Green bonds as a tool against climate change?

The growing interest of public policy towards green bonds has indeed already materialized into a number of initiatives to encourage market participants, on both the demand and the supply side

Green bonds are debt instruments that differ from conventional fixed income securities only in that the issuer pledges to use the proceeds to finance projects that are meant to have positive environmental or climate effects. Since its debut in 2007, the green bond market has been growing steadfastly. According to the Climate Bond Initiative (2020), new issues have reached 230 billion euros (257 bn USD) globally in 2019, up from 142 billion in 2018 and 28 billion euros in 2014. While the overall size of the green segment is still tiny in comparison to the funds raised with conventional bonds, there is massive potential for further market growth as environmental issues are raising high on the policy agenda. For instance, Europe alone is estimated to need about 180 billion euros of additional investment a year to achieve the targets set for 2030 in the context of the 2015 Paris Agreement on climate change, including a 40% cut in greenhouse gas emissions. The growing interest of public policy towards green bonds has indeed already materialized into a number of initiatives to encourage market participants, on both the demand and the supply side 

Disclosure of relevant information to the market has been identified as one of the reasons for the increasing popularity of green bonds among investors. Specifically, transparency on the allocation of proceeds is a characteristic feature of green securities, since they are tied to the “green nature” of the investment projects rather than explicitly to their ultimate environmental impact. Accordingly, the leading market guidelines require disclosure on the management of proceeds, at least annually after issuance (International Capital Market Association, 2018). As a common, less stringent market practice, information on the use of proceeds is provided at the issuance stage in the bond prospectus, alongside the bond’s financial features, whose disclosure essential in orienting investors’ choices, and, therefore, mandatory. 

What has changed after the Paris Agreement?

In December 2015 the United Nations Framework Convention on Climate Change (UNFCCC) established the Paris Climate Agreement, considered as a landmark in global efforts to tackle climate change. The agreement sets the ambitious target of limiting the rise in global warming to well below 2°C compared to pre-industrial levels by the end of the century (Art. 2.1(a)), which would require massive reductions in CO2 emissions in the next decades. At the same time, the Agreement recognizes the role of financing de-carbonization by putting forward a commitment to “making finance flows consistent with a pathway towards low Greenhouse Gas emissions and climate-resilient development” (Art. 2.1(c)). Naturally, by raising awareness on climate issues from the general public but also economic and financial actors, such unprecedented commitments might in general have made businesses more environmentally conscious and therefore more willing to align their behavior with climate objectives. Importantly, reaching climate policy objectives entails a transition process towards a more efficient allocation of resources, whereby some fixed and financial assets may become stranded, that is, undergo a significant devaluation.

After the Paris Agreement, climate change exposure is not only increasingly priced but also affects the overall creditworthiness of companies on bond and loan markets. 

Against this backdrop, arguably firms might have higher incentives in financing the investment in climate-friendly projects with green bonds after the Paris Agreement.

Source: European Commission JRC Technical Report

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