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Green Bond Additionality: The Big Picture

Green bonds have been a phenomenon in recent years, with the market growing consistently at double digit rates, cheering environmental activists and bankers alike. But what has this astounding growth achieved and has it created additionality?

Enabling capital to flow to green assets and projects that would not otherwise get financed is what is commonly understood as additionality. Green bonds have chalked up massive successes in creating the pre-conditions for large capital shifts in the next stage of the market. Green bonds’ major successes have been a global understanding of what constitutes green investments, an excitement for green investments across financial sector actors, and public sector engagement with green finance. The additionality of green bonds is not just about the direct and short-term effect of the specific green bond, it is also about larger systemic impacts.

A Global Understanding of What Constitutes Green Investments

Fundamental to the transition to a climate-aligned economy is developing a shared, scientifically defensible understanding of what assets and projects qualify as green. Green bonds are creating such an understanding and extending it into the financial community.

Green visibility

The green bond label makes visible bonds that are aligned with a low-carbon and climate-resilient future. Unlike vanilla bonds, green bonds offer transparency obliging the issuer to disclose precisely what assets and projects will be financed with the proceeds. The emerging best practice is for issuers to report, post-issuance, how proceeds were allocated and the investment’s environmental impact enabling investors to evaluate the green performance of the bond. 

Green scope expanded to all sectors

Green bonds have established an understanding that the transition to a low-carbon and climate resilient economy requires investments activity across all sectors of the economy. The green bond market has expanded the concept of green investment beyond renewables by debating and agreeing the climate-aligned activities in a still-growing range of sectors. As well as renewable energy (which heavily dominated issuance initially) definitions of green now exist for buildings, transport, water, agriculture and forestry. 

Green scope refined within sectors

The green bond market has also helped establish what is green within each of these sectors, through demonstration issuance, definitions and standards. For example, in the transport sector, rail and metros are understood and accepted as low-carbon transport solutions. In the building sector, it is increasingly accepted that radical - rather than incremental - improvements in energy efficiency are essential. In the water sector, it is becoming clear that green water infrastructure must account for climate adaptation. 

An increased availability of science-based standards within each of these sectors provide guidance to simplify for both issuers and investors on what specific level of environmental performance is required in each sector for an asset to be aligned with climate targets. 


Governments’ official green definitions, developed on the back of green bond market growth, play an important role in harmonising the meaning of green within and across countries. China, in particular, has shown leadership in developing green bond definitions. The EU is now following suit with a sustainable finance taxonomy. The two are collaborating to harmonise green definitions, providing the basis for a global set of green definitions. 

A key area of emerging global harmonisation is the exclusion of fossil fuels. The ASEAN Green Bond Standard excludes fossil fuels from eligible green bond assets. Green definitions in the EU are also expected to exclude fossil fuel production. This globally shared understanding is a huge step in discouraging continued investment in so-called bridging fossil fuel technologies, like “clean” coal, and will support the faster roll-out of renewables.

Including large ‘brown’ companies in the transition

The green bond market provides large diversified companies - including energy companies in the coal, oil and gas sector – with sizeable legacy stocks of brown assets with a mechanism to stimulate internal debate and receive external recognition for actions they take to transition to a low-carbon and climate resilient economy. Engaging with the largest companies on green is essential for a rapid transition to a low-carbon economy. 

An Excitement for Green Investments Across Financial Sector Actors

Beyond understanding what is green, belief in the green transition as an investment opportunity is a fundamental component of making the transition a reality. Sentiment and belief play a central role in financial markets, as established by the growing field of behavioural finance. Financial sector participants – investors, issuers, underwriting banks and rating agencies - need to believe green is an area of growth and opportunity to allocate resources and develop the capabilities and financial products required for capital to flow to green at scale. Green bonds have created a belief in green investments, while simultaneously offering an actionable tool for investors, issuers, banks, rating agencies and governments to act. The investor excitement we are seeing for green bonds is a ‘rational exuberance’, exuberance that is linked to sound investments in assets needed in the real economy.

Shifting perceptions of scale from billions to trillions

Green bonds have altered the scale associated with the green investment opportunity to several hundreds of billions and trillions, where before the scale talked about was millions and billions. Annual green bond issuance has grown from USD11bn in 2013 to USD162.5bn in 2017. Outstanding green bond issuance stands at USD419bn per August 2018, and USD1 trillion of annual green bond issuance by 2020 is targeted by Mission 2020. Using a single green umbrella label to capture green investments in one coherent green bond market, instead of breaking the market into smaller sector-specific markets of solar bonds, low-carbon transport bonds and so on, has strengthened the perception of scale.

Investor tool for engagement

Green bonds enable investors to engage with companies in the fixed income space in a new way. The green label has created a means for issuers to easily communicate to investors what they are doing on green, and provided an avenue for investors to ask issuers questions on the topic. Issuers report that green bonds have broadened their investor base attracting green investors alongside other investors (about half of green bond demand is from green investors and half from non-green). New investors are connecting with green assets and projects they previously did not have exposure to.

Benefits of refinancing

One important question raised about additionality of green bonds in how the market funnels resources to new projects. The majority of green bonds do not directly provide debt capital to new green projects. Green bonds largely refinance green projects or assets after the project construction phase is complete. This is the case for most bonds, green or not. Green bonds do not, nor are they intended to, provide investors direct exposure to project risks. Since investors look to bonds for low-risk, long-term interest payments, green bond issuance will typically provide refinancing for projects once they are complete and de-risked.

The refinancing role of bonds is crucial in growing the capital pipeline and indirectly facilitates the financing of new projects. It allows risk-taking sponsors or investors, who take on the project development and construction risk, to exit once this phase of the project is over. Once the asset is operational and the project is de-risked the initial high-yield debt can be refinanced by more risk-averse investors looking for stable, lower-risk longer-term investments. Refinancing frees up issuers’ capital from existing assets, which can be re-invested in new projects speeding up the velocity of project finance.

When green bond issuers commit to refinance, the label does not oblige the issuer to use the freed-up capital in another green project. They could invest in a brown project. This is sometimes flagged as a concern. But this is where the reputational signal given by green issuance plays an important role. A green bond is, to an extent, a public statement to a level of green investment. There are reputational costs to behaving inconsistently and for failing to follow through on their stated green intentions. In practice, issuers will have debated this internally before first coming to market with the green bond, and will understand they risk from acting in what will be perceived to be a short-term ‘tokenistic’ manner.

Internal push for transition to green

Many issuers report that a green bond accelerates an internal push to integrate green into the issuer’s wider investment strategy. This internal cultural shift arises as non-green areas of the business – especially the treasury - through the issuance of green bonds become educated about the green transition agenda and see associated business benefits: Accessing a broader investor base is commonly reported by issuers. Market players report an improved internal collaboration between treasuries and environmental departments, and expect a lower volatility risk. BerlinHyp is an example of an issuer working to greening their wider portfolio on the back of their first green bond. BerlinHyp now asks all its borrowers about the certification and/or energy efficiency rating of their buildings and is striving to grow the percentage in its portfolio. This longer-term impact of creating a stronger internal strategy of green is a form of green bond additionality, but is hard to measure and or to attribute solely to the green bond issuance.

Green bonds spur broader green finance expansion

The bond market is a significant segment of the financial markets, but to transition to a low-carbon and climate resilient global economy needs all parts of the financial markets to be engaged. Green bond growth needs to be complemented by expansion of other green products. Green bonds support growth in other green finance tools and products by demonstrating mainstream investor demand for green. Knowing there is investor demand creates an incentive for the development of green offerings for other instruments and asset classes. The green label developed for the bond markets can also be directly applied to other fixed income instruments as well as to other assets classes. We have seen labelled green loans and green sukuk successfully copying the green bond model. Banks such as Natixis, BerlinHyp and ABN Amro have started to use green definitions from the green bond market to do internal green tagging of their loan books. Green tagging can facilitate future green bonds, as well as helping banks with their climate-related financial disclosure. 

Public sector engagement 

Green bonds offer the public sector a supplementary actionable tool for supporting green investment. National and local governments have made commitments and introduced a raft of policies to encourage the shift to green, but these have far from sufficient to restrain global average temperatures rise to within 2 degrees Celsius, as set out by the Paris Agreement on climate change. Public policy support for green bonds is not an alternative to other climate policy, but needs to be brought in to complement other climate and infrastructure policies.

The public sector has played a catalytic role in the green bond market. This includes issuance and investments from development banks, sub-sovereigns and sovereigns to help the market develop capabilities to transact green bonds, official green bond guidelines needed to set norms and expectations from green investments, and targeted incentives that absorb the cost of undertaking an external review of the environmental credentials of green bonds, to level the playing field with other bonds.

Mainstream financial bodies engaged on green

Green bonds have contributed to moving the conversation on green finance into the mainstream economic and financial sector bodies. In 2016, the G20 launched a Green Finance Study Group. In 2017, a dedicated Network of Central Banks and Supervisors for Greening the Financial System was launched. The Sustainable Banking Network, which includes regulators from 34 emerging economies, also launched a dedicated Green Bond Working Group in 2017, and the International Organization of Securities Commission (IOSCO) set up a sustainable finance taskforce. In all the various fora, green bonds are central to the broader green finance discussions. 

Next Phase of Green Bonds: Rapid Capital Shifts

The ultimate aim is for green bonds to shift capital flows and enable green investments that would not have occurred in the absence of the green bond market. The rapid growth of green bonds is not of itself evidence of a shift in actual green assets and projects on the ground. A large share of the volume of issuance to date has been an exercise in labelling and creating visibility of green. In the next phase, the green bond market needs to impact on the cost of capital and access to capital for emerging market issuers to facilitate a rapid increase in the volume of green assets and projects on the ground. 

Cost of capital can account for a significant share of total project costs for infrastructure. Reducing the cost of capital for a green project instead relative to of a non-green project could help tip the balance in favour of the green project and pure business grounds.

Evidence from the first stage of the market suggests some evidence about differences in the cost of capital for green bonds and vanilla bonds, but not yet at a large and consistent level that can be easily measured and factored into the project’s financial models. More is needed.

Government action key due to urgency of climate change

Given the urgency of addressing climate change, the public sector could reduce the cost of and improve access to capital for green to incentivise capital shifts to occur within investors’ current financial models. If investors adjust their risk models to fully incorporate climate-related risks - supported by initiatives such as the Taskforce on Climate-related Financial Disclosure (TCFD) – this should lead to lower cost of capital for climate-aligned investments. The issue with relying solely on this approach is the urgency of the climate challenge contrasting with the long time it will take for investors to adjust their risk models. The question is what nature of government impact will be most effective and fiscally efficient, not whether government support is necessary.  

Time to build on the green bond foundations

The green bond market to date has created the foundations for the public and private sectors to work together to shift capital at scale. Discussions of the additionality of green bonds tend to have a narrow focus, considering only the projects or assets that are funded by individual green bonds. The aim of the green bond market is wider; to create system level change to support a transition to a low-carbon and climate resilient economy. The next stage of the market, the coming five years, is when we can expect green bond additionality to materialise in the form of shifting capital at scale to green assets and projects that would not otherwise have been financed. The capital shifts will occur not just directly through green bonds, but through green bonds having been a catalyst for a wider green finance expansion.

Global Policy & Government Sustainable Finance