What are green bonds and how do they work?

If you’re looking to make more sustainable or climate-focused investments, green bonds are an interesting option to explore.

It’s a way to invest for your future with the planet’s future in mind too.

Here’s everything you need to know about investing in green bonds for the first time.  

Green Bonds - the context

As the world’s climate crisis intensifies, more investors are waking up to the ethical importance and potential financial returns of climate-focused investments.

There are a number of ways to make sustainable investments, such as investing in renewable energy and investing directly into companies that are making a positive environmental impact.

But what about green bonds? 

The first green bonds were issued by the European Investment Bank in 2007 in response to growing concerns about climate change.

Increasing numbers of investors want to use their money to do good, but many remain fairly risk averse.

Between 2012 and 2020, the value of issued green bonds rose from $2.6 billion (£2.1 billion) to $270 billion (£218 billion) — so it’s clear there’s a healthy appetite for this kind of investment.  

Green bonds are an excellent way to balance risk and make a genuine contribution to a better future.  

What is a green bond? 

To put it simply, green bonds are a way to raise funds for environment and sustainability-focused projects. But how do they work? 

As with any bond, green bonds allow public or private institutions like governments or local improvement groups to take out a loan to fund their work.

Instead of borrowing money from a bank, the organisation will raise the money through a group of individual investors, with a set interest rate and repayment timeline for their debt. 

Green bond is a pretty diverse term, as it could support everything from building clean transportation systems to creating infrastructure to support renewable energy.

The only caveat is that the money must be used to impact the environment positively.  

Types of green bond

Green bonds are often described as sustainable bonds or climate bonds, but the terms aren’t always interchangeable.

Generally, sustainable or climate bonds will focus specifically on projects that directly reduce climate change or cut carbon emissions.

For example, a climate bond issued by a government could be aiming to expand the country’s renewable energy infrastructure to cut carbon emissions by a certain percentage.  

Broader green bonds can be focused on anything that has a positive environmental impact.

You could purchase a bond that intends to restore a country or region’s wooded areas, or that funds infrastructure to improve communities’ access to clean water.

While these bonds aren’t closely focused on climate change, they still help to improve the broader natural world.  

How do I know if I’m investing in the right green bond?

Most issuers (the institution or organisation that’s raising the money) will have their own criteria or rationale explaining how exactly the money will positively impact the environment.

Some work to the UN’s sustainable development goals (SDGs) while others have set targets for factors like reducing CO2 emissions.  

Many green bonds are verified by third parties, like the Climate Bond Standard Board, to give investors confidence that whatever they’re funding will genuinely benefit the environment.

Additionally, the International Capital Market Association published its Green Bond Principles for issuers, which also help investors understand if a green bond is worth investing in.  

As an investor, you can check which issuer best aligns with the impact you’d like your money to have.

If you’re particularly passionate about combatting deforestation, supporting renewable energy or improving waste disposal, there’s likely to be a green bond for you.  

Can I buy government green bonds?

Yes. In the UK, for example, you can buy government green bonds (also called gilts) through brokerages or directly through National Savings and Investments (NS&I).

If you know what you’re looking for and have invested before, investing directly can save you money in fees — but it may be better to seek an adviser or broker’s advice if you’re not confident.  

Are green bonds risky? 

Investing carries a level of inherent risk, but some types of green bonds sit at the lower end of the risk scale.

Government-issued bonds from countries with the highest credit ratings, such as Canada, Australia and Germany and the US, are considered pretty low risk.

These governments have been deemed extremely unlikely to default on their debts.

Any country ranked above a certain level (Baa3 for Moody’s, BB+ for Fitch and BB+ for S&P) is considered to issue investment grade bonds, meaning the government is highly likely to fully repay your bonds.

Those ranked any lower are considered speculative or junk bonds and there’s a much higher chance the government will default on its bond payments.

Yes, they may be much cheaper to invest in or promise higher interest rates, but they’re not suited to investors with low risk appetites.

Bonds issued by private companies are considered higher risk than investment-grade government bonds.

The exact level of risk is determined by the company’s financial record; a multi-national business with a strong balance sheet will be lower risk than a sustainable technology start-up, for example.

Make sure you get balanced advice before making an investment decision.

You can find the right adviser for you right here at Unbiased.