There is little doubt that considerable economic transformation is required to decarbonise the world economy. McKinsey forecasts that approximately US$275 trillion in green investment–approximately US$9.2 trillion annually–is needed over the next 30 years to achieve net zero emissions. At the same time, the public is increasingly expecting companies to address social and environmental issues. According to IBISWorld, the percentage of people concerned about environmental issues in Australia reached 86.8% in 2022, and is expected to reach 92% by 2025. Clearly, there is a need for new financial products that bridge the gap between the amount of capital needed for sustainable development projects and the demands of investors for consequential environmental action. Specifically, ‘green bonds’ appear to be a useful tool in allocating capital towards sustainable projects.
Traditionally, companies, banks and governments have issued bonds to raise funds to finance their business or other activities. A bond is a debt instrument which promises the investor regular interest payments plus the principal (initial investment) when it matures. Green bonds work in much the same way, with the obvious distinction that they are issued exclusively to finance projects which provide accompanying environmental benefits such as renewable energy or clean transport infrastructure.
With an explosive growth rate of over 50% in the last five years, according to Climate Bonds, green bond issuance is set to reach $US1 trillion by the end of the year and US$5 trillion by 2025. It is important to note here that investing in bonds tends to be out of reach for most retail investors like you and me. As such, the recent prominence of green bonds is largely the result of institutional investors such as hedge funds, insurance companies and pension funds, although unmistakably in response to the inclinations of the public.
Green bonds are not only beneficial in helping the investor to achieve a ‘double bottom line’ return, but also enable the issuer to meet their climate change targets. For instance, Apple, one of the largest private issuer of green bonds, is pledging to become carbon-neutral across its supply chain by 2030. The company has issued three rounds of green bonds since 2016, raising a substantial US$4.7 billion in the process. The funding supports 50 projects focused on the development of low-carbon manufacturing and recycling technologies, as well as being expected to offset 2.88 million tonnes of carbon dioxide equivalent. The forefront of such efforts has been the purchase of direct carbon-free aluminium, one of the world’s most widely used metals, following a breakthrough smelting technology which produces oxygen instead of greenhouse gases.
However, there are certainly pitfalls to investing in green bonds and obstacles which need to be overcome. Strong demand for and limited supply of green bonds has led to a green premium and illiquidity, with investors hoarding them and bonds trading at a lower yield compared to their non-green counterparts, as was the case with the sovereign green bonds issued by Germany. Structurally, there is currently little regulation in place to punish companies, banks or governments that issue green bonds and use the proceeds to fund something not ‘green’, irrespective of the reputational damage such an action would invariably have. Such problems may be mitigated by increasing supply, introducing regulation or creating penalties such as raising the coupon rate if an environmental target is not met.
In the future, there is considerable scope for the debt instrument to become increasingly targeted towards certain projects and environmental issues, such as ‘blue bonds’. As a growing part of the bond market, green bonds present an opportunity to direct financing to address ‘wicked’ problems like climate change and to encourage a mindset thinking about our future infrastructure needs for a net zero future.