Last update: 17/10/2022

They're a debt instrument public and private entities issue to finance eco-friendly projects. They're a thriving form of sustainable investment. 

Sustainable finance has become crucial to initiatives on reducing the devastating effects of the climate crisis. One of its most revered instruments are green bonds, a form of eco-friendly financing issued by public and private entities.  

The European Investment Bank (EIB) issued the first green bonds in 2007 in what was a giant leap towards building a responsible banking industry. Since sustainable doesn’t mean unprofitable, many investors are turning to green bonds. Their “eco-friendliness” doesn’t drive up their price.

To understand what they are, we must first get to grips with bonds — financial instruments for long-term liquidity that return investors’ money with interest. They're different from other short-term bonds (like government bonds).

How do green bonds work?

Green bonds' sustainable objectives also set them apart. They finance projects that help reduce the effects of climate change or protect the environment. They fall under the category of ESG (environmental, social and governance) and can benefit investors by offsetting emissions in proportion to their outlay.

But what must a green bond issue consider? The Green Bond Principles help businesses finance sustainable projects in a transparent way and transition to a green economy. Their four components are:

• Use of proceeds: Green bond proceeds must be used for green projects. Legal documents for green bonds must state clear environmental objectives, including climate change mitigation, biodiversity conservation and pollution prevention and control. They must also specify if funds are for financing or re-financing. If they're for re-financing, they should state which investments or project portfolios
  will benefit.
  
  
• Process for project evaluation and selection: Issuers should convey other evaluation criteria they consider to accept proposals. In the European Union, documents should be reviewed by a certified external provider.
  
  
• Management of proceeds: The issuer must credit and track the proceeds to ensure their correct use. The Principles state that “the issuer should make known to investors the intended types of temporary placement for the balance of unallocated net proceeds”.
  
  
• Reporting: The issuer should post regular, up-to-date information about the use of the proceeds and the expected environmental impact of projects. 

What type of project can green bonds finance?

Ana has recently paid off her mortgage. With less outgoings, she can now save a lot more. She’s contemplated investing some of her savings for quite some time. However, she’s looking for a responsible investment that generates returns and protects the planet and society. 

After checking her options, she pinpoints green bonds and wants to find out more about the projects they could finance if she invested in them. She wonders what green bonds are out there and finds a wealth of them that support: 

• Sustainable mobility: Initiatives to create “clean” transport with less CO₂ and other greenhouse gas emissions. Electric cars, bikes and other modes of transport have become perfect alternatives to traditional petrol and diesel-powered vehicles.
  
  
• Energy efficiency: According to the United Nations (UN), household energy consumption accounts for 21% of CO₂ emissions worldwide. Household automation is a practical solution to boost our energy efficiency.
  
  
• Waste management: The UN reports that every year, an estimated 11.2 billion tonnes of solid waste is collected worldwide. In recent years, the collaborative economy and other innovative ideas have given a second chance to items we were thinking of throwing away. We can recycle what we cannot reuse to create new products and services.   
     
• Pollution prevention and control: Greenhouse gas emissions are causing irreparable damage to the planet. Pollution prevention projects help organizations achieve net-zero emissions, which is one of Santander’s most ambitious sustainability objectives for 2050.
  
  
• Sustainable infrastructure: Many organizations strive to be more eco-friendly by powering machinery with renewable energy, sourcing biodegradable materials, promoting responsible water consumption and effective waste treatment, and doing other things. Sustainable farming, forestation, reforestation, and environmental protection should handle natural resources with care.

With all this in mind, Ana now understands the importance of investing in green bonds. She’s doing her part to help achieve UN Sustainable Development Goals (SDGs) 6 (“clean water and sanitation”); 7 (“affordable and clean energy”); 11 ("sustainable cities and communities"); and 13 (“climate action”). 

According to the Climate Bonds Initiative (CBI), in 2020 USD 270 billion (EUR 240 billion) were issued in green bonds. This has led to new special bonds, such as blue bonds to benefit marine ecosystems.