Investing Your Portfolio, Now Greener: The Emergence of Green Bonds

by Tom Anderson | May 27, 2021

Have you been hearing more about green bonds lately? You’re not alone. The worldwide green bond market has climbed sharply in recent years, surpassing the $1 trillion mark in December 2020. 

Big-name tech companies use them to finance clean energy projects. Car manufacturers issue them to support their efforts to make environmentally friendly vehicles. Green bonds have also been used to fund energy-efficient, multifamily developments and subway improvements in major cities. 

Fannie Mae, for instance, has issued green bonds to raise money for upgrading homes to be more energy- and water-efficient — which in turn can make those properties less expensive to operate. 

Among countries, the United States was the largest total issuer of green bonds by private companies and public sector agencies and multinational development banks last year, according to the Climate Bonds Initiative. (Fannie Mae’s $13 billion in 2020 activity was a major driver.) The current administration has pledged to do more to stop climate change, meaning you can expect the issuance of these sustainable securities to continue to grow.

“Green bonds are exciting both from the opportunity to align your investments with your values and to participate in a long-term secular trend,” says Harlin Singh Urofsky, Global Head of Sustainable Investing at Citi Private Bank, expressing the potential for investors to think of their personal financial future and the planet’s, as well.

While green bonds arrived more than a decade ago, they didn’t draw much interest from individual investors until recently. (One trading platform saw a 42% increase in its green bond trading volume from 2019 to 2020, and at least six new green bond funds were launched over the same two-year span.) The rise of environmental, social and governance (ESG) concerns among investors, who want to address global problems while reducing risk and earning a reasonable return, has fueled more demand for these bonds.

Following is a closer look at green bonds, what to consider before you invest in these securities and where the market may be headed.

A brief history of green bonds

A bond is like an IOU: investors lend money to a borrower for a set time by buying its bonds. A green bond is distinct from a traditional bond in that the proceeds are meant to support a climate-related or environmental project. For example, green bonds can be used for new or existing projects focused on renewable energy, energy efficiency, sustainable transportation, water quality and conservation, and green buildings, according to Citi’s Green Bond Framework.

In 2007, the European Investment Bank issued the first green bond with proceeds funding renewable energy and energy efficiency projects. From that modest start, the use of green bonds skyrocketed. The Climate Bonds Initiative, one of several organizations that certifies green bonds, reported a record $269.5 billion in green bonds were issued globally in 2020 by governments and private companies. The United States alone issued $51.1 billion in green bonds last year, followed by Germany with $40.2 billion and France with $32.1 billion. It's just the beginning. The Climate Bonds Initiative estimates green bond issuance could reach as high as $450 billion in 2021.

Caitlin MacLean, senior director of innovative finance at the Milken Institute, which researches and applies market-based principles and financial innovations to social issues, sees two main drivers behind the boom: "The first is that issuers are realizing they need to start making capital investments to better prepare themselves for a transition toward a more sustainable future. The second is investor demand."

Two greenhouse workers walking inside the garden center with crate full of plants.

What to look for before buying green bonds

As seen in just the past couple of years, the number of funds investing in green bonds is growing along with the market. Investors held $6 billion in sustainable bond funds at the end of 2020, according to data from Morningstar.

With this surge has come many standards but no universally agreed-upon definitions, which can make an eager new investor suddenly feel hesitant and uncertain. "I think the frustration that investors find when they first go into this market is, they're assuming that everything is going to look the same," MacLean says.

Thankfully, there are places you can turn to for guidance if you want to dig deeper into what makes a bond a green bond. In 2014, the International Capital Market Association created the Green Bond Principles, which are voluntary guidelines for issuers of green bonds. 

"Citi was one of the original authors of the Green Bond Principles," says Philip Brown, Head of Citi's Sustainable Debt Capital Markets business, based in London. "We wanted to form some simple principles around which green bonds would be structured."

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Thankfully, there are places you can turn to for guidance if you want to dig deeper into what makes a bond a green bond.
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Many issuers and organizations, such as Norway's Center for International Climate and Environmental Research, followed the lead of the Green Bond Principles to craft their own criteria. Plus, the European Commission is working on its own EU Green Bond Standard, which builds on the Green Bond Principles and the EU Taxonomy.

With all the different standards and labels, there is a relatively simple way to invest with confidence. Todd Gartner, director of Cities4Forests and World Resources Institute’s Natural Infrastructure Initiative, urges investors to find bonds certified by a third party. The Climate Bonds Initiative has a breakdown of how green bonds can be reviewed and certified.

“Each green bond standard has some differences, but with the big ones, you can have confidence that the proceeds are used for the good for the climate,” says Gartner. If you can't get that certification, slow down. “I would be quite critical of bonds labeled as green that a third party hasn’t verified,” he cautions.

Citi was not only an early architect of the guiding criteria by co-founding the Green Bond Principles, the bank has also been a facilitator as well as an issuer in its own right. As Citi’s latest ESG Report notes, in 2019 the bank issued a €1 billion green bond, followed by a second $1.5 billion note in 2020.  

Where green bonds can fit into a portfolio

Every investor has different strategies, and there’s no one-size-fits-all approach to green bonds. “For clients who have a significant interest in climate change or investing in environmental strategies, green bonds can fill a great place in their fixed income allocation,” Singh Urofsky says.

Socially responsible investors may pay a premium to buy green bonds, which means they would trade with a lower yield than comparable conventional bonds from the same issuer. That price difference, or “greenium,” can create financial incentives for more issuers to invest in sustainable projects.

“What we're finding is that on the primary market, there are cases where the green bonds price at a premium, and that's surely because of demand,” Singh Urofsky says. This high demand can give the issuers better financing rates. Singh Urofsky notes that there is a limit to the greenium. “In the secondary markets, we do find that they trade relatively in line with companies' vanilla or non-green credit,” she says. 

Rear view of friends commuting to work on electric bike share bikes

What’s next for green bonds

What does the future hold? Singh Urofsky envisions more companies issuing ESG bonds linked to key performance indicators, or so-called Sustainability-Linked Bonds. These bonds commit issuers to achieve predefined sustainability or environmental targets — say, reducing carbon emissions by 15% over five years. If not achieved, a financial or structural change in the bond (such as a coupon step-up) will be triggered. 

It’s early days for green bonds, and investors should expect more issuers to use them. “Structural innovation enables participation from all types of issuers,” says Amanda Boggs, a Managing Director at Citi within its Fixed Income Capital Markets group, based in New York. “It helps recognize that there's a role for other sectors or industries in transition that might not have been obvious green bond candidates.”

Whatever the green bond market brings, it will continue to fuel a more sustainable approach to financing everything from the water you drink to where you live to how you travel, showing investors you don't have to choose between managing your money and supporting the drive toward a more environmentally conscious global economy.

Tom Anderson

is a New York-based writer and has written for CNBC.com, Forbes, Kiplinger's Personal Finance, Money, Monocle and Wired.