Green bonds have only been around for six years but a recent report by Toronto-based TD Economics shows the environmentally focused investments is likely to see growth in future.
“The green bond market is in its infancy, but it is showing considerable promise,” reads the report. “There is a desperate need for funding of environmental initiatives, and the sad reality is that governments lack the financial resources to meet current and future requirements.”
At the moment, green bonds consists of roughly 0.4% of the total global bond market, according to TD, with estimates of its size ranging from US$10 billion and US$346 billion.
Projects funded by green bonds vary from climate bonds, which focus on mitigating or adapting to climate change effects, to more specific energy products. Governments, private corporations, commercial banks and international financial institutions, such as the World Bank are the typical issuers of green bonds.
The most successful green bonds issued to date, according to TD, are those issued by international financial institutions as they are similar to Treasury bonds, denominated in benchmark currencies and have relatively low credit risk. Municipality and private-corporation issued green bonds have been less successful, the report says, as institutional investors usually deem them non-investment grade.
To date there have been three Canadian green bonds, says Craig Alexander, senior vice president, chief economist, TD Bank Financial Group, in Toronto, all of which were issued by private corporations. As such, the Ontario government’s recent announcement of its intention to issue green bonds next year could prove to be a turning point in the Canadian market, according to Alexander.
“If [Ontario’s green bonds are] structured in a way that’s very attractive to investors, if the option of the bonds is over subscribed,” he says, “then I think you’re going to see other jurisdictions pay attention.”
Currently, institutional investors are the primary investors in green bonds, however, Alexander cautions against discounting the importance of the retail investor in this market. Retail investors typically buy regular bonds indirectly through mutual funds, he says, and they are likely to do the same with green bonds, particularly through funds that already have an environmental mandate.
Whether the bonds are being purchased directly by institutions or indirectly by retail investors, one of the key components to the success of the market will be accountability. Says Alexander: “If the money isn’t actually being used as intended then it’s going to really undermine the market.” Green bonds must be transparent and have proper monitoring in place, he says, to make sure the money raised is actually being used for an environmental initiative.
In addition to transparency, in order for the green bond market to grow, investors will have to feel confident about returns. Investors will not buy green bonds solely because they have an environmental focus, says Alexander. Instead, the bonds must have a high credit rating and a competitive yield to others on the market.