Why issuing green bonds is worthwhile for businesses, despite extensive reporting requirements.

Green bonds are to the bond market what “natural” foods are to a supermarket: both sound good, but neither term is strictly defined. How do investors know what the impact of their green bond investments really is?

In early March, the European Commission published a paper demanding standards for sustainable and green financial products, so the European Union clearly understands that there is a need for uniform terminology and clear labels. Until then, investors can rely on so-called second party opinions. For these, external experts monitor whether projects financed through green bonds actually adhere to certain criteria. These organizations have developed standard sets of criteria – a system roughly comparable to that of a rating agency. Investors can then be sure that products labeled as green are actually green.

How do a green bond’s risks and rewards compare to those of conventional bonds?

Basically, the credit risk is the same as with a conventional bond. For issuers, green bonds are often a little more attractive than conventional bonds since they are usually oversubscribed and thus offer better terms. On the secondary market, green bonds have been less volatile due to the excess demand. That means investors only pay a small premium for more stability.

Green bonds need to meet a number of requirements that conventional bonds don’t have. What additional cost and effort should issuers of green bonds expect?

The first issuance is definitely more work. Not only does a company need to prepare the bond, it also needs to develop the rules it wants to adhere to: Which criteria should be applied, and who will monitor them? But these are questions that only need to be answered once. The more green bonds a company issues, the easier it gets.

How much time does it typically take to prepare a green bond issue?

Issuers typically expect preparations to take about a year, but they often go a lot more quickly, sometimes in under six months. It partly depends on the response inside the company, and how easily the issuer can identify green assets within the company. The cost of second party opinions are exclusive to green bonds and may seem unnecessary to decision-makers. These costs, however, mostly only occur with the first green bonds issuance. As a smaller additional effort is necessary with next issuances, a company that has already been rated by a sustainability rating agency can expect lower costs for a second party opinion of the same agency.

Why are a growing number of businesses electing to issue green bonds despite the added cost and effort?

Today, no one would call green bonds a flash in the pan. They have become mainstream for capital markets. But they only make sense as part of an overarching strategy. They’re not a gimmick you use to lower financing cost a little. In many cases, senior management will initiate and support the decision. Financial markets, companies and society need to support the idea of sustainability together. The public sector alone can’t manage it. Additionally, companies can diversify their investor basis with green bonds: Many issuers notice with their first green bond that they suddenly have buyers who hadn’t previously invested in the company.

Do green bonds have any cultural implications for the issuing company?

Yes, green bonds are a strong driver to changing the way an organization thinks. They can help to make sustainability part of a company’s DNA. We’re headed for wide-ranging change in this area, and it’s better to prepare sooner than later. 

In your experience, what are the typical questions potential green bond investors have?

Often the first question investors ask themselves is, “Is this greenwashing or not?” Not everyone claiming the green label actually adheres to the minimum standards. Some also want to know whether a green bond is refinancing an existing project or whether the money will be used to finance new projects. Investors also have a growing interest in where exactly their money is going and what impact it has, so they might want to know how many tons of CO2 emissions were avoided thanks to the bond.

What role should green bonds play in a portfolio?

Everyone needs to ask themselves what they can do as an investor to promote sustainability. Green bonds are an economically sensible investment with the added benefit of a positive impact for society and the economy.