Key Takeaways
- Green bonds are fixed-rate debt instruments.
- They work just like traditional bonds, but must always fund projects that benefit environmental, climate or sustainability initiatives.
- As a green bond investor, you provide a loan to the issuer. In return, you receive periodic interest payments. Then, when the bond matures, you recoup your initial investment. This assumes the issuer does not default on the loan.
How Do Green Bonds Work?
Green bonds work the same way as traditional and government bonds. As an investor, you provide a loan to the bond issuer, who provides you periodic interest payments over the life of the bond. Then, at maturity, the issuer repays your loan.
The key difference between green bonds and other bonds is that green bonds always fund projects that benefit environmental, climate or sustainability initiatives. There are also differences in how these bonds are purchased and to whom they are available.
In many instances, green bonds offer tax incentives to bond issuers or investors. Examples include, but are not limited to, the following:
- Tax credits for investors
- Direct subsidies for issuers
- Tax-exempt interest for investors
Incidentally, individual green bond issues are not as prevalent as other bond issues and are typically purchased by institutional investors. However, individual investors can invest in green bonds via specialty mutual funds and exchange-traded funds (ETFs).
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If you feel strongly about supporting environmental initiatives, you can invest in an ESG-focused green bond fund. The fund’s website will provide detailed information as to how the fund’s managers use ESG-screening criteria in choosing investments, which you can use to ensure they align with your interests.
Toby Walters, CFA®Senior Financial AnalystToby Walters, CFA®, is a senior financial analyst with over 25 years of experience in financial research. His knowledge spans researching and analyzing financial data to developing a one-of-a-kind viewpoint on money-related topics.
Types of Green Bonds
At a high level, there are five types of green bonds. As outlined below, each is financed in a distinct manner.
- “Use of Proceeds” Revenue Bonds are secured by the specified projects’ fees, taxes and other revenues. Example: Hawaii State
- “Use of Proceeds” Bonds are secured by issuers’ assets. Example: Barclays Green Bond
- Securitization Bonds are secured by the cash flows from pools of green projects. Example: Tesla Energy
- Project Bonds are secured by the specified projects’ assets. Example: Invenergy Wind Farm
- Environmental Impact Bonds (EIB) pay returns based on the success of the specified projects. Example: DC Water EIB
To qualify as a green bond, the debt instrument must fund an environmental initiative. Examples of qualifying projects are as follows:
- Renewable energy infrastructure
- Public transportation
- Pollution cleanup
- Waste management and recycling
Who Issues Green Bonds?
Governments, organizations, companies and multilateral institutions, such as the United Nations (UN), can issue green bonds.
The World Bank was the first institute to issue green bonds in November 2008. Since then, it has issued over 160 green bonds, which equates to $15 billion in environmental funding initiatives.
In the first half of 2022, nearly $418 billion of green bonds were issued globally — a 27% drop from the same period the prior year. Economists cite rising interest rates and the Russian invasion of Ukraine, both of which stoked notable economic uncertainty, as the reason for the decline.
According to a report in Pensions & Investments, China was the top source of green bond issues in the first half of 2022, with approximately 22% of the aggregate funding raised by 40 leading countries.
The United States was the second largest source of green bond issues in 2022, with over $64 billion in funding. Fannie Mae, which raised almost $11 billion, was the largest U.S. issuer of green bonds. Its Multifamily Green MBS program finances green mortgages for apartments and other multifamily units.
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How Can You Buy Green Bonds?
Individuals can invest in ETFs and mutual funds that hold green bonds, but cannot usually invest in individual green bonds.
Direct investments in green bonds are made by institutional investors, which include pensions, endowments, insurance companies, banks and mutual funds.
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Green Bonds vs. Blue Bonds
Green bonds fund a variety of environmental projects, while blue bonds are focused on initiatives to protect and improve water management and aquatic ecosystems.
Blue bond investments may support sustainable fishing, waste management, ocean conservation and other water-based industries. Blue bonds are issued and purchased in the same way as green bonds.
What Are Green Bonds, Climate Bonds and Sustainability Bonds?
Green bonds, climate bonds and sustainability bonds all fund environmental initiatives. Green bonds are the most general type of environmental bond, financing a variety of projects. These include improvements in waste management, energy infrastructure or sustainable farming.
Climate bonds can be categorized as green bonds, but climate bonds are specifically used to finance initiatives designed to reduce the effects of climate change. Thus, all climate bonds are green bonds, but not all green bonds are climate bonds. An example of a climate bond project is a public transportation improvement to reduce greenhouse gas emissions.
Sustainability bonds finance a broader array of initiatives than green bonds. In addition to supporting environmental initiatives, they also support social improvements. An example of a multifaceted sustainability bond project is a local farming operation intent on reducing food insecurity and elevating nutritional awareness for low-income communities.
Green bonds are an increasingly popular way to support environmental initiatives, oftentimes with big return potential. Direct investments are not generally available to individual investors, but you can achieve exposure via a growing number of specialty ETFs and mutual funds.
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Frequently Asked Questions About Green Bonds
Green bonds are not inherently good or bad investments. Whether they make sense for you is dependent on your investment objectives and risk tolerance. When implemented properly, a green bond allocation can contribute to the growth of your investment returns and provide the benefit of knowing you are making a lasting difference in the world.
If you are not comfortable investing in green bonds, there are plenty of other ways to make a positive impact on the environment with your money. The most straightforward way is to carve out a modest portion of your retirement portfolio and devote it to a proven environmental, social or governance (ESG) fund.
Another approach is to divert some of your savings to an environmental-focused not-for-profit organization that inspires you. If your budget is solid and your retirement savings plan is on track, you can afford to make a modest annual charitable contribution.
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