Since 2011, global sales of green bonds—that is, financial instruments that fund projects with positive environmental or climate benefits—have more than tripled to nearly $42 billion in 2015; of this, almost 20% went to energy efficiency projects (CBI 2016). However, concerns have arisen over whether the “green” label is strictly for advertising, as standards for defining greenness are still evolving (Clean Energy Finance 2016) and no industry-wide alignment exists around next steps for standardization or issuances.
Institutions such as the Climate Bonds Initiative and Moody’s Investors Service have put forth methodologies on how to certify a bond’s greenness, but both have been released only recently. Other institutions, such as the World Bank, have developed their own criteria and have their methods independently reviewed. Agencies such as the European Investment Bank opt for complete transparency, detailing how the proceeds of each dollar are used, as well as offering greenhouse gas reductions estimates on a project-level basis (Environmental Finance 2016).
In this toolkit, we describe green bonds in more detail—including their benefits, drawbacks, and types—and discuss how US states and municipalities can issue and use them.
Benefits of Green Bonds
For the State or Municipality
Green bonds may attract new types of investors for the issuer, creating a larger and more diverse investor pool. The strong demand for green bonds from investors—particularly institutional investors, such as pension funds—has led to some green bond issuances being oversubscribed (that is, there is more demand than supply). This advantageous position might allow the issuer to raise more capital, get better pricing, or seek longer paybacks. Some evidence shows that investors will pay a premium on green bonds (Barclays 2015), but the market is still very small and young compared to the global bond market, so results will vary.
For the Investor
Green bonds allow investors to invest funds in mission-aligned purposes, such as clean technology investments, while retaining the advantages of bond investment.
Drawbacks of Green Bonds
For the State or Municipality
- Seeking third-party verification of greenness costs money. For instance, the Climate Bonds Initiative has a fee of one-tenth of a basis point of the bond principal—that is, 0.001% of the total bond size (CBI 2016). Note, however, that these costs, while not insignificant, are fractions of a percent of the total capital raised (Govtech 2016).
- Additional staff time may be needed to identify green projects and separate them out from other public projects so that they may be earmarked for green bond use.
- Additional resources may be needed to adhere to the additional conditions of green bonds (including evaluation, verification, and ongoing reporting).
For the Investor
- Standards for green vary, and investors might purchase a bond that is not as environmentally friendly as the name implies. Ensuring that bonds are independently verified by a reputable source and that transparency guidelines exist will ensure greenness.
- If oversubscribed (more demand than original supply), the green bond may cost slightly more. This is true of any bond.
Types of Green Bonds
General Obligation Bond
The issuer of the bond agrees to use all available and legal means (full faith and credit) to repay the investors. For a state or locality, this usually means funds are repaid by tax revenue. From an investor and credit-rating standpoint, this bond is very secure. The pricing and rating of this green bond will be very similar to any other bond that the state issues (green or not) as the source of repayments is the same (see the Massachusetts example in “Examples of Green Bonds” below).
Revenue Bond
The issuer repays the investor from specific income streams only, and the bond is not backed by the full faith and credit of the issuer. For this reason, revenue bonds are considered riskier and are typically priced higher. In clean energy, a typical revenue bond may use a specific water or sewer tax or fee to repay bond issuances.
Examples of Green Bonds
In 2013, Massachusetts became the first state to issue a municipal green bond. As part of a $475 million general obligation bond, the state designated $100 million as green and followed the World Bank model (Reuters 2013).
The Hawaii Green Infrastructure Authority’s Green Energy Market Securitization (GEMS) program was capitalized by the Public Utility Commission through a $150 million green bond. The investors are paid via a ratepayer tariff on customer utility bills. To offset the tariff, another utility bill item was reduced (ACEEE 2016). The program will initially provide financing for distributed solar equipment, but could eventually be used for other technologies, including residential energy efficiency (Hawaii 2017).
The Upper Mohawk Valley Regional Water Finance Authority issued an $8.78 million green bond to increase water system resiliency. This was the first municipal green bond rated by Moody’s Investor Service’s Green Bond Assessment program, and it received the highest mark possible (Bondbuyer 2016)
The District of Columbia Water and Sewer Authority issued a bond to fund part of its DC Clean Rivers Project. Originally a $300 million offering, it received subscriptions of more than $1 billion, enabling DC Water to increase the size of the bond to $350 million, decrease it by 15 basis points, and extend the maturity to 100 years (ACEEE 2016).
For full details on these bonds, you can search for them on the Electronic Municipal Market Access.
How to Issue a Green Bond
Any entity with bonding authority and bond capacity (with sufficient access to capital markets) can issue a bond. The determination of “green” is still somewhat loose, although entities such as Climate Bonds Initiative and Moody’s have certifying standards. Issuing a green bond is the same process as issuing a regular bond, but there may be additional verification processes to ensure that any adopted standards are met (some financial advisors and auditors offer this service).
