On 12th December 2015, almost 200 countries have committed to climate goals, including the primary objective—“the finance flows have to be consistent with the path leading to lower Greenhouse Gas emissions and development of resilient climate systems.” Green finance instruments play a crucial role in achieving this objective by mobilizing private capital. Green bonds are the most successful of these financial instruments recently as their global issuance is proliferated by crossing 250 billion dollars in 2019, which is 3.5% of global bond issuance.
Many state-run and private entities have mandated that the allocations to their respective portfolios support climate change mitigation. The central banking community has linked climate change mitigation with financial stability and systemic risk through NGHS (Network for Greening the Financial System).
What are Green Bonds?
In this context, the preferences of the investors are changing in recent years from 2015, and there is a rising demand for green financial instruments. Green bonds are similar to the other standard bonds in the financial aspect, and they differ only by the green label they carry. This green label signifies that the proceeds from the bond issuance are used for beneficial environmental projects.
These benefits range from reducing the emission of Greenhouse Gases, water security (Positive Water Processes), waste reduction and adaptation of climate change. One significant benefit expected from the green bonds is low carbon transition. It is a process where the firm changes to use only low carbon energy.
There is also misinterpretation among the investors that the green bond issues low carbon intensity and high carbon intensity firms should be disqualified as the issuer. But the same is not true as a more significant fraction of the green bond issuers have higher carbon intensity of more than a hundred tons of Carbon Dioxide per revenue of every million dollars.
Role of Green Bonds on the Carbon Transition of the Entities
It is to be noted that globally there are no defined regulatory standards for green bonds on how the projects taken up from the capital raised are beneficial to the environment. However, some private sector entities have already developed high-level GBP (Green Bond Principles) and also follow the specific standards based on these GBPs. These standards are, however, voluntary but remain effective in multiple contexts.
Due to the absence of official regulatory standards, there are some debates that the capital raised through the green bonds do not provide the expected outcomes which are equally beneficial to the environment in the general context. Hence it is desirable to ensure that the green bonds do support reducing carbon emissions and finance the green projects with next level climate goals.
The most preferred measure for the greenness of any firm is the carbon intensity, and this ratio measures the firm’s carbon transition towards low emissions. Entities that use energy-efficient and greener technologies have already achieved the required carbon transition with the same productivity and economic activity levels.
Notable Research Findings
Several studies assess if the corporate green bonds are issued by firms that are less carbon-intensive and the effect of green bond issuance on reducing carbon emissions by the issuer. The results of the studies further highlight the requirement of more robust standards for the successful flow of the capital generated through green bonds to the projects which are more viable and beneficial to the environment. These studies highlighted that there is limited evidence to measure the positive impact associated with the issuance of green bonds on the carbon transition of the issuers. It is primarily due to the absence of mandatory regulatory standards globally.
The leading developer has recently set the mandatory official regulatory standards for the Green Bonds, proposed by the European Union Green Bond Standard.
Given the above, the investors should note that the existing labels of the green bonds do not necessarily indicate that the issuer has achieved low carbon transition. Hence the firms are to be rated rather than the bonds issued. These ratings will provide the investors with the correct information before investment and further encourage the specific firms to achieve a low carbon transition. These firm-level rating systems can also complement the existing green labels, which are project-based and thus worth noting.
This rating system should focus on the activities and processes of the high polluters of the environment rather than focusing more on the firms with low carbon intensity. It will result in the considerable gains in reducing carbon emissions and also high-level transition towards standard carbon processes.
Low carbon intensity is an easy measure to identify the low carbon transition. The availability of the carbon intensity will allow more straightforward verification by the investors. It will be easier for them to understand the level of low carbon transition of the concerned firms.
Further, as the countries are also committed to the Paris Accord, there are several broader policy changes in these countries mandating their public sector green bond issuers to comply with the energy-efficient processes and low carbon transition. More than 100 countries have already adopted goals to achieve carbon neutrality by 2050.
Overall, Green Bonds have maintained a key role in developing a wider global market for more sustainable financial instruments. The rapid growth in its investments in the last five years is already evidence of the demand for such devices. However, complementary ratings of the firms to the current certifications will certainly help convert the market trends into very much needed low carbon transition processes. Further development of globally accepted mandatory regulatory standards for these financial instruments and standardized impact reports for the existing green bonds are currently in progress which will further help the investors.