The main difference between green bonds and traditional bonds is that the issuer publicly states how it will use the proceeds to fund sustainable projects, allowing the bond to be marketed to investors as green. While there are no universal requirements for a green bond, the Green Bond Principals (GBPs) and Climate Bonds Standard (CBS) are popular voluntary guidelines that advise on the appropriate use of funds, project selection process, and reporting.
The projects considered for green bonds are typically described in a pre-issuance report detailing how the financed projects will achieve the issuer’s desired impact. An external party can prepare this report to one of four levels:
- Second party opinion on the bond’s general alignment with the GBP;
- Verification against stated business or environmental criteria, such as science-based goals;
- Certification against an external standard like the Climate Bond Standard; or
- A score/rating against an external methodology, much like a credit rating.
Issuers often develop a green bond “framework” in support of their environmental and sustainability objectives and then apply this framework to issue multiple bonds. With no governing body for green bonds, it is possible for issuers to self-label green bonds and perform internal impact verification.
As a debt instrument, the terms of the green bond rely on the strength of the balance sheet of the issuer, with the best rates available to issuers with a strong credit rating. For this reason, the most common types of green bond issuers are large, often publicly traded corporations or municipalities. While there are public listing venues available for green bonds, such as the Luxembourg Stock Exchange (LuxSE), successful green bond sales often involve negotiation directly with investors.
After selling bonds to raise capital, the issuer is responsible for managing the use of proceeds to meet the objectives of the green bond. Projects can be funded directly, with the issuer purchasing equipment or hiring contractors to carry out projects. Issuers can also use proceeds to pay for service agreements, such as Energy Services Agreements (ESAs) or Energy Service Performance Contracts (ESPCs) in coordination with an energy service company (ESCO).
Green bond issuers also typically release regular public post-issuance reports. These reports are required by many of the voluntary guidelines, including the GBP and CBS. Most reports are annual and account for the use of proceeds (i.e. where the funds are going) and the progress achieved towards the green bond’s stated objective. These post-issuance reports are distributed to investors and can be released publicly.
Given the administrative costs associated with investor management and third-party verification, projects funded through the sale of green bonds tend to be large and ambitious in scope. For this reason, projects financed in this way frequently include renewable energy generation projects or the portfolio-wide installation of efficient building technologies.
