Green bonds explained & the different types of green asset (2024)

Until recently, many financial market participants may have found climate-related financial risks to be largely abstract. However, it has become increasingly difficult for reasonable observers to deny that there is at least an element of climate change causality behind events such as the catastrophic fires in California and Australia or the floods in Western Europe.

In the face of such events, financial decision-makers and investors are quickly becoming more “climate aware.” For example, institutional investors and banks, which are answerable to end-investors and shareholders, are under growing pressure to present their investing and lending decisions as compliant with emerging environmental, social, and governance (ESG) standards. Large fixed income buy-side institutions are increasingly motivated – or even required – to have a positive climate impact as well as generating financial returns.

As a result of these pressures, financial markets are adapting and changing. In many cases, bonds and other instruments which do not meet relevant ESG criteria trade at a discount to those that do – this gap is likely to widen in the future. Increasingly, investors are allocating resources to instruments that are certified as adhering to certain ESG principles, such as green bonds and other so-called labeled assets (assets that have achieved some type of certification or label associated with ESG characteristics).

As these shifts occur, the market for green bonds and green assets is growing fast. Investors are snapping up new issues and dedicated international climate funds and development banks are looking to support the flow of capital into environmental projects – including the development of green bond markets – using concessional finance, credit enhancement tools, and their own balance sheets.

But what are green bonds and assets, and why do they matter?

[ESG factors explained: Environmental | Social | Governance]

Green bonds explained & the different types of green asset (1)

What are green assets?

Green assets are financial instruments that raise funds which will be used to finance environmentally beneficial or “green” projects or business activities.

Green projects may include building renewable energy capacity, clean transportation infrastructure, or energy-efficient buildings.

Typically, green assets are bonds, but they may also be loans or securitized instruments such as asset-backed securities.

In the case of green bonds, most are backed by their issuers’ total balance sheets.

However, some green bonds are instead backed by revenues from the associated green projects.

Other types of green instrument, such as green asset-backed securities, are backed by cash-flows from the underlying green assets.

Solar asset-backed securities, for example, are backed by cash flows from pools of loans used to finance the installation of solar energy systems.

Green assets are associated specifically with environmental concerns, rather than social or governance ones.

However, as green assets have become more popular, new instruments targeting non-environmental ESG issues have emerged.

Collectively, these green, social, sustainable, and other types of ESG-linked instruments are sometimes known as “labeled” bonds.

This term properly applies only to those instruments that have achieved a green or sustainable “label” through a recognized certification process.

At times, however, the term is used to refer to the category overall.

[Biodiversity explained: What is its impact on the finance industry?]

Green bonds explained & the different types of green asset (2)

The different types of green asset

Green bonds

Green bonds are the oldest and most popular form of labeled asset. They are fixed income securities structured much like traditional bonds. However, the funds raised by these bonds are earmarked for green projects, such as the development of renewable energy assets or clean transportation.

Climate bonds

In many cases, the term “climate bonds” is used as a synonym for green bonds. However, some distinguish between the two, arguing that while green bonds can be used to finance a wide range of environmental projects, climate bonds must focus on climate change adaptation or mitigation (typically, emissions reduction).

Blue bonds

A subset of green bonds, blue bonds are focused on green projects related to ocean conservation. They are structured and function like traditional green bonds.

Green asset backed securities (ABS)

Green ABS are instruments backed by pools of sustainable assets. The market for solar ABS – instruments backed by loans used to finance the installation of solar energy systems – is relatively well developed, for example.

Green collateralized loan obligations (Clos)

As green securitization expands, another emerging area is green collateralized loan obligations (CLOs). CLOs are special purpose vehicles (SPVs) that house pools of leveraged loans.

Green mortgage-backed securities (Mbs)

There is a growing market for green commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS), although defining which of these MBS instruments qualify as sustainable can be complex. In general, the focus is on energy-efficient buildings in the case of CMBS and energy efficiency and affordable housing in the case of RMBS.

Green bonds explained & the different types of green asset (3)

Green bonds explained & the different types of green asset (2024)

FAQs

Green bonds explained & the different types of green asset? ›

Green bonds are the oldest and most popular form of labeled asset. They are fixed income securities structured much like traditional bonds. However, the funds raised by these bonds are earmarked for green projects, such as the development of renewable energy assets or clean transportation.

How many types of green bonds are there? ›

Types of green bonds
TypeProceeds raised by bond sale are
"Use of Proceeds" BondEarmarked for green projects
"Use of Proceeds" Revenue Bond or ABSEarmarked for or refinances green projects
Project BondRing-fenced for the specific underlying green project(s)
4 more rows

What is the green bond? ›

Green bonds are a type of debt issued by public or private institutions to finance themselves and, unlike other credit instruments, they commit the use of the funds obtained to an environmental project or one related to climate change.

What are green assets? ›

A green asset is an asset that generates more energy than it consumes. This creates a positive impact on the environment, as well as provides a net positive benefit to the economy.

What are the basics of green bonds? ›

Green bonds are a type of fixed-income investment used to fund projects with a positive environmental impact. Like traditional bonds, green bonds offer investors a stated return and a promise to use the proceeds to finance or refinance sustainable projects, either in part or whole.

What are the 5 main types of bonds? ›

There are five main types of bonds: Treasury, savings, agency, municipal, and corporate. Each type of bond has its own sellers, purposes, buyers, and levels of risk vs. return. If you want to take advantage of bonds, you can also buy securities that are based on bonds, such as bond mutual funds.

How are green bonds paid back? ›

Investors buy the bonds and the company or government pays them back over time with interest. But the investors aren't often everyday investors — green bonds are usually sold to larger organizations such as pension funds that can buy bonds in bulk.

Do green bonds pay interest? ›

In many ways, green bonds are similar to "plain vanilla" bonds. They are securitized debt investments, issued by corporations and governments, that bear an interest payment to the bondholder and can be traded on secondary markets.

How safe are green bonds? ›

Additionally, they demonstrate a strong safe haven property with high-emission sectors for the entire study period and with all sectors except financials during the COVID-19 period. This hedging and safe haven benefit of green bonds is agnostic of the environmental disclosure score of a firm.

What are the best green bonds? ›

  1. 1 - Xtrackers EUR Corporate Green Bond UCITS ETF +USD 145 million. ...
  2. 2 - iShares Global Green Bond ETF +USD 124 million. ...
  3. 3 - Xtrackers USD Corporate Green Bond UCITS ETF +USD 122 million. ...
  4. 4 - Lyxor Green Bond UCITS ETF +USD 75 million. ...
  5. 5 - Franklin Liberty Euro Green Bond UCITS ETF +USD 66 million.

What are the four types of bonds? ›

Four main bonding types are discussed here: ionic, covalent, metallic, and molecular. Hydrogen-bonded solids, such as ice, make up another category that is important in a few crystals.

What is the difference between ESG bonds and green bonds? ›

ESG bonds refer to any bond with set environmental, social, or governance objectives. This can include everything from affordable housing to improved infrastructure, reduction of racial or gender inequity, or renewable energy. Green bonds specifically focus on issues related to the climate and environment.

What are the four components of the green bond? ›

Green Bond Frameworks Issuers should explain the alignment of their Green Bond or Green Bond programme with the four core components of the GBP (i.e. Use of Proceeds, Process for Project Evaluation and Selection, Management of Proceeds and Reporting) in a Green Bond Framework or in their legal documentation.

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