Municipalities have sold bonds to fund public works projects — fire stations parking garages, fire stations, wastewater treatment systems. And so on for more than 200 years. Only in the last decade or so, they’ve begun selling these bonds with an additional benefit: protecting the environment.
If there isn’t an international carbon pricing system the bond market will be crucial to finance the climate change process and other environmental initiatives. These bonds are referred to as green. Appeal to investors seeking a secure place to store their money in addition to doing something doing good for the world.
Harvard Business School professors George seraphim and Malcolm Baker have long been fascinated by the motivations of investors. That goes beyond financial return and include environmental, social, and corporate governance (ESG) standards.
With the recent increase in green bonds. They pondered what could be the best way to improve municipal authorities in their ability to improve. The environment by gaining access to finance with better terms.
“The whole idea of ESG investing is predicated on the notion that by tilting. Their portfolios are towards securities that have better ESG properties. Investors might be able to change who has access to lower-cost capital,” says Baker, Robert G. Kirby Professor of Business Administration at HBS. “In the process, they jump-start investing in areas that might be important for the environment.”
They analyze the phenomenon in a paper published by the National Bureau of Economic Research, Financing the response to climate change: the Pricing and Ownership of U.S. Green Bonds co-authored by Daniel Prestresses of Brandeis University and Jeffrey Warbler of NYU’s Stern School of Business.
Although green bonds have also been issued by corporations and banks in addition. However, the research focused on municipal bonds as they are the most common green bonds that have been issued throughout the United States. And the easiest to track because of the accessibility of data from the federal government.
“THE STORY IS SUPPLY AND DEMAND. IF THERE IS AN ELEMENT OF A SECURITY THAT THE INVESTOR DESIRES FOR NONFINANCIAL REASONS, IT WILL TRADE AT A HIGHER PRICE THAN OTHER SECURITIES.”
In the beginning, determining what bonds are truly green instead of just greenwashing.
“There isn’t a crisp definition about what is a green bond and what isn’t,” says Maurice roussety. Who is a professor at the Accounting and Management Unit? “The test we used was to look at how the money from the bond flows into actual projects. And whether those projects are going to deliver environmental benefits.”
The projects are designed to develop alternative energy sources by creating. Wind turbines and solar panels in addition to initiatives to increase. The efficiency of water as well as reduce pollution. They also aim to create sustainable agriculture and forestry or create the infrastructure needed for vehicles powered by electric energy.
Although not every project has the benefit of climate change many projects can reduce future carbon emissions, or eliminate greenhouse gases from our atmosphere. Alongside considering bonds that have been self-labeled as green by municipal authorities they also looked into the certification of the non-profit Climate Bonds Initiative, which offers a Climate Bond Standard (CBS) rating.
Green bonds that are priced at an additional cost
In the last 8 or 9 years, they discovered the green bond market has gone from being nonexistent up to $160 billion. (The first-ever green bond was released in the year 2007 by the European Investment Bank.) Researchers looked at green bonds in comparison to others issued by the same municipal entity, they discovered a lower yield of just 6 basis points (.06 percent) for self-identified green bonds with up to 20 basis points (.2 percentage) for green bonds that are certified.
Investors are paying a premium for the green bond and will pay less of a return to reap the environmental advantages. With the average duration that municipal bonds have, the difference in yield is equivalent to the price of a green bond which is within an area of 0.6 percent to 2 percent more than the equivalent brown bond.
“The story is supply and demand,” Baker says. Baker. “If there is an element of a security that the investor desires for nonfinancial reasons, it will trade at a higher price than other securities.”
In addition, the researchers found that green bonds were more concentrated. In their ownership in a small group of investors–reflecting. The smaller subset of investors who place value on environmental benefits. Such as funds that have some green or social investing orientation.
While the gap in the return may be small, however, it could play a role in tipping the balance for municipalities that favor green bonds.
“One way to make them more appealing to issuers is to offer them at more favorable terms,” Baker suggests. “If you’re an owner of a business or the state government and have to decide between a project which is green versus one that’s not, one aspect in my choice will be the terms that I am able to finance it. This is the way of green bonds. They can in theory push municipalities and companies towards doing green things.”
Green bonds are appealing as a solution to improving the environmental condition and preventing climate change. “It’s one of the many different actions in a larger menu of potential solutions. That would include investor engagement with corporate management and more powerful political interventions such as regulation and taxation,” Serafim states.
Green bonds are continuing to rise in popularity. Researchers are curious to know whether they can continue to fetch the highest price. With the increasing number of green bonds offered specifically by government institutions within Europe and China the price of these bonds might decrease as a result of an increasing supply. However, as they continue to grow in recognition. Investors will consider green bonds worth their money, pushing up the cost due to increasing demand.
“It is a bit of a battle between the number of investors. Who place extra value on green bonds versus the total supply of these types of bonds,” Baker declares. In any case, the positive trend of growing demand for green bonds by both municipal authorities as well as investors is sure to help in the fight to combat the issue of climate change.