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by Salvatore Cantale, Barry Gavin Published 18 December 2024 in Sustainability • 16 min read
The global shift toward a more sustainable economy is one of the most pressing issues of our time. This “green transition” requires significant investment. The World Economic Forum posits that we need something between $100tn to 300tn invested by 2050 to reach our goals. Traditional funding sources such as government budgets and private capital alone are insufficient to meet this challenge, highlighting the need for innovative financial instruments. This is where instruments like green bonds and sustainability-linked bonds (SLBs) and notes (SLNs) come into play.
The gap between funding needs and appetite among institutional investors (as will become clear later in this article) represents a unique opportunity that companies focused on sustainable transformation cannot afford to let pass by. In this article, we will illustrate what these financial instruments are, the differences between them, and give a few examples. Both typologies of instruments are central to bridging the financial gap and accelerating the green transition, but they function in different ways. Understanding these differences is crucial for companies to raise capital, for investors to understand what they are really financing, and for stakeholders seeking to deploy capital efficiently to achieve much-needed impact.
Green bonds and sustainability-linked bonds are part of what is known as the labelled bond market (LBM), which also includes sustainable bonds and social bonds, and has been in existence since 2008. 2024 was the second highest year for issuance, following a record high in 2021. The market continues to grow and stands at almost $4tn in outstanding bonds, representing more than 6.2% of the entire corporate bond market. We also see a discount of between 10 to 15 basis points in the cost of borrowing via green bonds relative to the market, making them a more affordable option for companies and indicating that investors are willing to pay a “greenium” for sustainable investments.
Transparency in how funds are earmarked is critical to maintaining investor trust.
Definition: A type of fixed-income security where the loaned amount is earmarked for climate and environmental projects. Typically, these bonds are backed by the issuer’s balance sheet and linked to assets. They normally have the same credit rating as the other debt obligations of the issuer.
In general, to understand green bonds, we can refer to a set of defined characteristics contained in a framework called the Green Bond Principles (GBP), developed by the International Capital Market Association (ICMA). The GBP provides a set of voluntary guidelines that issuers can follow to ensure that the proceeds are allocated to projects that deliver clear environmental benefits.
These guidelines can be summarized in the following four pillars:
“The market started in July 2007, when the European Investment Bank (EIB) issued the first-ever green bond: the climate awareness bond (€600m), aimed at funding renewable energy and energy efficiency projects.”
The market started in July 2007, when the European Investment Bank (EIB) issued the first-ever green bond: the climate awareness bond (€600m), aimed at funding renewable energy and energy efficiency projects. Since then, the market has expanded significantly, with issuers ranging from national governments to multinational corporations such as Apple and Tesla. Bloomberg reports the issuance of green bonds in 2023 rose to $575 billion. Let’s look at how Apple has navigated this emerging market.
Apple entered sustainable finance in 2016, issuing its inaugural $1.5 billion green bond. Issued in response to the Paris Agreement, it was one of the largest green bond issuances by a US company at the time. The following year, Apple issued a second green bond, raising $1 billion to reaffirm its commitment to sustainability. In 2019, the consumer tech giant issued a third, worth $2.2 billion, marking its largest issuance yet (some of the funds went into developing Apple’s “Daisy” recycling robot). In 2022, Apple returned to the market with a $1 billion green issuance for, in part, the production of low-carbon aluminium through the ELYSIS project. For reference, here are terms of this 2022 issuance:
In 2021, a paper – “Corporate Green Bonds” by Caroline Flammer – was published in the Journal of Financial Economics. It investigates the impact of corporate green bonds on both the issuing companies and the environment, covering 1,189 issuances in 25 countries between 2013 and 2018. Here are some of Flammer’s key findings:
Apple committed the proceeds from this bond issuance to projects aligned with environmental sustainability goals. These projects fall into several categories outlined by the GBP, such as climate change mitigation, energy efficiency, and natural resource conservation.
Apple has a team that manages the evaluation and selection process for eligible green projects to ensure that its eligibility criteria are met. This team evaluates the environmental benefits of each project, confirming benefits exist and can be estimated, and that they fall within categories that align with Apple’s environmental strategy.
Apple uses a robust system to manage and track the allocation of proceeds. For example, this process ensures they are allocated to eligible projects, which are tracked and audited for transparency, and that any unallocated proceeds are temporarily invested in cash or equivalents, in line with Apple’s financial policies.
Apple provides comprehensive annual reporting on how the proceeds of its green bonds are used, including qualitative and quantitative data on impact. It regularly discloses the amount of renewable energy generated, emissions reductions, and other environmental impacts of funded projects. For example, projects funded by Apple’s Green Bonds helped mitigate 13.6 million metric tons of CO2 emission over their lifetime, contributing significantly to Apple’s goal of reducing its carbon footprint.
Any company, independent of size or sector, public or private, who can issue bonds can issue green bonds. However, as the reporting and compliance costs are generally non-trivial and fixed, larger companies tend to have an advantage. As such, with investor demand for green bonds outstripping supply, medium to large companies are in prime position to capitalize on the funding gap:
SLBs are “general purpose” and tie their investor coupon (interest) payments to specific sustainability outcomes, rather than specific projects (as is the case with green bonds).
Definition: A type of innovative financial instrument that ties the bond’s financial and/or structural characteristics to the issuer’s achievement of pre-defined sustainability performance targets (SPTs). The most common SPTs are linked to GHG emissions, energy efficiency measures, or an ESG-related target. Targets could also relate to diversity, water, waste management, or the proportion of female board members, for example.
SLBs are “general purpose” and tie their investor coupon (interest) payments to specific sustainability outcomes, rather than specific projects (as is the case with green bonds). SLBs are seen as a key source of finance for “hard to abate” sectors, which have traditionally struggled to obtain finance for the green transition. Often, if an issuer fails to meet its SPTs, the coupon payment rate increases (typically by 25 basis points) – providing an incentive to strive for better sustainability outcomes. SPTs must be achieved by a certain date, specified at the time of issuance and typically verified by an external examiner. Some SLBs carry other forms of penalties. As SLBs are not tied to specific projects, they represent a more flexible financing instrument than green bonds. As Katsiaryna Souvandjiev, ESG lead at Austria’s Raiffeisen Bank International, told the Financial Times: “We do not need to know if they (the issuer) will use more solar panels or employ more skilled workers to develop better products – it’s up to the company”. Instead, issuers are held accountable for meeting broader sustainability goals. This can make these instruments more appealing to companies in sectors where capital expenditure plans may not always align with green project financing:
This form of financing has been growing since 2019. Today, we see issuers ranging from corporations, public companies, and sovereigns embracing SLBs. Bloomberg informs us that the SLB market issued $68 billion in 2023 .
Julian F. Kölbel and Adrien-Paul Lambillon in the research paper “Who Pays for Sustainability? An Analysis of Sustainability-Linked Bonds”, 2022 (Swiss Finance Research Institute, Research Papers Series No: 23-07) examine a sample of 441 SLBs issued by a total of 264 companies covered by Bloomberg until December 2021, and find the following interesting patterns and results:
Italian utility giant ENEL was the first global company to issue an SLB, raising $1.5 billion in 2019. ENEL’s “general purpose” bond was tied to the company’s commitment to increase its renewable energy generation to 55% of total capacity by 2021. The SLB was issued just below face value (under par) (99.879/100) and carried a regular interest coupon of 2.65% per year. If the target renewable capacity was not met, ENEL agreed to a step-up penalty of 25 basis points on top of the regular coupon, making the bond a more onerous one. The bond signalled ENEL’s strong commitment to sustainability goals. ENEL successfully met its target, demonstrating that SLBs/SLNs can drive real progress toward sustainability goals. ENEL has returned to this market again and again, and has to date issued 24 billion euro in SLBs/SLNs. Let’s take a look at one example, issued in 2023. This SLB “2.0” provides a new set of KPIs linked directly to EU taxonomy and Scope 3 emissions reduction including:
You can see that these KPIs are more numerous than ENEL’s first SLB in 2019, and their narrative is deeper. In fact, for each KPI, ENEL has offered a more exhaustive explanation of why they are chosen. When ENEL issued this bond, it committed to meeting all five KPIs by the stated date. If any one of those is in breach, ENEL must pay an interest penalty (25 basis points). In practice, ENEL failed to fulfil the first KPI in 2023. Ten SLBs/SLNs, worth about 11bn euro, were subject to this breach. The penalty will cost ENEL an additional Euro 90m euro. While there was a view in the market that ENEL could have claimed “force majeure”, it decided not to. The market responded very positively to this decision and has helped underpin the credibility and reliability of the debt.
Green bonds offer a more prescriptive and process-oriented approach to financing green projects, ensuring that funds are used exclusively for environmental purposes and projects.
Without wishing to appear too optimistic (or cynical), we believe the funding gap between the resources needed and the funds committed to the green transition so far represent the opportunity of a lifetime. Faced with the double objective of pursuing green transformation and raising capital to fund it, there is a highly attractive window of opportunity for diverse companies to enter the green finance market.
Both green bonds and sustainability-linked instruments play crucial roles in mobilizing capital for the green transition, but they cater to different issuer needs. Green bonds offer a more prescriptive and process-oriented approach to financing green projects, ensuring that funds are used exclusively for environmental purposes and projects. Sustainability-linked notes, on the other hand, are more flexible and outcome-focused, incentivizing issuers to meet sustainability goals without needing to commit to how they allocate the capital.
Making the right choice between these instruments depends on the issuer’s business model, sustainability strategy, and investor expectations. Both, however, represent vital tools in the fight against climate change and the push toward a sustainable future.
In deciding whether to issue green bonds, CFOs and CSOs must first ask: Do we have a clear sustainability strategy in place? A green bond issuance is not just a financial exercise but a demonstration of the company’s long-term environmental and sustainability goals. It’s crucial that the company’s mission includes measurable and impactful sustainability initiatives. Then ask: Are we familiar with relevant green bond standards? Familiarize yourself with these standards to ensure any bond issuance will meet market expectations and regulatory requirements. A deep understanding of these frameworks will ensure that the bond is credible and will appeal to ESG-conscious investors, while also mitigating the risk of greenwashing claims.
Once strategic alignment is confirmed, assess the availability of qualifying projects and the company’s funding needs. Are there projects that meet the green bond criteria? Without a clear set of green projects, the issuance of a green bond cannot happen. Second, evaluate your company’s funding needs for its sustainability projects: Do we need external funds? If external financing is required, a green bond could be an effective mechanism to raise capital while aligning with your sustainability goals.
Issuing a green bond requires both financial stability and operational readiness. CFOs should assess whether the company has enough financial slack to support the new bond issuance: Is the company financially stable enough to issue green bonds without jeopardizing its balance sheet? Ensuring financial health is critical, as weak financials could undermine investor confidence. Equally important is operational readiness: Do we have the internal capacity to handle the ongoing reporting, compliance, and communications required by a green bond? Green bonds come with added obligations, including tracking the use of proceeds and producing regular impact reports. If these systems are not already in place, the company must decide whether to build them internally or outsource to third-party experts. Operational readiness will ensure the company can meet investor and regulatory expectations not only before the issuance, but also after.
Additionally,
The final step is to build a compelling business case for green bond issuance, weighing both the costs and the potential benefits. CFOs and CSOs need to assess whether the company can absorb the costs associated with issuing green bonds, including certification, legal fees, reporting, and third-party verification. These costs can be substantial, especially for first-time issuers. However, the potential benefits can outweigh these costs. Issuing green bonds can provide access to a new base of ESG-focused investors, improve the company’s ESG reputation, and potentially lead to better financing terms. Additionally, consider whether the issuance will open doors to further green bond offerings and support long-term financing strategies. Lastly, assess the risks, such as reputational damage from greenwashing accusations, regulatory changes, or market volatility. A thorough risk assessment will help ensure that the green bond issuance is sustainable both financially and reputationally in the long term.
This four-step process provides a structured approach for CFOs and CSOs to evaluate whether issuing green bonds is a viable and strategic option for their company. If your company meets these criteria and can manage the costs and compliance, green bonds can provide access to a growing pool of ESG-focused capital while strengthening your sustainability credentials.
Professor of Finance at IMD
Salvatore Cantale is Professor of Finance at IMD. His major research and consulting interests are in value creation, valuation, and the way in which corporations structure liabilities and choose financing options. Additionally, he is interested in the relation between finance and leadership, and in the leadership role of the finance function. He directs the Finance for Boards, Business Finance, and the Strategic Finance programs as well as the Driving Sustainability from the Boardroom program and the newly designed Bank Governance program.
Barry Gavin has over 25 years of experience in financing, developing and managing clean infrastructure assets across the major emitting sectors: power, transport and buildings. He sits as an Independent Non-Executive Director of Boards across a number of sectors including Private Equity Funds, Regulated Funds, National Postal Service in Ireland and a large IPP. Barry is an adjunct lecturer at the UCD Michael Smurfit Graduate Business School where he lectures in sustainable finance and renewable energy finance. He is a Fellow of the Chartered Institute of Management Accountants (FCMA), a graduate of DCU (BA & MBA), a graduate of the SaĂŻd Business School, and a member of the Institute of Directors.
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