By Flor Morillo
Over recent years “Going Green” has been a recognized trend in many industries. Green cars and appliances have become the standard. As the current generation becomes more environmentally conscious and global warming is believed to be more than a hypothesis, more businesses have made an effort to adjust to the preferences and new needs of this generation.
The financial industry is not any different from these other industries. A new class of financial instruments resulting from this green trend is “green bonds”. Green bonds are debt instruments issued to finance or refinance environmentally friendly projects. Born in France, green bonds currently represent 1% of the global fixed-income market and are projected to continue growing rapidly. These bonds have helped fund projects such as energy efficient buildings, water and sewer systems and mass transit around the world. In February 2016, the New York Metropolitan Authority (MTA) issued $500 million in green bonds to fund infrastructure renewal in an effort to reduce the emission of carbon dioxide. The same month, Apple issued $1.5 billion in green bonds to finance clean energy projects.
Governmental entities, banks, and corporations can issue green bonds. Like any other bond, the issuing entity promises to repay the principal at maturity and to pay interest (coupons) over time. They could be tax-exempt if issued by a governmental entity like MTA or taxable like in the case of Apple. The credit rating of the bond is based on the issuer credit rating.
To be classified as green, the bond has to be certified. The certification can be achieved by following any one of the voluntary “standard” or “principles” available. These standards or principles try to achieve transparency and compliance by setting out guidelines of what is “green” and creating rules for internal and external monitoring throughout the life of the projects. The certification later serves as an information tool for investors who want to ensure their investment is in fact green from beginning to end.
Bond issuers benefit from having green bond classification because it enhances its reputation and attracts new investors. Some green bond issuers including MTA have used this type of bond to attract non-traditional investors such as millennials seeking to make a positive impact. The issuer, however, has to pay a price for these benefits. There are high costs associated with the additional monitoring and reporting as well as large up-front costs to fulfill the green criteria. Furthermore, green bonds can expose the issuer to liability as investors may seek penalties for failure to stick to green requirements or “green default”.
For investors that want to make an impact in the environment these bonds may be a great alternative. However, these investors have to be aware of potential risks. Due to the lack of popularity, green bonds at the moment could be highly illiquid. The demand is likely to peak in upcoming years, but in the meantime, green bonds are recommended to investors who will keep it until maturity. The investor may also face a moral dilemma as the proceeds of the bonds could be used to fund projects that are not necessarily “green” enough for the particular investor. For instance, there is an ongoing debate about whether nuclear power is considered to be “green” despite the discharge problems nuclear plants create. Investors also need to be aware of “green washing” by companies seeking to benefit from superficially displaying concern for the environment just to sell.