Impact Investing: Green Bonds 101

Prior to joining EDF, I worked in a variety of finance-related roles, from building the alternative energy franchise at an investment bank to pioneering investment in rural communities in the developing world at Root Capital. As part of my work at EDF, I’m investigating what financing mechanisms can drive investment in projects with big environmental returns, as well as financial ones. This post is the start of a new series looking at the green bond market, and in the future, I’ll be delving into other areas of impact investing.

Namrita Kapur

Eighteen months ago, you might have never heard of a green bond. The market averaged less than $3 billion per year, but that is quickly changing.  $14 billion in green bonds were issued in 2013 and Bloomberg New Energy Finance projects as much as $45 billion to be issued this year. One expert even sees the market climbing to $100 billion in 2015.

Flexible financing for sustainability projects

So what are green bonds, and what is driving this market growth? Simply put, they’re a debt instrument that can be linked to an environmental benefit. One compelling aspect of green bonds is their flexibility. While some may be tied to energy efficiency and renewable energy projects, others are used for projects around climate resiliency, water infrastructure and a growing list of other high-priority sustainability areas.

As countries experience the mounting impacts of climate change, there is an increasing global demand for capital in these critical infrastructure categories. At the same time, funds that are integrating environmental, social and governance criteria in their investment decisions are looking for these types of instruments to add to their portfolios.

Marquee banks joining the marketplace

This growth coincides with a shift in the players. Before this year, multilaterals like the World Bank led the way in green bond issuance. But now we see companies including GDF Suez, Toyota and Unilever entering the green bond market with underwriting from mainstream investment banks including Bank of America, JPMorgan Chase and Morgan Stanley. Sweden’s SEB was the biggest issuer of green bonds in 2013, according to Bloomberg. These household name financial institutions are also supporters of the Green Bond Principles – a broad set of principles aimed at promoting transparency, disclosure and integrity in this nascent marketplace.

Although the growth trajectory in this marketplace is significant, it’s still a tiny fraction compared to the $1 trillion of clean energy financing that the International Energy Agency estimates is needed to avoid the worst impacts of climate change. But it’s an important starting place.

As the green bond market grows in volume, important signs to look for include standardization of issuance and even the development of a secondary market. The more that green bonds function as plain vanilla investments, the more attractive they will be for pension funds and other large investors, which will then drive capital at the scale of the need.