Green bonds are bond issues whereby the proceeds are ring-fenced and exclusively applied to finance or re-finance in part or in full new and/or existing projects that will promote progress on environmentally sustainable activities.

Green bonds have historically been issued by multilateral lenders such as the World Bank, the African Development Bank and the European Investment Bank. However, there have been many corporates issuing green bonds – whether it be for environmentally friendly projects such as the development of renewable energy, green buildings or to reduce greenhouse gas emissions in respect of its ordinary business activities – thereby tapping the high investor demand for green bonds and also increasing its market appeal to a broader investor class. Green bonds have become one of the key funding platforms for many issuers.

Sovereign issuances of green bonds have also taken off with the first sovereign green bond being issued by Poland in December 2016, followed by the €7bn issuance by the Republic of France in January 2017 and numerous other sovereign issuances since. The United Kingdom (UK) also issued its record £10bn inaugural green gilt in 2021, followed by a second issuance in the year with the world's first standalone retail green savings bond. The European Commission also issued in 2021 the first NextGenerationEU green bond with an issue size of €12bn, which was 11 times oversubscribed with a final order value of €135bn.

It is expected that the trend for green issuances by corporates and sovereigns will continue and drive accelerating growth in the green bond market.

It is expected that there will be an acceleration in the issuance of green bonds, not only because this aids diversification of investor pools, but also because of investors' growing intention to implement environmental, social and governance (ESG) targets initiated by the United Nations Principles for Responsible Investment (PRI). There are over 3,800 PRI signatories representing over $US 120tn of assets under management. Asset managers are developing new products to meet the demands of investors who appreciate competitive yields but which also support green projects. Such movements towards green investments have also been further buttressed by the global commitments shown at COP26 in Glasgow held in Q3 2021.

The green credentials of green bonds can be broadly structured and categorised in the following ways:

Green use of proceeds bond

A 'green use of proceeds bond' is a standard recourse-to-the-issuer debt obligation for which the proceeds are held in a sub-portfolio or otherwise tracked by the issuer and attested to by a formal internal process that is linked to the issuer's lending and investment operations for projects.

The Green Bond Principles (explained below) recommend that issuers disclose to investors the types of temporary investment instruments for the balance of unallocated proceeds.

Green use of proceeds revenue bond

A 'green use of proceeds revenue bond' is a non-recourse-to-the-issuer debt obligation in which the credit exposure in the bond is to the pledged cash flows of the revenue streams, fees, taxes, etc and the use of proceeds of the bond goes to related or unrelated green projects. The proceeds are moved to a sub-portfolio or otherwise tracked by the issuer and attested to by a formal internal process that will be linked to the issuer's lending and investment operations for projects.

The Green Bond Principles recommend that issuers disclose to investors the types of temporary investment instruments for the balance of unallocated proceeds.

Notably, the underlying collateral need not always be 'green' as demonstrated by the green bonds issued by Toyota in March 2014. The structure involved the securitisation of auto loans to collateralise its green bonds, the issuance proceeds of which were allocated to fund the development of environmentally-friendly automobiles.

Green project bond

A 'green project bond' is a project bond for a single or multiple green project(s) for which the investor has direct exposure to the risk of the project(s) with or without potential recourse to the issuer.

Green securitised bond

A 'green securitised bond' is a bond collateralised by one or more specific projects, such as covered bonds, asset-backed securities and other structures. The first source of repayment is generally the cash flows of the assets securing the bonds. This type of bond covers, for example, asset-backed securitisations of rooftop solar photovoltaic.

The Green Bond Principles are voluntary best practice guidelines set out by the International Capital Markets Association (ICMA), an industry body. They are intended to encourage transparency and disclosure, and promote integrity to facilitate the development of the green bond market. They are designed to provide issuers with guidance on the key components involved in the issuance of green bonds. The principles are administered by ICMA as Secretariat.

The Green Bond Principles have also contributed to, or form a basis for, the development of green bond standards such as the ASEAN Green Bond Standards, and the proposed EU Green Bond Standard.

The Green Bond Principles do not seek to define what green bonds are, or set out comprehensively eligible categories of green bond projects. Rather, they recommend that issuers communicate their use of proceeds categories clearly and transparently so that investors can make their decisions based on their determination of the bond's consistency with their investment strategy. By facilitating greater disclosure, they aim to assist at the point of making investment decisions and buttress the green credentials through accountability, assessment and reporting. As a result, investors will be better equipped to evaluate environmental and/or social impact.

The Green Bond Principles consist of four components, set out below.

Use of proceeds

Issuers should declare the eligible green project categories (including types of investments made indirectly through financial intermediaries) in the 'Use of Proceeds' section of the legal documentation and disclosure for the green bonds. The Green Bond Principles recommend that clear environmental benefits be described and, where feasible, quantified and/or assessed.

The Green Bond Principles include a non-exhaustive list of certain types of recognised 'green' projects as including:

• renewable energy (including production, transmission, appliances and products)
• energy efficiency (such as in new and refurbished buildings, energy storage, district heading, smart grids, appliances and products)
• pollution prevention and control (including reduction of air emissions, greenhouse gas control, soil remediation, waste prevention, waste reduction, waste recycling and energy/emission-efficient waste to energy)
• environmentally sustainable management of living natural resources and land use (including environmentally sustainable agriculture; environmentally sustainable animal husbandry; climate smart farm inputs such as biological crop protection or drip-irrigation; environmentally sustainable fishery and aquaculture; environmentally sustainable forestry, including afforestation or reforestation, and preservation or restoration of natural landscapes)
• terrestrial and aquatic biodiversity conservation (including the protection of coastal, marine and watershed environments)
• clean transportation (such as electric, hybrid, public, rail, non-motorised, multi-modal transportation, infrastructure for clean energy vehicles and reduction of harmful emissions)
• sustainable water and wastewater management (including sustainable infrastructure for clean and/or drinking water, wastewater treatment, sustainable urban drainage systems and river training and other forms of flooding mitigation)
• climate change adaptation (including efforts to make infrastructure more resilient to impacts of climate change, as well as information support systems, such as climate observation and early warning systems)
• circular economy adapted products, production technologies and processes (such as the design and introduction of reusable, recyclable and refurbished materials, components and products; circular tools and services) and/or certified eco-efficient, and
• green buildings which meet regional, national or internationally recognised standards or certifications for environmental performance.

The Green Bond Principles recommend that issuers provide an estimate of the share of financing versus re-financing, and where appropriate, also clarify which investments or project portfolios may be refinanced and the expected look-back period for any refinancings.

Process for evaluation and selection

Issuers should outline the decision-making process followed to determine the eligibility of the projects, including the type of projects the funds are meant to support and the environmental sustainability objectives, and the processes by which the issuer identifies and manages perceived social and environmental risks associated with the projects. Issuers are further encouraged to communicate such information in the context of the issuer's overarching sustainability strategy, and the alignment with any market-based taxonomies, green standards or certifications, and have a process to identify mitigants to known negative material social and/or environmental impacts. The processes for project evaluation and selection can be supplemented by a review by a third party.

Management of proceeds

Net proceeds should be moved to a sub-portfolio or otherwise tracked by the issuer and attested to by a formal internal process that will be linked to the issuer's lending and investment operations for projects. The Green Bond Principles recommend that issuers make known to investors the intended types of temporary investment instruments for the balance of unallocated proceeds. The proceeds can be managed per bond (bond-by-bond approach) or on an aggregated basis for multiple green bonds (portfolio approach).

Reporting

Issuers should report at least annually via newsletters, website updates or filed financial reports on the specific investments made from the green bond proceeds, detailing (wherever possible with regards to confidentiality and/or competitive considerations) the specific projects and amounts invested along with the expected environmentally sustainable impact.

Investors are increasingly focused on impact reporting as an important mechanism, not only for issuers to be accountable (on a 'soft' basis) on the achieved environmentally sustainable impact, but also as a metric to measure their own investment performance from a sustainability perspective.

Market participants have looked towards having a harmonised framework for impact reporting to facilitate issuers in the reporting process and also for investors to understand and compare the impact report easily. ICMA has developed a harmonised framework for impact reporting for the various green project categories.

The Green Bond Principles recommend that issuers use external assurance to confirm their alignment as set out above. Such assurance might include:

• third-party reviews and consultations — recognised experts in environmental sustainability may review or help in the establishment of the issuer's processes for project evaluation and selection;
• audits — auditors may independently verify or audit, for example, the internal tracking method and the allocation of funds. Such reports and audits by qualified third parties or internal and/external auditors may be publicly disclosed at the discretion of the issuer;
• third-party certifications — these may be used to provide assurance on the green credentials of green bonds (see further below); and
• ratings — a number of credit rating agencies are developing their own green assessments to assist investors in determining how 'green' a project is.

There is no single or universal standard to establish green credentials, in part because the potential scope and areas in improving environmental and social impact are quite vast and varied. Further new technologies and improvements are continuously developing. Neither is there a single authoritative global body to provide a stamp of approval.

In light of this, issuers have procured various third parties to provide verifications or certifications on green credentials. They include Centre of International Climate and Environmental Research Oslo (CICERO), Sustainalytics, Vigeo Eiris, Climate Bond Initiative and Leadership in Energy and Environmental Design. These are neither exclusive nor exhaustive.

Credit rating agencies and stock exchanges have also made further developments in this area (see further below).

Although the market is generally seen to be fairly robust, greenwashing concerns remain in some quarters. In order to achieve the objectives of the European Green Deal and following recommendations by TEG (see further "Regulations and incentives" section below), the Taxonomy Regulation was introduced (the EU Taxonomy). The EU Taxonomy is a classification system, establishing a list of environmentally sustainable economic activities – thus defining which economic activities can be considered to be environmentally sustainable. This is intended to provide a common language and understanding to issuers and investors and to prevent greenwashing. Pursuant to the EU Taxonomy, the European Commission has to come up with the actual list of environmentally sustainable activities by defining technical screening criteria for each environmental objective through delegated acts.

The EU Taxonomy establishes six environmental objectives:

1. Climate change mitigation
2. Climate change adaptation
3. Sustainable use and protection of water and marine resources
4. Transition to a circular economy
5. Pollution prevention and control
6. Protection and restoration of biodiversity and ecosystems

To qualify under the EU Taxonomy, economic activities need to:

• provide a substantial contribution to at least one of the six environmental objectives;
• cause 'no significant harm' to any of other environmental objectives;
• comply with robust and science-based technical screening criteria; and
• comply with minimum social and governance safeguards.

There are currently plans going through the EU legislative process to introduce the EU Green Bond Standard, which was originally proposed to be voluntary but is undergoing review by the European Commission as to whether this should be mandatory. The EU Green Bond Standard requires that green bonds under its standard follow the EU Taxonomy criteria, in addition to requiring issuers to publish a Green Bond Framework, allocation and impact reporting and verification. There will also be a registration requirement and supervisory regime for external reviewers under the proposed EU Green Bond Standard.

The green bond market continues to develop and as it matures, issuers would continue to be sensitive to its reporting obligations, costs and any assessments and/or audits whereas investors would continue to review from yield, liquidity and benchmarking perspectives.

Green bond indices

From the inception of the green bond market, green bond indices (including those administered by MSCI, Barclays, Standard & Poor's, Bank of America Merrill Lynch and Solactive) have been launched to aid in benchmarking and liquidity. It is interesting to note that each of the indices have a slightly different criteria for inclusion on its index (be it issuer eligibility criteria, reliance on third-party assessment, self-labelling, etc) and this may facilitate or form part of an investor's investment criteria.

Green exchanges

A number of stock exchanges (including the London Stock Exchange Group and the Luxembourg Stock Exchange) have also set up green exchanges, with their own eligibility criteria. Most tend to require a third party review or 'green' assurance in some form.

Green evaluation/assessment

Various independent third parties have also developed frameworks for assessing how 'green' a project is. S&P Global Ratings launched its Green Evaluation tool in 2017 which assesses how 'green' a project is on a project-specific basis and on instruction (this evaluation will not automatically continue during the life of the project(s), unlike credit rating evaluations). Vigeo Eiris provide sustainability ratings and ESG assessments, in addition to the second-party opinions usually provided in relation to green bonds as per the recommendations by the Green Bond Principles.

Expansion of jurisdictions

There is an expanding coverage of jurisdictions where green bonds are issued. This has been led by sovereign issuers (including Poland and France for conventional bonds, and Indonesia for sukuk issuance) and public sector issuers (such as Transport for London and SNCF Reseau). To further facilitate the development of impact reporting, a working group of Nordic public sector issuers published a Position Paper on Green Bonds Impact Reporting in October 2017 which may be helpful to public sector issuers in other jurisdictions. This paper aimed at striking a balance between a commitment to report at a manageable level and providing detailed and verifiable numbers on the projects.

In December 2019, the European Commission published the 'European Green Deal', which has been described as 'a roadmap for making the EU's economy sustainable by turning climate and environmental challenges into opportunities across all policy areas and making the transition just and inclusive for all'. Initiatives include labels for green retail investment products and an EU Green Bond Standard.

Green city bonds

An increase in the issuances of green bonds by cities is expected and a number of cities in the US and Sweden have undertaken issuances. This is a natural evolution as cities currently account for 70% of emissions and 50% of the global population. With their populations expected to rise by 70% by 2050, cities will be key in driving impact on climate change. Cities are projected to require at least $US 1.7tn a year for climate change mitigation and adaptation purposes in order to align greenhouse gas levels with that required to limit global warming to 2°C. In the UK, the Green Finance Institute has also launched a campaign to help local authorities issue Local Climate Bonds (a type of municipal green finance investment). Such fundings have been used for green projects including in respect of solar panels, habitat restoration, tree planting and LED lighting.

Regulations and global initiatives

The High Level Expert Group in Sustainable Finance published its final recommendations to the European Commission on 31 January 2018. The European Commission has subsequently built upon those recommendations and published its Action Plan on 8 March 2018. This included, amongst others, the following:

• creating an EU taxonomy
• creating standards and labels for green financial products
• fostering investments in sustainable infrastructure projects
• developing sustainability benchmarks
• better integrating sustainability in ratings and market research
• clarifying institutional investors' and asset managers' duties
• incorporating sustainability into prudential requirements, and
• fostering sustainable corporate governance and attenuating short-termism in capital markets.

As part of the Action Plan on the various workstreams taking place in the immediate future, the European Commission has tabled legislative proposals, established public consultations and invited feedback from other organisations, and appointed a technical expert group (TEG) on sustainable finance. It is expected that this will significantly contribute to the development of the green bond market, and sustainable finance more generally. In March 2019, a call for feedback was set up by TEG. It particularly requested feedback on obstacles to the development of the green bond market, eligible use of proceeds raised, reporting and verification requirements, as well as on possible incentives to help the European green bond market grow. On 18 June 2019, TEG published a report on an EU Green Bond Standard to reflect both the feedback received from stakeholders and the latest analyses conducted by the group. A summary of the report is also available. Based on the recommendations of this report, in March 2020, TEG published a guide on the EU Green Bond Standard. The guide offers guidance on the use of the proposed standard and the setup of a market based registration scheme for external verifiers. In June 2020, the European Commission launched a targeted consultation on the establishment of a uniform Green Bond Standard in the EU. On 6 July 2021, the European Commission proposed a regulation for the EU Green Bond Standard, and this is currently undergoing the European legislative process including review by the European Parliament.

COP26, which took place in Glasgow in late 2021, further secured commitments by global market participants and facilitated global initiatives particularly in respect of mobilising private capital for net zero transformation. Through the Glasgow Financial Alliance for Net Zero (GFANZ), over $130 trillion private capital is committed to net zero transformation. 24 other finance initiatives for COP26, led by Mark Carney, will help transform the financial architecture by mainstreaming and scaling, including in respect of climate-related reporting, climate risk management, climate-related investment returns and the mobilisation of private finance to emerging and developing economies. Further, 38 central banks, in countries comprising 67% of the world's emissions, have committed to climate-related stress tests to review the resilience of the world's largest financial firms in the face of several climate-related risks. And 33 central banks and supervisors, representing 70% of the world's emissions, have committed to issuing guidance to firms on managing climate-related financial risks. These and various other environmental regulations and/or initiatives help drive the economy generally towards a more sustainable/green basis, which should facilitate the flow of capital towards green investments and projects.

On 30 March 2020, BIS published a working paper exploring how central banks might expand the usual triad of regulatory objectives—liquidity, safety and return—to fit environmental sustainability considerations into their reserve management frameworks. This can be done either by explicitly articulating sustainability as a defined purpose of holding reserves (reserve management), or implicitly as a supporting aspect of existing policy purposes. The paper finds that sustainability objectives can be integrated into reserve management frameworks without forgoing safety and return. Indeed, the results of an illustrative portfolio construction exercise suggest that adding green bonds to a conventional bond portfolio allows reserve managers to improve their reserves' risk profile without sacrificing expected return.

Aggregation solutions

It is expected that there will be increased aggregation structures being used, for example, the securitisation of green loans (and other asset-backed securities or covered bonds) which will create the pathway for a further maturing of the market. This has been facilitated by the Green Loan Principles which were published in March 2018 and subsequently extended in December 2018.

Greenium

'Greenium' is referred to in the market as being a premium in price (i.e. higher price) obtained by an issuer when issuing green bonds (as compared to issuing a conventional non-green bond). Over the years, greenium has been posited as potentially existing due to the typically larger book cover and greater spread compression achieved by green bonds as compared to their vanilla equivalents on average. However, historically this has been challenging to determine definitively without having a direct vanilla comparable. The greenium theory was first put to the test when Germany raised EUR6.5 billion by selling its inaugral green bonds in 2020. In particular, the green bond was matched with a conventional twin bond thereby allowing a direct pricing comparison. The lead managers stated that investors paid a 1bp premium for the green bonds compared to the conventional twin bond (and this greenium has since risen up to 5bp in secondary trading). Greenium has been further demonstrated when Denmark sold 10-year bonds worth around DKK 5 billion ($760 million) in January 2022 alongside a conventional bond. The order book was oversubscribed by almost five times that amount at DKK 23.5 billion, the highest at an opening auction for Danish government bonds since 2008. Investors were willing to pay a greenium of 5bp – one of the largest for a high-grade sovereign issuer.

Sustainability-linked and transition bonds

There has been development in the sustainable finance sphere with the advent of issuances of sustainability-linked bonds. Unlike green bonds, the use of proceeds of sustainability-linked bonds are not restricted; instead, characteristics of such bonds will change (e.g. coupon payments) depending on whether such sustainable performance targets are achieved. ICMA has also published the Climate Transition Handbook to provide guidance to issuers in 'hard-to-abate' sectors on recommendations when raising funds in debt markets for climate transition-related purposes (whether via green bonds or sustainability-linked bonds). Such transition bond has been issued in the shipping sector by Seaspan Corporation pursuant to its Blue Transition Bond Framework.