the money borrowed through their sale goes towards vetted projects that fit into pre-determined frameworks to meet sustainability standards.

Most green bonds are asset-linked bonds or “use of proceeds” bonds, where the money raised from the sale of the bonds is earmarked for green projects and backed by the issuer’s balance sheet. For example, “use of proceeds” revenue bonds use the issuer’s revenue as collateral; green project bonds rely on the assets and balance sheet of the particular project as collateral; and green securitized bonds where a group of projects are collateral.

How Do Green Bonds Work?

Green bonds work much the same as other types of bonds. They’re issued by an entity and pay a certain interest rate, with the main difference being that institutional investors are usually buying the bonds, not retail investors.

Who Issues Green Bonds?

When a business, government, or financial institution wants to raise money for a sustainability project, they might choose to issue green bonds, which can be purchased by individual or institutional investors. Generally green bond issuers are large municipalities or public corporations, because a strong credit rating provides the issuer with a better borrowing rate.

The difference between investing in a green bond and buying a traditional bond is the issuer publicly discloses their plans for how the money will be spent. Uses of the money must be considered ‘green’ for it to be marketed as a green bond. The issuer generally releases a pre-issuance report describing the projects the funds will be used for and their expected impact.

Green Bond Principles

In 2014, a group of investment banks established four “Green Bond Principles” to help investors understand green bonds. The principles are:

1.    Use of Proceeds: How money is spent and what types of projects are included

2.    Process for Project Evaluation and Selection: How projects are chosen and vetted

3.    Management of Proceeds: How the money raised by the bond is managed

4.    Reporting: How project progress and impact is shared

Certifying Green Bonds

Issuers don’t have to follow specific requirements to call their bond green, but many follow voluntary frameworks such as the Climate Bonds Standard (CBS) or the Green Bond Principals (BGPs). By following those frameworks the bond will have a higher rating and investors will be more likely to buy it.

The guidelines outline the types of projects funds are recommended to be used for, how to select green projects, and how to report on the use of funds and results of the bond issuance. Third-party firms work with the issuer as underwriters, certifiers, and auditors to ensure the money is going towards quality projects and used in the ways the borrower claimed it would be.

Examples of Green Bonds

There are many green bonds on the market. Here are some examples:

•   Goldman Sachs Renewable Power: In 2020, Goldman Sachs issued a 24-year, $500 million bond, certified by Sustainalytics, to use for solar energy projects.

•   PNC Financial Services Group: In 2019, PNC Bank issued its inaugural green bond, and issued another in 2023. The first was a 5-year, $650 million bond, using an internal green bond framework, to use for energy projects.

•   Verizon Communications Inc.” Also in 2019, Verizon Communications issued a 10-year, $1 billion bond to use for energy generation and storage, buildings, and land use projects.

Why Invest In Green Bonds?

Investing in green bonds can be a good way for investors to put their money where their values are. Like other kinds of sustainable investing, ESG investing, or impact investing, green bonds may be a way to both generate returns and to try and make a positive difference in the world. While individuals can’t usually purchase green bonds directly, they can add them to their portfolio by purchasing certain ETFs and mutual funds.

Interest in sustainability, ESG, renewable energy, and climate change has increased in recent years and could keep growing. As investor interest grows, more and more green bonds are being made available with better disclosure and transparency to give investors peace of mind about the quality of the asset.

For many investors, the main draw of green bonds is they are designed to help support sustainability projects (companies, new technologies) that support people and ecosystems around the world.

Another potential benefit of investing in green bonds is they can come with tax exemptions and tax credits, so investors might not have to pay income tax on the interest earned from the bond.

How to Buy Green Bonds

Many investors may be able to invest in green bonds directly from issuers. For instance, if a company or government organization is offering green bonds directly to investors, you may be able to do so.

Further, there are funds that offer investors exposure to green bonds. You can search out ETFs or mutual funds, for instance, that track or invest in green bonds. It may also be possible to invest in green bonds directly through a brokerage, but there may be stipulations, such as additional fees or commissions.

Green Bonds vs Climate Bonds vs Blue Bonds

Green bonds can be structured in different ways and generally fall into the category of impact investing.

•   For example, the term green bond can cover a broad spectrum of projects, from renewable energy to waste management to climate change.

•   There are also climate bonds that put money specifically towards climate change projects such as reducing emissions or adapting infrastructure to changing climate conditions.

•   Blue bonds specifically fund water-related projects, such as cleaning up plastic from the oceans, marine ecosystem restoration and conservation, sustainable fisheries, and wastewater treatment projects.

The Takeaway

Green bonds are an increasingly popular type of investment product that aim to help make the world a more sustainable place. When a company, government, or financial institution wants to raise money for a sustainability project, they might choose to issue green bonds.

Though green bonds work similarly to other types of bonds, in that they’re a form of debt issued by an entity and pay a certain interest rate, the main difference is that institutional investors typically purchase the bonds, not retail investors. Generally, green bond issuers are large municipalities or public corporations, because a strong credit rating provides the issuer with a better borrowing rate.

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FAQ

Can individuals buy green bonds?

Individual investors may be able to buy green bonds directly from issuers, or through their brokerage under certain circumstances. They may also gain exposure through mutual funds or ETFs.

How do investors make money from green bonds?

Like other types of bonds, green bonds pay investors interest payments which can generate returns. Further, investors may be able to take advantage of any applicable tax incentives.

Are green bonds a good investment?

Green bonds may be a good investment if they align with your overall investment strategy and personal investment goals.

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