Are Green Bonds good investment option for long term retail Investors?

Green Bonds is a type of fixed income security issued to raise money for climate & environmental projects. Like any other type of bond, green bonds offer a stated return and represent a loan from an investor to a company, organization, or government agency. 

Green bonds may come with tax incentives such as tax exemption and tax credits, making them a more attractive investment vs. a comparable taxable bond. Investors interested in green bonds should learn the diverse types and the pros and cons of investing before buying. 

To qualify for green bond status, bonds are often verified by a third party such as the Climate Bond Standard Board, which certifies that the bond will fund projects that include benefits to the environment. 

This article covers what are green bonds, its types, how do they work along with pros & cons of investing in green bonds.  

As there is no specific definition of Green Bonds, investors should be aware that there are two internationally recognized sets of standards for the issuance of green bonds: 

• Climate Bond Standard and Certification 

The Climate Bonds Standard and Certification Scheme is a labelling scheme for bonds and loans. This rigorous scientific criterion ensures that bonds and loans with certifications are consistent with the 2 degrees Celsius warming limit in the Paris Agreement.  

The Scheme is used globally by bond issuers, governments, investors, and the financial markets to prioritise investments which genuinely contribute to addressing climate change. 

• Green Bond Principles (GBP) 

The Green Bond Principles (GBP) look to support issuers in financing environmentally sound and sustainable projects that foster a net-zero emissions economy and protect the environment. These principles are voluntary best practice guidelines to encourage transparency and disclosure.  

Thus, GBP helps investors by promoting exact information to evaluate Green bonds and their impact on the environment.

Types of Green Bonds 

Green Bonds are standardised bonds created to finance environmentally beneficial projects. There are 4 types of Green Bonds: 

• Securitization Bonds 

These debt instruments involve a group of projects gathered into a single debt portfolio, with bondholders having recourse to the assets underlying the full set of projects. Some examples of green securitization bonds have included green mortgages and solar leasing projects. 

• Loans 

Financing for green projects may be secured (backed by collateral) or unsecured. In the case of unsecured loans, lenders have full recourse to the assets of the borrower. For secured loans, lenders have recourse to the collateral—and, in some cases, partial recourse to the borrower. 

• Covered Bonds 

This type of instrument involves financing a group of green projects, known as the “covered pool.” In this case, investors have recourse to the issuer, but if the issuer is unable to make debt payments, then bondholders gain recourse to the covered pool. 

• “Use of Proceeds” Bonds 

This type of instrument is dedicated to financing green projects, but in the case of a liquidation, the lenders have recourse to the issuer’s other assets. These instruments carry the same credit rating as the issuer’s other bonds. 

How do Green Bonds work? 

Green bonds work just like any other corporate or government bond. Borrowers issue these securities to secure financing for projects that will have a positive environmental impact. Green bonds finance environmentally friendly projects, such as energy efficiency, pollution prevention, and clean transportation. 

These bonds pay a stated amount called a coupon payment to an investor who is loaning money to the issuer to finance a project. Investors who buy these bonds can expect to make a profit as the bond matures. In addition, there are often tax benefits for investing in green bonds. 

Green bonds finance projects aimed at energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean transportation, clean water, and sustainable water management.  

They also finance the cultivation of environmentally friendly technologies and the mitigation of climate change. 

Pros  

• Tax Benefits, as green bonds issued by certain government entities supply tax free income for investors. 

• Helping the environment, as investors have the excellent opportunity to earn while benefitting the environment. 

Cons 

• Low yields. Bonds issued by governments often pay lower yields as compared to corporate bonds. 

• Lack of control. Governments may already have the money to fund a green bond project. If they issue green bonds for that same project, it may free money up to do other things. 

Green Bonds vs Climate Bonds vs Blue Bonds 

Climate Bonds and Green Bonds are sometimes used interchangeably. 

Those bonds that are specifically issued to prevent or mitigate climate change and are certified by the Climate Bond Initiative are referred to as climate bonds. Whereas green bonds are a broader category that includes climate bonds as well as some other bonds that are issued to benefit the environment.  

On the other hand, blue bonds are issued specifically to finance projects that protect the ocean and other water ecosystems. Blue bonds too are a type of green bond. 

Bottom Line 

Green bonds are fixed-income investments that finance projects intended to benefit the environment. Since green bonds are often issued by government entities, they may provide tax benefits to an investor. 

According to the Climate Bonds Initiative, the issuance of green bonds reached $269.5 billion in 2020. The United States was the largest player, with $50 billion in new issuances. 

Investor demands for green bonds continues to grow as Environmental, Social and Governance (ESG) criteria become increasingly important. Institutional investors, ESG investors, governments, corporate treasuries, and retail investors are all including green bond projects into their portfolios. 

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