How the Incorporation of Green Bonds Impacts Economic Sustainability Globally?

Posted: August 27th, 2021

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How the Incorporation of Green Bonds Impacts Economic Sustainability Globally?

Introduction

As much as green finance centrally focuses on how a specific investment can be environmentally friendly, recent studies have stressed the importance of deriving greater economic sustainability from green bonds. In this line of thought, investing in green bonds would significantly impact sustainability due to the following reasons. Green finance not only delivers additional sustainability but also impacts the economy on a larger scale. Therefore, the most recent approach to green financing seeks to facilitate the transformation of the entire process of initiating sustainability by integrating various sustainable projects. The combination of several green bond projects would equally lessen the high costs attached to an unsustainable system’s side effects. With the creation of green bond markets, there has been assured mitigation of both finance and risk constraints. In this regard, the introduction of green financing through green bond markets has positively impacted sustainability by slowing down the growth of environmental degradation.

Green Bond Market

With the intensification of environmental degradation globally, it is essential to invest in green bonds because it seeks to improve sustainability (Alonso-Conde and Javier Rojo-Suárez 4). In particular, it is now of high economic advantage to invest in green financial products like bonds. Investments in green financing have increased across the globe, with many nations channeling their efforts towards sustainability. For example, the move towards economic sustainability has been earmarked by massive initiatives in green bond markets, as illustrated in figure 1 (Alonso-Conde and Javier Rojo-Suárez 4). The figure expounds on the trends in the primary green bond market, ranging from 2012 to 2019. The trend has significantly improved up to 2019, with many issuers of bonds diversifying their projects in green financing (See figure 1). Graph (a) displays the growth in both new issues and market size in $ billion; it signifies the recent diversification of financial products to receive green fixed incomes (Alonso-Conde and Javier Rojo-Suárez 4). On the other hand, graph (b) portrays the geographical distribution of green bond issuers worldwide, from Germany to the US.

Figure 1. Green bonds market and its universally geographical diversification (Alonso-Conde and Javier Rojo-Suárez 4)

Illustratively, the graph implies an increasing appetite for green bonds among the corporate and government issuers with a 60% growth in 2019 (Alonso-Conde and Javier Rojo-Suárez 4). More so, graph (b) indicates that the Europeans are leading in the move towards green financing, with an additional 32% of new issuers across the market. The US green bond market follows 20% for new issuers, and the Chinese market is recording a new number of issuers at 7.5% (Alonso-Conde and Javier Rojo-Suárez 4). All these indicators in the growth of an additional number of green bond issuers happen in 2019. From these illustrated figures, it can be opined that the green bond market has emerged as a well-established market among investors. The green bond market has continued to grow exponentially since 2019 because it receives immense support from the UN-SDG on climate awareness (Alonso-Conde and Javier Rojo-Suárez 4). Although the market is still young and promising with developing countries’ dominance, there has been a recent comparative embrace among other nations like Brazil, Mexico, and China (Alonso-Conde and Javier Rojo-Suárez 4). Therefore, the emergence of the green bonds markethas fortunately bolstered cross-regional trades by pinpointing various international trading opportunities a country might harness.

            Besides, this juvenile green bond market necessitates increasing regulation from the relevant governments. The market requires a comprehensive and broad set of government control since its growth is pegged on the degree of issuance, supervision, and liquidity (Alonso-Conde and Javier Rojo-Suárez 5).Considering this kind of bond market as a subject of energy transition when allocating huge finances, many European nations have increasingly tightened their regulatory actions. In turn, the ever-growing regulation situation has compelled the need for a public-private regulatory framework to identify and analyze the challenging gaps in governance (Alonso-Conde and Javier Rojo-Suárez 5). In the long run, the government is responsible for optimizing the wide-ranging interests of both the investors and stakeholders. For example, the European Commission published an Action Plan on Financing Sustainable Growth in 2018. The Action Plan is capacitated to offer a comprehensive strategy on improving the link between finance and sustainability (Alonso-Conde and Javier Rojo-Suárez 5). Categorically, the action plan encourages the redirection of capital flows towards sustainable growth, intending to attain inclusive growth. Also, the action plan is aimed at handling the risks, which result from adverse climate change, depletion of resources, and degradation of the environment. More so, the said action plan has equally promoted transparency coupled with a long-term visualization of both financial and economic activity (Alonso-Conde and Javier Rojo-Suárez 5). Subsequently, a European Union Green Bond Standard (EU-GBS) benchmark encourages the financing of low carbon projects.

Theoretical Background on the Green Bonds and its Government Regulation

Literature on green bonds concentrates wholly on the close association between its pricing and the attached financial market (UN- ECLAC 2). In particular, existing literature establishes the relation of fixed income together with currency markets. However, the authors draw a weak connection between the green bond and the value of stock and energy. This literature provides a systematic analysis of the derived returns, liquidity, and volatility of the green bonds (UN- ECLAC 2). Besides, they offer discussions on third-party authorization’s primary responsibilities initiated on both personal and institutional challenges. Third-party authorization is critical for private issuers because corporate green bonds are regarded as less favorable regarding volatility and liquidity (UN- ECLAC 2). Furthermore, the corporate bonds might have higher interest rates as compared to their conventional counterpart. Therefore, this empirical literature reviews the pricing of the green bond in the market. For example, the green bonds have a higher comparative liquidity-adjusted yield premium than the regular bonds (UN- ECLAC 5). With lower interest rates pegged on the greater liquidity, the green bonds attract higher daily interest spreads, leading to favorable market prices. Subsequently, the authors have opined that both the financial and corporate green bonds trade more often than non-green bonds (UN- ECLAC 5). Most importantly, the marginal sales of the government-associated green bonds are more significant due to the size of the issue and maturity. However, the type of currency does not influence the pricing of the green bonds. Instead, the set rating on the Environmental Social Governance (ESG) dictates the market prices of the green bond (UN- ECLAC 5). In this regard, this literature provides an inquiry on the dynamics of volatility coupled with spillovers attached to the green bond markets. Thus, government regulation on the green bond market is a measure of controlling the bond’s sensitivity in respect to its volatility factor. As much as a considerably more significant part of literature discusses an investor’s perspectives in the green bond market, talks on the offered incentives on issuance are significant (UN- ECLAC 6). Primarily, governments provide financial incentives to issuers; these green bonds decrease the cost of invested capital through financing, leading to lower risks on the availability of capital (UN- ECLAC 7). All these measures are relevant to encourage the issuance of green bonds because they enhance the protection of the environment by creating value among investors.

Measuring and Tracking the Additionality of Green Bonds Globally

The primary features of assessing the impact of the green bond are based on the following two significant yardsticks. First, evaluating the impact of such an example of a green fixed income depends partly on establishing whether the finances attached to the bond flows towards a verifiably green project (Tu, Sarker, and Rasoulinezhad 4). Second, assessing the impacts of the bonds also relies on the determination of the extracted sustainable value in respect to the green label project (Tu, Sarker, and Rasoulinezhad 4). In this regard, it is essential to designate an appropriate framework for channeling the required green financing towards specific projects. Such a move would prevent diverting green resources into more minor “green” investment projects. The reason is that measuring and tracking the addition of a green bond inside a less “green” project is difficult (UNEP 10). Thus, this test of addition is underscored on the possibility of measuring if more significant financial flows would result in higher sustainability.Furthermore, the incorporation of green financing stimulateshigh levels of sustainability via reducing the relative costs of financing in extra sustainable investments (UNEP 11). Thus, green bonds encourage high economic sustainability by lowering the relative cost of sustainability undertakings.

Underscoring Sustainability as a Worldwide Transition through the Use of Green Bonds

Achieving green financingrequires a clear comprehension of both the start and endpoint associated with the direction of sustainability. Such understanding is gained by having expeditious knowledge on the following questions concerning the green bonds (Tu, Sarker, and Rasoulinezhad 5).

1. What a sustainable economy looks like and itsprospective pathway to sustainability.
2. What barriers or prospective catalysts impedeor encourage sustainability vision.
3. How finances help overcome barriers or activate catalysts.
4. The measurement metrics for guiding finance along the attained green path

The path and sustainability of a green bond entirely rely on the circumstances surrounding the issuance of such a bond. For example, the case study of the green bond market in China has utilized Shanxi and Sichuan energy systems to illustrate the same pathway to sustainability (Alonso-Conde and Rojo-Suárez 11). Apart from that, there might be impeding barriers and catalysts, including technological, behavioral, financial, or political, which negatively impact the market of green bonds. Hypothetically, the introduction of green financing through government bonds would decrease the technological cost like the R&D. Moreover, there are assured financial incentives that catalyze the behavioral change of issuers in a bond market. Consequently, the provision of government incentives helps reduce capital costs, leading to the financing of projects that would otherwise be unfinanced (Sartzetakis 2).  Also, lower capital costs would encourage the government to initiate policy changes on the regulation of green bond markets. As much as there are many sustainable energy investments financed using lower costs, the application of green bonds helps avoid the financial risks associated with the shift to a low carbon system (Sartzetakis 7). Thus, the shift to low carbon energy entails several expensive infrastructural changes that impact the economy differently.

Implications of Green Bonds on Economic Sustainability

Though the application of green bonds helps increase the number of financed projects, the green bond helps deliver the added value or addition (Maltais and Nykvist 4). Whereas some pundits argue that the usability of green bonds does not imply additional value, others have disagreed over the implied economic benefits. In this regard, the consideration of green financing saves on the initial costs of capital, thus ensuring that a vast number of projects are entirely financed (Sartzetakis 13). Therefore, the legitimate concern that the issuance of green bonds offers a false impression regarding its sustainability variable is true based on the following analysis. From the Swedish perspective, it is understood that the actors trade green bonds the same way they would do to the conventional bonds (Nelson 6). They argue that the green bonds function just like other financial instruments, and therefore these bonds have similar environmental impacts on economic sustainability (Nelson 6). Further, they have constantly opined that they falsely created an impression about the green bonds is the specific reason why many investors have pumped large capital bases into novel investments. Practically, there is strong evidence that indicatesmost investors and issuers have changedtheir interaction activities in the capital markets (Maltais and Nykvist 8). Indeed, such alterations in the bond market have occasioned positive effects onmany organizations’ operation sustainability. Furthermore, numerous similarities pinpoint the way green bond market and active ownership function among external stakeholders (Maltais and Nykvist 8). Even though many bonds lack voting rights, all buyers of these green bonds have engaged in sustainability dialogues. Consequently, the trading of green bonds only signifies a small percentage of the bond market; there is an effort among the investors to expand the rising number of opportunities.

Conclusion

The introduction of green bonds is designed as a familiar and low-risk financial instrument because its issuance significantly contributes to economic sustainability at a comparatively low cost. Additionally, the market requires a comprehensive and broad set of government control since its growth is pegged on the degree of issuance, supervision, and liquidity. The ever-growing regulation situation has compelled the need for a public-private regulatory framework to identify and analyze the challenging gaps in governance. In the long run, the government is responsible for optimizing the wide-ranging interests of both the investors and stakeholders. Also, lower capital costs would encourage the government to initiate policy changes on the regulation of green bond markets. As much as there are many sustainable energy investments financed using lower costs, the application of green bonds helps avoid the financial risks associated with the shift to a low carbon system. Though many pundits do not consider green bonds responsible for transiting capital from unsustainable to sustainable investments, green bonds’ trading offers incentives to issuers. In brief, the provided incentives allow the issuers to finance any number of projects.

Works Cited

Alonso-Conde, Ana-Belén, and Javier Rojo-Suárez. “On the Effect of Green Bonds on the Profitability and Credit Quality of Project Financing.” MDPI – Sustainability, vol. 12, no. 6695, 2020, pp. 1-23.  

Maltais, Aaron, and Bjorn Nykvist. “Understanding the Role of Green Bonds in Advancing Sustainability.” Journal of Sustainable Finance and Investment, 2020, pp. 1-20.

Nelson, David. “Green Finance in China: Achieving Sustainability through Finance.” Climate Policy Initiative, 2020, pp. 1-24.

Sartzetakis, Eftichios. “Green Bonds as an Instruments to Finance Low Carbon Transition.” Economic Change and Restructuring, 2020, pp. 1-34.

Tu, Chuc, Sarker, Tapan, and Ehsan Rasoulinezhad. “Factors Influencing the Green Bond Market Expansion: Evidence from a Multi-Dimensional Analysis.” MDPI – Journal of Risk and Financial Management, 2020, pp. 1-14.

UN Economic Commission for Latin America and the Caribbean (ECLAC). “The Rise of Green Bonds.” Financing for Development in Latin America and the Caribbean, 2017, pp. 1-46.

UNEP. “Green Bonds: Country Experiences, Barriers, and Options.” UNEP inquiry in Support of the G20 Green Finance Study Group, 2020, pp. 1-39.