ESG Investing: The Growing Allure of Green Assets

Environmental, social, and governance (ESG)-related investments – or ‘green assets’ – have been recently growing in number, as well as type. Examples of these include:

• Green bonds,
• Social bonds,
• Sustainability-linked bonds, and
• Certain exchange-traded funds

But what differentiates these products from one another, and how are they aligned with corporate or government goals that address ESG-related concerns? Moreover, what are the benefits and risks of investing in these types of products?

Green Bonds

Green bonds have become increasingly popular financial instruments, which are intended to finance projects that are designed to benefit the environment, including climate concerns.

According to the Climate Bonds Initiative, there are several types of green bonds, including “Use of Proceeds” bonds, which peg their proceeds to fund green projects. These types of bonds are typically backed by the issuer’s balance sheet – for example, the European Investment Bank’s “Climate Awareness Bonds” are backed by the EIB.

There are also “Use of Proceeds” revenue bonds or asset-backed securities (ABS). Issuers that sell these products typically fund their debt service through the revenue streams generated by these projects, while investors have recourse to their debt through the fees and taxes the issuer collects as collateral.

The State of Hawaii, for example, has issued special purpose revenue bonds to help achieve its 100% renewable target by 2045. The deal is backed by fees on the state’s utility electric bills.

Other types of green bond issuance include project bonds, where the debt is backed only by the project’s assets and balance sheet, certain covered bonds, as well as certain ABS issuance – which may be backed by pools of green projects such as solar leases or green mortgages.

The International Capital Market Association (ICMA) oversees and helps to develop the so-called Green Bond Principles, a set of voluntary best practice guidelines first established by a consortium of investment banks in 2014. These guidelines indicate the required transparency, accuracy and integrity of information that issuers will disclose and report to stakeholders, with its four core components comprising:

• Use of Proceeds,
• Process for Project Evaluation and Selection,
• Management of Proceeds, and
• Reporting

As these Green Bond Principles do not detail what “green” should entail, issuers are typically left to determine its definition. However, categories for green projects generally involve areas such as:

• Energy
• Buildings
• Transport
• Water management
• Waste management & pollution control
• Nature-based assets, including land use, agriculture and forestry, as well as
• Information technology & communications (ICT)

The global focus on climate change, coupled with supportive fiscal and central bank policies for the broader credit markets, appear to have spurred a rise in green bond issuance.

Moody’s Investors Service, for example, recently observed that green debt types are “evolving,” with green capital instruments as one of the “emerging areas to watch.”

To date, green bonds have been issued by governments such as Germany, Sweden, and the Republic of Chile, as well as supranational organizations such as the EIB, and the Japan Finance Organization for Municipalities.

The European Central Bank (ECB) also recently decided to invest in the euro-denominated green bond investment fund for central banks introduced by the Bank for International Settlements (BIS). With this investment, the ECB contributes, within its mandate, to global efforts to promote environmental objectives – including the EU climate goals. Meanwhile, the BIS green bond fund invests in renewable energy production, energy efficiency and other projects intended to improve environmental conditions.

Also, on the corporate front, Sumitomo Mitsui Banking Corporation touts that it “regularly issues green bonds.” The Japanese bank has allocated most of the proceeds from its sales to wind and solar energy projects in Japan and the UK, as Japan grapples with meeting its Paris Accord goals on reducing greenhouse gas emissions. And among US-based issuers, tech giant Apple, real estate investment trust Duke Realty, and Bank of America have also issued green bonds.

Want to Know More?

Learn more about ESG-related financial products, including social and sustainability-linked bonds, certain ETFs, and more, in our Traders’ Academy lesson ESG Investing: Financial Products – Benefits & Risks, part of our full Traders’ Academy course on ESG Investing.

Also, issuance of green, social, sustainable, and sustainability-linked (GSSS) bonds has been on an upward trajectory over the past five years, with an exceptional rise throughout 2020, as government mandates to stave the Covid-19 pandemic roiled global economies and financial markets.

But what is the allure behind these fixed-income instruments? Who is selling and buying them? How do they differ from conventional bonds? And what purposes do they serve within the ESG investing sphere?

Join James Cardamone, Associate Director, ESG Product, at FactSet-owned Truvalue Labs for a deep discussion about these increasingly popular products and stay up to date on their latest trends in the upcoming IBKR Webinar – ESG Investing: The Global State of GSSS Bonds – to be held Monday, August 23 at 12:00pm EDT.

Register via IBKR Webinars here.