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They’re laying the groundwork for the future of climate financing.

Seattle-based Sound Transit issued more than $900 million in so-called “green bonds” last week to improve the bus and train system, with a goal of cutting down on carbon emissions from transportation in the region.

The green bond offering, which Sound Transit says is the largest ever by a municipal government, marks a milestone in the growth of a financial instrument that’s only been around for less than a decade. Green bonds work much the same way as any other bond: an institution takes money from investors to finance a project, and pays it back with interest over time. But with green bonds it’s the money’s destination that makes all the difference.

Green bonds typically go through an independent vetting process to ensure the money finances projects that benefit the environment (or that minimize harm to it, depending on how you look at things). Whether this scrutiny amounts to optics or the path to a more sustainable society is up for debate, but proponents argue the bonds provide additional social benefits beyond the cash and cater to a growing community of ecologically responsible investors.

The concept of green bonds is fairly new. In 2007, the European Investment Bank issued a “Climate Awareness Bond” linked to an equity index. The next year, the World Bank launched its first green bond issuance at the request of Scandinavian pension funds that were looking for safe investments that also tackled climate change. After working with them on the first offering, the World Bank kept going with the concept and by 2013 utility companies, banks, and government agencies had joined the mix, for a total of about $11 billion. That amount shot up to almost $37 billion in 2014.

So far this year green bond issuances have come to almost $22.5 billion. That’s a drop in the bucket of the roughly $80 trillion global bond market, but it’s a start.

The amount of green bonds and the types of groups issuing them have increased considerably since their appearance in 2007. (Data from Bloomberg and the World Bank)

There aren’t any legal qualifications for what constitutes a green bond. Instead, there’s a system of verification and scrutiny that goes into any green bond issuance, says Chris Davis, who directs the investment program at Ceres, a nonprofit group that advocates for sustainable business practices and investing. His organization recommends that green bond issuers go to an outside inspector to vet eligible programs before financing them. The issuer should then set up internal tracking protocols to ensure the money does indeed go to green purposes. That’s become standard practice, and is included in the Green Bond Principles, a voluntary code of conduct for issuers.

The verification process takes some time and money that a traditional bond issuer doesn’t have to pay. “We don’t think it’s a lot or crushing, but it’s not zero,” Davis says. Plenty of bonds have raised money for infrastructure improvements that would qualify as green without going to the trouble of labeling them as such. Given that they pay about the same, one might ask what the green moniker really achieves.

For starters, it draws demand from investors who want to earn money while helping finance projects like wind and solar power plants and more efficient transportation around the world.

“If you can pick a financially equivalent green bond, particularly if you are concerned about the risks of climate change or the well-being of the beneficiaries of your pension fund, a lot of pension funds and institutional investors find that this is a positive for their long-term mission,” Davis says. “It’s an extra benefit that you don’t have to pay for.”

Indeed, demand for green bonds has consistently exceeded the amounts available. (“There’s a clamor for more of them,” Davis says.) The Sound Transit offering of nearly $1 billion sold out in the first morning, says agency CFO Brian McCartan. Then again, McCartan estimates that only 1 or 2 percent went to dedicated green bond investors (people who exclusively invest in environmentally responsible ways). The rest were investors looking for a good bond and finding one that happened to be green.

The green designation, though, earned the project more national news headlines than the typical municipal infrastructure bond enjoys. In a crowded media landscape, green bonds get people’s attention for sustainability projects in a way that traditional bonds do not, and that can draw in environmentally conscious investors who didn’t know about the opportunities before.

“We hoped we could attract some additional marginal green investors,” McCartan says. “By being a best-in-practice issuer, we hoped we could deepen and strengthen the green bond market for future issuers, and I think we did that.”

Green bonds further increase the mixing of climate change expertise with financial expertise, says Heike Reichelt, head of investor relations and new products at the World Bank. She oversees the World Bank’s green bonds, which have raised $8.5 billion for climate change projects around the world since their launch in 2008.

Investors such as pension funds and bank portfolio managers expect more transparency around the projects that green bonds are supporting, so they can dive into the nitty-gritty of the projects and explain the expected positive impacts to their stakeholders. In the process, they end up with a greater awareness of climate change and the efforts to deal with it.

"I have a finance background—I’m not a climate expert. But I’ve learned so much working on green bonds and we see a similar process with many of the bond portfolio managers we meet,” Reichelt says. “Finance people are talking about hybrid cars and greenhouse gas emission reductions, and how different baselines in different countries matter in measuring them. Those are topics that they didn’t talk or ask about before. It’s just becoming an additional aspect they look at when they invest."

In other words, the most environmentally significant effects of green bonds may be the hardest to quantify. The projects themselves could likely draw financing just as readily from traditional bonds. The green bonds, though, have expanded the market share of explicitly environmental investments and contributed to a greater awareness within financial institutions of climate change risks and responses.

Both of these outcomes could help cities and climate advocates fund vital adaptation projects in the decades to come. The International Energy Agency has estimated that limiting global warming to 2 degrees Celsius will require an additional $1 trillion of investment worldwide each year. In that light, an annual green bond total on the order of $37 billion or so isn't just optics—it's a start.

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