Green Bonds: what they are and how they work

Global warming is a global problem that began to develop in the early twentieth century, and is caused by the increase in greenhouse gas emissions by humans.

Unfortunately, it is only in the last few decades that we have begun to worry about the imminent consequences of climate change, which is why we are increasingly trying to move from a carbon-based economy to one based on sustainability and transparency. An example of this transition is Green Bonds.

Green Bonds (or "Green Bonds") are debt securities that are used to finance or refinance projects that have a positive impact on the environment.

Invented in July 2007 by Aldo Romani (currently head of Funding Sustainability of the European Investment Bank), Green Bonds quickly became very useful tools in the fight against climate change, and while for an initial period they were only issued by institutions supranational financial institutions such as the aforementioned EIB, or the World Bank, after a short time also began to be used by individual companies, municipalities and state agencies.

Unlike traditional bonds, Green Bonds only finance projects created to reduce the negative impact that man has on the environment and which therefore deal, for example, with renewable energy, pollution prevention and control, biodiversity conservation, production of eco-friendly products and much more.

The green bond principles

To date, there is no global standard for classifying a project as sustainable, but the International Capital Market Association (ICMA) has drawn up guidelines to indicate the characteristics necessary to be able to issue a Green Bond: the Green Bond Principles.

The Green Bond Principles promote market integrity and transparency, with the aim of supporting the transition towards sustainability; however, following the indications of the Green Bond Principles is not mandatory, in fact no sanctions are imposed if the issuer does not comply with these principles.

The Green Bond Principles are as follows:

1. Use of Proceeds

Proceeds must be invested in projects that have environmental impacts, which must be detailed in the title's legal documents.

2. Process for Project Evaluation and Selection

The issuer must communicate to the investors the environmental objectives of the activities that will be financed, the processes thanks to which it has determined the validity of the projects and their eligibility requirements, also including the assessment and possible resolution of damages that the activity could cause in other sectors.

3. Management of Proceeds

Proceeds must be credited to a sub-account, or transferred to a sub-portfolio, or otherwise tracked by the issuer appropriately and documented.

4. Reporting (Reporting Activities)

The issuer is required to create a report on the use of the proceeds and update it annually, or in case of concrete developments. The more information put into the report, the better.

EU taxonomy and green bond standards

Given that, as mentioned in the previous paragraph, there is still no global standard for classifying a project as sustainable, the European Commission wanted to clarify sustainability, and for this reason it created the EU Taxonomy, a classification of economic activities that can be defined as sustainable which will enter into force on 31 December 2021 and which can easily be correlated with European Green Bond standards.

Both the EU Taxonomy and the Green Bond Standards are pieces of legislation that derive from the EU Sustainable Action Plan, and serve to finance sustainable economic growth in Europe.

Each activity must meet certain criteria to be classified as sustainable, in fact six environmental objectives are defined in the EU Taxonomy regulation and to be compliant an activity must contribute to the achievement of at least one of these:

• Climate change mitigation;
• Adaptation to climate change;
• Sustainable use and protection of water and marine resources;
• Transition towards the circular economy, also with reference to waste reduction and recycling;
• Pollution prevention and control;
• Protection of biodiversity and ecosystem health.

By 1 January 2022, asset managers will have to demonstrate compliance, while issuers will have to demonstrate compliance by the end of 2022.  

The European Green Bond Standards depend on the Taxonomy and are parameters used to ensure that all assets financed by debt securities comply with the Taxonomy, issuers, on the other hand, will have to follow the Green Bond Principles.

Greenwashing and Green Bond: How are they related?

Europe is trying to promote a more sustainable lifestyle, but it is not always easy to understand which companies are actually dedicated to achieving the objectives set. This is why the European Green Bond Standards and the EU Taxonomy are also two extremely useful tools for unmasking Greenwashing.

Greenwashing is defined as the attempt by an activity to give a better image of itself than the real one, in this case lying about the company's environmental involvement.

NN Investment Partners conducted surveys and found that 15% of Green Bond issuances come from companies that finance sustainable projects, but are involved in activities that have a negative impact on the environment. An investor, not knowing it, risks investing money in unreliable companies, which are not committed to achieving a more sustainable economy, for this reason the EU Taxonomy is necessary, because it allows investors to actually know every aspect of companies with which they do business.

The climate bond initiative

In 2020, the Green Bond market reached a volume of one trillion dollars, a target set in 2007 when the first Green Bond was launched, and estimates say that it will continue to grow over the years.

We have this figure thanks to the Climate Bonds Initiative (CBI), an international non-profit organization that was created to mobilize the bond market, facilitating the transition to a low-carbon economy.

For many years, the CBI has facilitated collaboration between banks, investors, governments and the industrial sector to ensure that more and more capital is invested in sustainable activities, monitoring the market and demonstration projects, developing standards to establish market definition criteria green, offering policy advice and creating market development activities.

Btp green 2045: the green bond issued by the Italian state

According to a ranking by the CBI, Italy is the eighth country in terms of emissions, with 17 billion, which is why the Italian state is making an effort to issue its first Green Bond in 2021.

The Treasury Department has entrusted BNP Paribas, Crédit Agricole Corp. Inv. Bank, Intesa Sanpaolo S.p.A., J.P. Morgan AG and NatWest Markets N.V. the task of placing the first BTP Green, the government bond that will be used to finance the expenses that the state will bear to have a positive environmental impact, exactly as envisaged in the budget law for 2020.

It will expire on 30 April 2045, with a maximum ceiling of 35 billion (theoretical ceiling, given on the basis of the quantity of "compatible" projects), and will contribute to the environmental objectives and the Italian sustainability strategy.

A look to the future

In conclusion, Green Bonds are a functional, transparent and effective method of advancing the fight against climate change.

The need of fashion companies to achieve ever more ambitious goals in the field of sustainability is progressively driving them to invest in projects to reduce their environmental impact, often asking for funds from banks and the market to finance them. Giants such as Adidas and Vf Corporation have issued Green Bonds that will be used to finance, for example, the purchase of recycled materials, the use of renewable energies or the energy efficiency of offices. Among the luxury companies committed to financing this type of project there are also brands such as Chanel, Burberry, Moncler or Salvatore Ferragamo.