What are Climate Bonds

• 28 January 2020 | 1289 Views | By Abhinav Mishra

Climate Change is a crucial and critical issue of our time and we all are at a defining moment. From unstable weather conditions that threaten our food production, to addressing issues of the rising sea levels that upsurge the risk of catastrophic flooding. The impacts of climate change are global in scope and unmatched in scale. Without drastic and immediate action taken today, adapting to these impacts in the future will be more difficult and even more costly. To help address a little to this ever-increasing climate change are Climate bonds. Let us understand about these.

What is Climate Bond?

Bonds are a type of loan or IOU that companies, governments, and banks use to finance projects. The issuer of the bond owes the holder a debt and, depending to the terms they agree on, is obliged to pay back the amount lent within a certain amount of time and with a certain interest. This is the basic concept of bonds. Climate bonds are used to finance projects needed to address the issues related to climate change. These projects could range from wind farms and solar and hydropower plants, to rail transport and building sea walls in cities threatened by rising sea levels. These could even be used in greenhouse gas emission reduction projects. Climate bonds are a relatively new asset class, but they are growing promptly.

Like normal bonds, governments, multinational banks or corporations can issue climate bonds. The bond issuing entity guarantees to repay the bond over a certain period of time added with either a fixed or variable rate of return. Most of the climate bonds are asset-backed with investors being promised that all funds raised by it will only go to specified climate-related programs or assets.

What is the Climate Bonds Initiative (CBI)?

The Climate Bonds Initiative is an investor-oriented and a not-for-profit initiative launched to upturn investments contributing to the transition to a low-carbon and climate-resilient economy. It provides standards and guidance on green bonds and publishes studies on the evolutions of the green bonds market every year since 2012. 

What is the Climate Bonds Standard? 

The Climate Bonds Initiative has developed environmental standards with which projects must abide by in order to achieve the corresponding Certification mark. Investors of these approved programs are therefore assured that their funds are being used for projects that support climate change and the green bonds associated with these projects are easily labeled and identifiable.

Types of Climate Bonds

Broadly climate bonds can be categorized as into 3 categories:

1. Organization-guaranteed bonds: These are like the general bonds where the investor invests on the basis of the credit worthiness of the organization.  The return that the investor will receive will depend on the various sources of revenue and assets the organization owns.
2. Asset-backed securities or secured bonds: These are bonds where the coupon or say the interest is linked directly to cash flows from specified assets, such as wind energy farms or loans to the solar project.
3. Dual recourse bonds: This is a variation of asset-backed securities. These are the types of bonds where the investor has recourse to both the company and the specified assets. If a company goes bankrupt it’s the investor who owns the assets, not the bankruptcy administrator, so the investor knows what they’re getting as security. 

Benefits of Climate Bonds

The growth of bond markets provides increasing opportunities to finance the implementation of sustainable Development growth. Climate bonds offer the same returns as other bonds, but with the added benefit that funds are only going to climate change solutions. Climate bonds are becoming an increasingly dominant form of green finance, particularly for clean and sustainable infrastructure development and their large funding needs. In many developing countries, climate bonds are already financing critical climate-related projects, including projects like renewable energy, urban mass transit systems, and water distribution. The key benefits of issuing climate bonds are as under:

• Benefits the country:

The climate bond market has numerous benefits to a country and its environmental goals and commitments as it increases the finance available for green projects, therefore incentivizing an increase in their number. Bonds are also an instrument and an approach that attracts foreign investors too, so these institutions need little new understanding or capacity. Investors are also interested in investing money in those bond which yield higher environmental impact per unit of currency, and emerging and developing economies have the potential to offer this where lower project costs exist.

• Investor Diversification

These are a very different type of investment as compared to normal bonds as this also gives an additional satisfaction to the investor to be able to do his or her bit towards the environment along with yielding returns to their investment. It just adds variety to an investor’s portfolio.

• Positive public relations

Climate bonds can help in building issuer’s creditworthiness, as this is an effective way for an issuer to demonstrate its green credentials. It displays the issuer’s commitment towards the development and sustainability of the environment. 

• Potential for pricing advantage

Climate bond issuance attracts a wider investor base and this may, in turn, benefit the issuers in terms of better pricing of their bonds in comparison with a regular bond. As the demand for the climate bonds surges, it is likely to initiative increasingly favorable terms and a better price for the issuer. Further, with the rising focus of the global investor community towards green investments, it is anticipated that a new set of investors will enter into this space in quantity, leading to lowering the cost of funding for green projects even more.

Conclusion

Climate change affects all of us in a massive manner. Its potential effects on temperatures, precipitation patterns, sea levels, and frequency of weather-related disasters pose risks for agriculture, food, and water supplies and more so a hazardous planet for the future generations to survive in. Tackling this immense challenge must involve both mitigation to avoid the unmanageable and adaptation to manage the unavoidable along with maintaining a focus on its social dimensions. Addressing climate change requires unprecedented global cooperation across borders too. The climate bonds are a pleasant solution to this problem. More so, the climate bond market has an estimated value of $346 billion. Even though the climate bond market has attracted international criticism with some questioning the green credentials of certain bonds but in the light of the global commitment to shift to a greener and a low-carbon economy, the climate bond market has the potential to grow significantly, while fascinating more diverse issuers and investors.