Green Bond

What Is a Green Bond?

A green bond is a debt security that raises money for projects with clear environmental benefits. Like any bond, it is a loan from an investor to an issuer, which may be a government, a municipality, a development bank, or a company. The bond pays interest and returns principal at maturity. What sets it apart is the commitment that the borrowed money will be spent on green purposes.

Eligible projects typically include renewable energy, energy efficiency upgrades, clean transportation such as rail and electric vehicle charging, pollution prevention, sustainable water management, and climate adaptation. The green label describes how the proceeds are used, not the credit quality of the issuer. A green bond can be issued by entities with a wide range of credit ratings.

How Green Bonds Work

Many issuers follow the Green Bond Principles, voluntary guidelines published by the International Capital Market Association. The principles center on four areas:

• use of proceeds: funds are earmarked for defined green projects.
• Project evaluation and selection: the issuer explains how projects meet environmental criteria.
• Management of proceeds: funds are tracked, often in a separate account or sub-ledger.
• Reporting: the issuer publishes information on how funds were allocated and what environmental results they produced.

Many issuers also obtain an independent review or certification to support their label. The principles are voluntary and are not binding law in most places, so the depth and quality of disclosure can vary considerably from one bond to another.

Benefits and Risks for Investors

Green bonds allow investors who want to support environmental goals to hold fixed-income assets while doing so. Because they are structured like conventional bonds, they carry the usual risks. interest rate risk and credit risk still apply, and the price of a green bond can move when market rates change, just as with a comparable bond.

The main concern specific to green bonds is greenwashing, where a label is attached to projects with limited environmental value. Investors may find it difficult to verify environmental claims, and reporting standards differ by issuer and region. Some studies have found that green bonds sometimes trade at slightly lower yields than comparable conventional bonds, a difference sometimes called a "greenium." Evidence on this effect is mixed, and it does not appear in every market or every period.