Green Bonds: How They Benefit the Issuer
Green bonds: the issuer perspective
Before we can discuss why investors may want to hold green bonds in their portfolio, it’s important to consider an issuer’s standpoint. An entity may issue a green bond to achieve environmental goals that it has adopted. Green bond issuance may also create goodwill by promoting a “green” public image. From a treasurer’s perspective, issuing green bonds may allow an issuer to diversify its funding profile by attracting new types of investors.
Despite the increased disclosure necessary to issue a green bond, it is important to remember that from a legal standpoint, a green bond ranks equally in seniority with a conventional bond, all else being equal. The vast majority of green bonds are senior unsecured instruments, backed by the balance sheet of the issuer. Although proceeds are used to finance specific projects, investors generally have full recourse to the issuer rather than to specific assets (although it should be noted that project bonds, securitizations, and revenue bonds do exist, but in much smaller amounts).
However, when the additional costs associated with obtaining independent verification, ongoing reporting, and the auditing of the use of proceeds are considered, some issuers may choose to refrain from placing a green label on their bonds. This may explain why a much larger unlabeled green bond universe currently exists. Further, given the lack of clear definitions and standards for green bond issuance, some issuers may have liability concerns if the issuer’s definition of green does not coincide with that of an investor.
Regulators have begun to take note, however, given government efforts to promote green finance as a way to combat climate change. For example, the Governor of the Bank of England and Chairman of the G20 Financial Stability Board, Mark Carney, recently called for establishing standard terms for the issuance of green bonds to promote market growth (Source: Reuters: Bank of England’s Carney calls for progress on green bonds. September 22, 2016).Given the costs and concerns around potential liabilities, one might expect a lower cost of financing for issuers of green bonds as an incentive to participate in the market. However, this is not necessarily the case.
Green bonds are generally priced the same as conventional bonds at issuance. There are a few reasons for this. First, green bonds are the same as conventional bonds, other than having a disclosed use of proceeds versus the more typical bond issuance from which proceeds are often used for general corporate purposes. From a credit standpoint, there is no justification for a different interest rate, all else equal. Second, the majority of investors, even those seeking green bonds, are typically not willing to sacrifice return to achieve their environmental investing objective. Third, many green bonds are purchased by traditional bond investors who may not even be aware of the green label.
Benefits to the issuer
One purpose of green bonds is to invest in environmentally friendly projects. Green bonds can also boost an issuer’s image and reputation, reflecting its commitment to the environment. Green bonds also provide investors access to various types of global investors and various kinds of climate-related projects. The pricing of green bonds is similar to an ordinary conventional bond (BND) (AGG) (TLT) (SHY).
Green bond (GRNB) issuers include any organization, government agency, or financial institution that issues a bond.