Green bonds are a type of debt investment in which the proceeds have a specific environmental purpose. An issuer raises funds from investors and uses those funds for eligible green projects or assets. Renewable energy, clean transportation, energy efficiency, sustainable waste management, and climate-related projects are among the areas that can qualify.
For an investor, the basic structure is still that of a bond. Money is lent to the issuer, and the investor receives interest according to the terms of the issue, with repayment of principal subject to those terms.
In this article, you will learn what green bonds mean, how they work, the different types of green bonds, what projects they can finance, their advantages and risks, and what to check before investing.
Key Takeaways
- Green bonds are debt securities linked to eligible green projects or assets.
- The proceeds raised through a green bond are meant for a stated environmental purpose.
- Renewable energy, clean transportation, energy efficiency, and sustainable waste management are among the eligible areas.
- Green bonds can be issued by companies, financial institutions, municipalities, and governments.
- In India, green debt securities are regulated by SEBI, with sovereign issuances managed through the Reserve Bank of India (RBI).
What is a Green Bond?
A green bond is a debt security issued to raise funds for projects or assets that have an environmental objective.
The investor lends money to the issuer through the bond. In return, the investor may receive interest and repayment of the principal in accordance with the terms of the issue.
For example, an issuer may raise funds to finance a solar power project, clean transportation infrastructure, or an energy-efficient building. The proceeds are linked to the stated green purpose rather than being available for unrestricted use.
So, the simplest way to understand a green bond is:
It is a bond with a defined environmental purpose attached to the money being raised.
How do Green Bonds Work?
The process begins when an issuer decides to raise money for eligible green projects or assets. The issuer identifies the projects, determines the required amount, and provides information on how the proceeds will be used.
Investors then subscribe to the bond. Once the issue is completed, the issuer uses the funds for the stated purpose. The issuer also has reporting and disclosure responsibilities relating to the deployment of the proceeds.
This is an important difference from simply calling an ordinary bond "green." The use of proceeds and the related disclosures form an important part of the green bond structure.
Types of Green Bonds
Green bonds can be grouped by issuer type.
- Corporate Green Bonds: Companies can issue green bonds to finance eligible environmental projects.
- Green Bonds Issued By Financial Institutions: Banks and other financial institutions can issue green bonds and use the proceeds for eligible green financing activities.
- Municipal Green Bonds: Municipal bodies can also raise funds through green bonds for eligible infrastructure and environmental projects.
- Sovereign Green Bonds: Sovereign Green Bonds are issued by the Government of India. The government raises money through these securities and earmarks the proceeds for eligible green projects.
Green Bonds vs Regular Bonds
| Feature | Green Bonds | Regular Bonds |
| Nature | Debt security | Debt security |
| Use of proceeds | Intended for eligible green projects or assets | Used according to the terms of the issue |
| Environmental objective | Present | Not necessary |
| Interest | Depends on the issue | Depends on the issue |
| Credit risk | Depends on the issuer | Depends on the issuer |
| Maturity | Depends on the issue | Depends on the issue |
| Disclosure | Includes additional green-related disclosures | Applicable disclosures |
Benefits of Green Bonds
| Benefit | What It Means |
| Financing green projects | Green bonds provide another way to raise money for projects with environmental objectives. |
| Fixed-income structure | A green bond remains a debt investment. Depending on the terms, the investor may receive periodic interest and principal repayment. |
| Defined use of proceeds | The issuer specifies how the proceeds from the bond are intended to be used. |
| Additional disclosures | Green debt securities have additional requirements relating to the environmental objective, eligible projects and tracking of proceeds. |
| Sustainable investment choice | Investors who want their money linked to environmental projects can consider green bonds as an option in the debt market. |
Risks of Green Bonds
| Risk | What It Means |
| Credit risk | The issuer may not be able to make interest or principal payments as promised. The level of risk depends on the issuer's financial position and the security's credit quality. |
| Interest-rate risk | Bond prices can change when interest rates move. When market interest rates rise, existing bonds can become less attractive, putting pressure on their market prices. |
| Liquidity risk | A bond may not always have enough buyers and sellers in the secondary market. If an investor wants to exit before maturity, finding a buyer at the desired price may not always be easy. |
| Market risk | The market price of a green bond can move after purchase. An investor selling before maturity may therefore receive more or less than the purchase price. |
| Greenwashing risk | Environmental claims may appear stronger than the actual environmental benefit associated with the underlying projects or activities. |
What to Check Before Buying a Green Bond?
Before buying a green bond, check its maturity, use of proceeds, liquidity, funded green project, and issuer quality. Review when the principal will be repaid, how the funds will be used, and whether the bond can be sold easily if needed.
Also, understand the project being financed, such as renewable energy or cleaner transport, and assess the issuer’s financial position and credit quality rather than relying only on the bond’s green classification.
Green Bonds in India
Green bonds have found a place in India's debt market as financing for environmentally focused projects has increased.
The market includes different types of issuers. Companies and financial institutions can raise money through green debt securities, while municipalities and the Government of India have also issued green bonds.
The Government of India entered the sovereign green bond market in January 2023, when it conducted its first Sovereign Green Bond auctions. The funds raised are meant for eligible green projects.
Are Green Bonds Right for Everyone?
The first question is still the same as with any other bond: who is borrowing the money and on what terms?
The credit rating, interest payments, maturity, and market liquidity can affect the investment. Someone who expects to need the money in two years, for example, may not want to lock it into a bond with much longer maturity.
There is also a difference between issuers. A green bond issued by a company carries a different credit profile from a sovereign green bond issued by the Government of India.
The environmental purpose may be an important reason for choosing a particular bond. It should not, however, replace the basic assessment of the investment.
Conclusion
A green bond is, at its core, a debt investment. What sets it apart is the purpose for which the money raised is meant to be used. The proceeds may go towards renewable energy, clean transportation, energy efficiency, or other eligible green activities. Investors therefore get an investment linked to a stated environmental purpose.
That does not eliminate the risks associated with bonds. The issuer's credit quality, interest rate, maturity, yield, and liquidity can still affect the investment. The green label tells you what the money is intended for. It does not tell you whether the bond is a good fit for your portfolio.
