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Green bonds: a powerful way to take climate action

Achieving net zero means global carbon neutrality, where any greenhouse gases emitted are cancelled out by those removed with new technologies and new habits. It requires a major shift in how investors allocate capital, and how they engage with companies to turn well-meaning ideas into action.          

Investing with purpose

When you buy a normal or ‘vanilla’ bond, you’re lending your money to the issuing company or government with no strings attached. The issuer uses the proceeds for an unspecified purpose, and pays a coupon on the bond in return. Eventually – in most cases – you get your principal (loan) back.

Green bonds, in contrast, raise money for a specified purpose. For a bond to be certified as green, its proceeds must help fund climate or environmental projects. So, unlike with a vanilla bond, you will always know where your money is going. You can think of it as financing with ‘green strings attached’.

A green bond could be financing a new windfarm, or a project to increase a low-lying town’s flood resilience, or a train station refurbishment which boosts public transport use – any of a wealth of projects that will go on to benefit the environment in a specific, tangible way.

Put simply, green bonds offer much more transparency and measurability than normal bonds. Yet they still fly under the radar for many investors. Many, that is, but not all. Away from the mainstream, the green bond market has been booming in popularity.

Why green bonds are going mainstream

Speak to any climate activist and you’ll hear the fight against climate change is slow – too slow. One reason why is because climate projects need to be financed, and there hasn’t been a good mechanism for connecting investor cash with the green projects that need it most.

Let’s consider for a moment what climate-action or mitigation projects involve. This could be capital expenditure for new infrastructure, or major changes to existing systems, or investment in developing technologies. It all costs money, and sometimes that money is hard to find. But it’s not an act of charity – these are investments, and so they come with a return. Just like their vanilla counterparts, green bonds pay a coupon. After all, a windfarm will generate and sell electricity. A new transport hub will process thousands of paying passengers. Flood resilience is worth paying for today if it reduces future costs. Investing in the energy transition is still investing.

That’s why, even putting environmental concerns aside, green bonds can be an attractive investment. They offer returns and diversify portfolio risk while contributing to climate action in a measurable way. And they are being rapidly snapped up by investors waking up to the fact that environmental benefits don’t have to come at a premium.

Investors are waking up to the potential

Green bonds are still a small part of the giant global bond market, but they’re on a very strong growth trajectory. In 2021, cumulative global green bond issuance crossed the $1.5trn threshold, having hit $1trn as recently as 2020.3

When we look at cumulative flows into green bond ETFs domiciled in Europe, we see a similar shape emerge, one which has been referred to as exponential growth by Climate Bonds Initiative, an organisation mobilising capital for climate action.