The Potential for Climate Bonds

Associate Editor Jordan Sabin

February 12, 2015

 

Science journals have covered climate change for several decades, and since the beginning of the century, global warming has seen plenty of front page press in newspapers around the world.

Despite the large body of work on the subject, the vast majority of writings have stressed a single point—the moral obligation to preserve the planet for future generations. However, climate change has recently begun to find itself in the business section as investors realize that new technologies and industries created to fight global warming offer an opportunity for significant financial returns. Nothing represents this paradigm shift more clearly than the dramatic increase in the issuance of climate bonds over the past several years.

As capital markets mobilize to reduce greenhouse emissions and preserve the environment, climate bonds have arisen as a means to guarantee invested capital flows to environmentally conscious endeavors. The term is given to any bond whose proceeds are used to finance green initiatives, such as building a renewable power plant. As climate finance remains a nascent field, investors have been hesitant to engage, and the low-risk nature of bonds has served as a natural way to enter the market. Interest in climate bonds has surged in recent years: The Climate Bonds Initiative reported USD 36.6 billion worth of new issuance in 2014, triple that of the year previous.

The most consistent critique of climate bonds thus far has been focused on the wide variability in what constitutes a “green” bond. In general, the sustainable investing space suffers from a lack of stringent metrics, but defining climate bonds has proven especially difficult—the Green Bond Principles are an admirable first step, but until regulation improves, the sector remains on shaky ground. Addressing investor concerns about the legitimacy of climate bonds, a new paper in Nature Climate Change suggests science should seize the opportunity to play a more central role in financial markets. In particular, the authors draw attention to the need for continued research into climate science; they argue persuasively that any bond wishing to receive the title of climate bond should be subject to a thorough scientific analysis to gauge its environmental impact.

Simple one-size-fits-all metrics will most likely be too broadly defined to ensure the legitimacy of the market, and bonds will need to be analyzed on an individual basis.

Climate bonds are only just gaining traction in international financial markets, currently representing well less than 1% of the total global bond market. However, the dramatic oversubscription of offerings in the past year, combined with changing investor preferences, suggests climate bonds will have staying power—as the financial sector continues to realize that investing in the planet has the possibility for fantastic returns, we can expect climate bonds to become a fixture in the low-carbon economy.