Green bonds are fixed income instruments issued for the specific purpose of financing projects that have positive environmental and/or climate benefits.

Like any typical coupon debt instrument, they have a specific end goal for the use of the funds raised.

The bond issuer is required to use the proceeds exclusively to finance environmentally friendly businesses or assets such as renewable energy, clean transportation, sustainable waste and water management systems, energy efficient and green buildings and biodiversity conservation.

Green bonds generally have the same credit ratings and recourse to bondholders as conventional bonds from the same issuer (all other things being equal).

These bonds tend to have higher reporting and monitoring costs than traditional bonds, which can lead to higher costs for the issuer.

But they might have a lower cost of capital due to the green bond premium (“greenium”), which would lead to lower interest charges.

Policies are being developed with a focus on reducing carbon emissions as nations and citizens have become aware of the negative impacts of climate change.

Many countries have explicitly announced net zero emissions targets for a given year. In addition, global green initiatives such as the Paris Agreement and the United Nations Sustainable Development Goals have helped to further boost these programs.

Such clear directions call for massive infrastructural developments involving huge capital outlays. As a result, governments, credit financial institutions, and corporations would plan debt issuances worth trillions of dollars over the next few years.

Green bonds have attracted a lot of interest over the past decade after the first issuance in 2007. According to the Climate Bonds Initiative, annual funds raised could reach $1 trillion in 2023.

That would be a significant achievement, even if it would be only a fraction of the $130 trillion global bond market. Although the United States is the largest source of green bonds, the European market is also growing very rapidly, with $300 billion to be issued over the next five years.

In its efforts to make India a low-carbon economy and achieve the ambitious target of 175 GW of renewable energy capacity, the Union budget for FY22-23 announced that green bonds sovereigns would be part of the government’s overall borrowing program.

The resources thus mobilized would be deployed towards public sector projects qualified as “green”. SEBI has also established a legal framework (SEBI Green Framework) as well as principles and guidelines regarding reporting and disclosure requirements for issuers of green debt securities.

Although green bonds may offer the same or slightly lower return/yield than other conventional bonds, there could be other benefits associated with sustainable investing:

a)- Investors can showcase social responsibility and support climate action by investing in green bonds, as the investment is eligible for SRI or ESG classification

b)- This could provide a means of earning interest income that is not taxable as is the case in some countries. A few federal/local governments have offered tax-exempt status to green bonds in the form of a tax credit, direct grant, or tax exemption

c)- An allocation to green bonds can contribute to the diversification and moderation of climate risk at the overall portfolio level. This investment can act as a hedge against other carbon emitting and polluting sector exposures that may be threatened by changing policy frameworks around the world.

d)- Investors with a broader view of stakeholders or society can be assured that their money is being used for a good cause and in a way that does not harm the ecosystem.

e)- According to a 2021 research study, there is some evidence that green bonds trade at a premium to conventional bonds from the same issuer. The sustainable angle has created positive sentiment in the market, driving demand from investors higher even though supply has not increased at the same pace. The other factors could expect favorable policy and regulatory measures in the future.

But, as with any investment, this category of investment is also subject to risk and fraud.

a)- A unique risk associated with green bonds is “greenwashing”, which is the risk that the proceeds of the bond will not be used for the declared beneficial climate-related project.

b)- Another risk could be a lack of liquidity, as bonds are held by long-term investors and asset managers such as insurance companies and pension funds.

Thus, the best approach for investors is to consider their risk-reward profile and construct portfolios aligned with the strategic asset allocation required to achieve stated investment objectives and goals.

Given the lack of time and lack of knowledge about the most productive method to have a valuable impact on planet Earth, a need to do something for Mother Nature can be indirectly satisfied through Green Bonds.

(The author is Chief Investment Officer at Validus Wealth)

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