What Can Green Bonds Achieve?

Green bonds can be a good place to start with sustainable finance. But they have limits, too. Here’s what they offer issuers, investors, and the planet.

Dr. Aaron Maltais and Dr.  Björn Nykvist are Senior Research Fellows at the Stockholm Environmental Institute.

If you’re an investor interested in sustainable finance, or a company trying to raise money for green projects, you’ve probably heard of green bonds.

Bonds are loans taken out by companies or governments, with money raised from investors instead of banks. The loan has a set interest rate, offering investors a safe and predictable rate of return.

What Are Green Bonds?

Green bonds are used to fund projects in diverse environmental areas, including renewable energy, energy and resource efficiency, pollution reduction, water and waste management, conservation, and climate adaptation. What makes a bond green is usually not regulated (except in China and India), but follows the Green Bond Principles and other voluntary standards. For example, a new voluntary EU Green Bond Standard will require 85% of the proceeds from bonds to be dedicated to activities classed as green by the EU Taxonomy for sustainable economic activities.

Over the last decade, green bonds have been booming. The first green bond was issued in 2008; today, they’re roughly 5% of the global bond market, or $492 billion in 2023. Green bonds have spread in large part because they are a familiar and low-risk financial instrument. They are typically structured like conventional investment-grade bonds – except that a ‘use of proceeds’ clause restricts the money to be spent on green investments. Standards guide documentation and reporting, from initial disclosure on the assets being financed to tracking and reporting on spending.

Indeed, green bonds are such a durable model that they have paved the way for related tools. There are now “social bonds,” “transition bonds,” “sustainability bonds,” and “sustainability-linked bonds.” However, green bonds remain the largest part of this new bond market: about 60%.

Green bonds can be a good first step into sustainable finance. They’re easy to implement and understand and they offer some real benefits, especially around institutional learning and clearer processes for sustainable finance.

But green bonds also have limits. Financially, green bonds perform similarly to traditional bonds, with comparable borrowing rates and returns for investors. As a result, they haven’t led to significant new capital available for sustainability projects. Most projects funded by green bonds would have been funded without them.

In this article, we describe in detail what green bonds offer investors, issuers, and the planet, in terms of financial benefits, non-financial benefits, and sustainability impact.

We draw on our research on green bonds, published in 2020. For that research, we reviewed past studies of green bonds and also interviewed 22 actors in the Swedish green bond market. Our interviewees were primarily green bond issuers from the public and private sectors and investors, including public pension funds, private pension and investment funds, and insurance companies.

Benefits for Green Bond Issuers and Investors

What’s the value for green bond issuers and investors? We looked at the financial and non-financial case.

The financial case (short-term and long-term)

Green bonds generally have a slightly lower return than from comparable investments, largely because they’re in high demand. As demand for the bonds rises, companies issuing them can offer lower interest rates. That’s good news for issuers, and bad news for investors. However, the difference with conventional bonds isn’t major. A study of 110 green bonds found yields 2 basis points (.02%) lower on average than those of comparable conventional bonds (Zerbib 2019).

Our interviewees generally saw green bonds as on par with other fixed-income investments. Bond issuers we interviewed told us that capital benefits were small, though they did cover the processing costs associated with green bonds: e.g. reporting and certification.

Although the short-term financial case for green bonds is not strong, issuers saw longer-term financial benefits. Bond issuers told us that future access to capital will depend on green credentials, and so they saw first-mover advantages to engaging with sustainable finance. Investors saw companies issuing green bonds as addressing potential risks and thus becoming more stable investments.

Non-financial benefits

Sustainability action has always been partly about non-financial benefits, like maintaining a good public reputation and attracting employees. Our interviewees linked green bonds to these benefits as well. Investment companies described green bonds as a way to draw customers and skilled staff. Issuers saw the bonds as an opportunity to broaden their investor base and signal the organization’s sustainability commitment.

Green bonds are also a learning and development opportunity. Investors said that green bonds led to dialogue on sustainability with issuers, which increased their understanding of sustainability performance. Issuers told us that the process of creating a bond led to consolidating the company’s existing sustainability work and demonstrating its value for core business issues, such as securing financing and attracting new institutional or private investors.

Green bond standards for documentation and reporting result in a level of clarity that’s appealing to investors and issuers. Our interviewees liked being able to link investment to a specific and verified project. The “use of proceeds” clause in green bonds specifies how money will be used, prompting related reporting. Metrics like avoided emissions or improved water efficiency let investors demonstrate impact to customers and stakeholders.

Do Green Bonds Benefit the Planet?              

It’s exciting to see green bonds growing. They have some benefits for investors and issuers. What about impact for the planet? Are green bonds leading to new sustainability efforts?

Many have said that the sustainability transition requires much more private capital supporting the cause than is currently available. This capital is required to fund new sustainability projects including retrofits, investments in renewable energy, and more.

Unfortunately, green bonds don’t seem to be making large amounts of new financing available for sustainability projects. Instead, they’re largely funding projects that could have been funded anyway, by conventional bonds.

Why?

Because even though green bonds are marketed for their clear environmental gains, they’re not so different from conventional bonds. Their interest rates are comparable — so even if they introduce new sustainability benefits for investors, they don’t unlock new, lower-cost capital for the types of sustainability investments that have difficulty securing financing at attractive rates. They simply don’t open up that many new opportunities to fund projects that companies couldn’t fund before. Long-term projects with a less clear business case – like biodiversity impact management, for example — may remain difficult to fund.

Ultimately, our analysis (and research from the Institute for Climate Economics) shows that, as a financial tool, green bonds are a quite conservative innovation in terms of their impact on funneling capital toward sustainability projects.

However, they do reflect a growing trend where investors increasingly demand that the companies they finance show progress in improving their sustainability performance. Read on to discover the change they have achieved.

Green bonds do affect organizations and markets

Green bonds’ greatest sustainability impact isn’t in enabling specific projects, interviewees told us. Instead, it comes through raising the profile for sustainability and sustainable finance. Involvement with green bonds builds sustainability awareness within investing and issuing organizations. It raises sustainability ambitions and the status of sustainability work, in part by connecting sustainability and finance. Green bonds help to ‘make the case’ for organizations’ internal sustainability work, issuers said.

Green bonds have helped shape markets as well, by offering a new infrastructure that can guide sustainable finance more broadly. Reporting standards and other processes designed for green bonds, have set precedents for other sustainable finance tools. Examples of Green bonds’ infrastructure include:

• Guidelines for what counts as a green investment, as determined by government or voluntary standards.

• External validation of the credibility of issuers’ green bond frameworks. Green bond standards recommend external reviews (or audits) of bond proceeds’ use and impacts.

• Reporting on the use of proceeds and their environmental impacts. Conventional bond proceeds may go to a specific project or to “general purposes.” A green bond’s “use of proceeds” is more specific, leading to related and more detailed reporting.

Beyond Bonds: The Finance Tools Driving Sustainability Projects

If we look at the sustainable finance toolbox, are there other approaches more likely to create sustainability impact by directing capital to more long-term and sustainability aligned investments? We asked the investors we interviewed to identify and rank the most important tools they use to advance sustainability and realize more green investments.

Below are approaches that they saw as most promising, with additional detail from research by Amir Amel-Zadeh and George Serafeim. These strategies would be higher risk than green bonds, but have more potential for change.

• Integrating Environment, Social, and Governance criteria into financial analysis of individual stocks: for example, as inputs into cash flow forecasts and/or cost of capital estimates. While critique of ESG as greenwashing is widespread, integrating meaningful criteria into individual stock analysis would have impact.

• Active ownership. This means using shareholder power to influence corporate behaviour, including through shareholder proposals, proxy voting, and direct communication with the management or board. Interviewees saw this as especially effective when multiple shareholders worked together.

• Positive and negative screening for funds. This is including (or excluding) specific sectors, companies, or practices from a fund or portfolio based on specific ESG criteria. For example, negative screening has historically used to exclude “sin industries” such as alcohol and gambling from socially responsible portfolios.

• Longer-term investment strategies that a) focus on industries and companies expected to grow as we transition our economies to sustainability and b) manage risks various sectors face associated with climate change and environmental degradation.

Green Bonds as Part of the Sustainable Finance Portfolio

As researchers, we’ve spent years working on sustainable finance. It’s a huge field. Our recent work has looked at everything from systems thinking in asset management to financing decarbonization of heavy industry.

That broad lens helps us put green bonds in perspective. They have a valuable role. They’re not going to solve all our problems, but they can advance the conversation and help build the foundation for greater change.

A Note on Sweden, Our Research Setting

Our interviews were all within the Swedish green bond sector. You may wonder whether they reflect circumstances elsewhere. If you’re in America or India, would the green bond experience look different?

Sweden is a bit different in having a larger green bond sector than other countries. When we conducted our research, in 2018, green bonds were 10% of the total bond sector in Sweden compared to 1% of bonds worldwide.

We believe that issuer and investor experiences are likely similar elsewhere, especially across North America and Europe – because their financial markets are similarly structured. However, our interviewees = did emphasize that having a strong sustainability profile has become a norm in Sweden. As a result, there may be more interest in organizational learning and development around sustainability, for both bond issuers and investors.

Additional Resources

Liang, H. 2022. What is Sustainable Finance? Network for Business Sustainability.

Ferraro, F., & Solomon, J. 2019. How Money Can Do Good. Network for Business Sustainability.

Lohin, R. How to Finance Your Sustainability Strategy. Network for Business Sustainability.

Souder, D., Reilly, G., & Ranucci, R. 2015. Long-Term Thinking in a Short-Term World. Network for Business Sustainability.