In the realm of sustainable finance, green bonds have emerged as a powerful financial instrument, dedicated to financing projects that drive positive environmental impact. Green bonds are a beacon for funding initiatives such as renewable energy, low-carbon transport, and forestry projects. This article introduces the fundamentals of green bonds, emphasizing adherence to standards like the Green Bond Principles (GBP) and the Climate Bonds Initiative (CBI) Taxonomy. Through real-world examples, it explores tax implications and highlights the role of green bonds in measuring and reporting financed emissions.
Green Bond Issuance
Green bonds are a category of fixed-income financial instruments created to finance projects that deliver environmental advantages. Green bonds are termed “use-of-proceeds” because the money they raise is set aside for financing or refinancing eligible green projects, whether new or existing, either partially or entirely.
Green bonds can be issued by any type of organization without specific restrictions. While a company's environmental stance is not a determining factor, issuing green bonds for a specific environmentally focused project may lead to accusations of greenwashing from investors. The key factor in evaluating green bonds is the environmental impact of the projects funded by the bonds. While a universally agreed standard for defining green bonds and specifying eligible activities does not exist, issuers can turn to a range of evolving guidelines and sources, including the International Capital Market Association's GBP, the CBI Taxonomy, national guidelines, green bond indices, and sector-specific standards. These resources offer valuable guidance to issuers in shaping their green bond framework and establishing criteria for project eligibility.
Projects under consideration for green bonds are typically detailed in a pre-issuance report outlining how the funded projects align with the issuer's desired impact. This report can be prepared by an external party and categorized into four levels:
- Second-party opinion on the bond's alignment with the GBP.
- Verification against specified business or environmental criteria, such as science-based goals.
- Certification against an external standard like CBI.
- A score or rating against an external methodology, similar to a credit rating.
Along with pre-issuance reports, issuers often establish their own green bond frameworks aligned with existing standards to support their environmental objectives. Green bond issuers also release public post-issuance reports required by many of the voluntary guidelines, including the GBP and CBI. Most reports are annual and account for the use of proceeds and the progress achieved towards the green bond’s stated objective.
Guidelines for Best Practices
Several programs play a role in shaping best practices for green bond issuance. The Green Bond Principles (GBP) offer comprehensive voluntary guidelines that help issuers structure and communicate the environmental benefits of their green bonds. The Climate Bonds Initiative (CBI) provides a specific framework for evaluating the eligibility of climate-related projects, ensuring a systematic approach to their environmental impact.
Green Bond Principles (GBP)
The GBP plays a pivotal role in shaping the landscape of sustainable finance. Established by the International Capital Market Association (ICMA), a prominent global trade association for participants in the international capital markets, the GBP provides a comprehensive and voluntary framework guiding issuers in structuring green bonds. This association, ICMA, acts as a unifying force, fostering collaboration and setting industry standards within the realm of international capital markets.
The ICMA’s GBP offers clear guidelines on the use of funds, project selection, and reporting. The principles embedded in the GBP contribute significantly to the integrity of green bonds, providing issuers with a widely recognized standard to communicate their environmental commitments. The GBP is the most widely used framework that provides guidance for issuers, investors, and other stakeholders to align their activities with environmentally sustainable projects.
The four core components for alignment with the GBP are:
- Use of Proceeds: All designated eligible Green Projects should provide clear environmental benefits, which will be assessed and, where feasible, quantified by the issuer. These projects may be categorized according to the available listing of eligible Green Project categories.
- Process for Project Evaluation and Selection: The issuer of a Green Bond should clearly communicate to investors the environmental sustainability objectives of the eligible Green Projects, the process by which the issuer determines how the projects fit within the eligible Green Projects categories, and complementary information on processes by which the issuer identifies and manages perceived social and environmental risks associated with the project.
- Management of Proceeds: It is recommended that an issuer’s management of proceeds be supplemented using an external auditor, or other third party, to verify the internal tracking method and the allocation of funds from the Green Bond proceeds.
- Reporting: The annual report should include a list of the projects to which Green Bond proceeds have been allocated, as well as a brief description of the projects, the amounts allocated, and their expected impact.
Climate Bonds Initiative (CBI)
Working in tandem with the GBP, the Climate Bonds Initiative (CBI) provides a specific framework for evaluating the eligibility of climate-related projects, ensuring a systematic approach to their environmental impact. While GBP offers broad voluntary guidelines for issuers to articulate the environmental benefits of their green bonds, the CBI specifically concentrates on climate-related initiatives, providing a detailed taxonomy and criteria to assess project eligibility based on their contributions to climate change mitigation or adaptation. The CBI strictly requires third-party verification for green bonds which enhances the reliability and credibility of assessments. A directory of third-party verifiers for green bonds can be found here. Ultimately, the CBI contributes to the effectiveness of green finance by establishing a robust benchmark for climate-aligned projects within the broader sustainable finance landscape.
In the green bond issuance process, issuers may refer to the GBP and CBI guidelines to structure their green bond frameworks, ensuring alignment with market expectations. It's important to note that while GBP or CBI alignment are recommended for tax-related reporting, there are various other resources that contribute to best practices.
Tax Reporting Implications
Green bonds play a crucial role in reporting, particularly for tax-related purposes as policy makers have a range of tax incentives to foster the issuance of green bonds. One strategy involves tax credit bonds where bond investors receive tax credits in lieu of traditional interest payments. This relieves issuers, such as municipalities, from the obligation of paying interest on their green bond issuances. Notable examples include the U.S. federal government's Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs) program, where a significant portion of the coupon is provided as a tax credit or subsidy to bondholders. Another approach is the use of direct subsidy bonds, where bond issuers receive cash rebates from the government to offset their net interest payments, a mechanism also employed in programs like CREBs and QECBs. Additionally, tax-exempt bonds offer an incentive by allowing bond investors to forego income tax on the interest earned from holding green bonds, potentially resulting in lower interest rates for issuers. These diverse tax incentives serve as powerful tools to encourage investments in environmentally sustainable projects.
To qualify for tax benefits and exemptions, entities issuing green bonds must adhere to recognized standards and frameworks, such as the ICMA’s Green Bond Principles or the CBI Taxonomy. These frameworks establish stringent criteria for evaluating and categorizing projects as genuinely green, ensuring alignment with environmental goals. Consequently, reporting green bonds as per ICMA or CBI requirements becomes not only a means to foster transparency but also a prerequisite for entities seeking tax exemptions based on the environmentally sustainable nature of their financial instruments.
Financed Emissions Reporting Implications
Green bonds play a crucial role not only in the financing of environmentally sustainable projects but also in the broader context of reporting and measuring financed emissions. In particular, they have a significant impact on the measurement of financed emissions. Financed emissions refer to indirect greenhouse gas (GHG) emissions arising from financial services, investments, and lending activities conducted by investors and financial service providers. The qualification of bonds as green provides a mechanism for companies to gauge their involvement in financing projects contributing to indirect GHG emissions. This qualification is crucial, as it not only aids in identifying environmentally responsible investments but also facilitates the reporting of financed emissions.
Financed emissions represent a significant aspect of a company's carbon footprint. Green bonds establish clear criteria for environmentally sustainable projects which enable organizations to distinguish between investments that contribute to emissions and those aligned with climate-conscious objectives. This distinction is essential for companies to comprehend the extent of their environmental impact and take targeted actions to mitigate it. To read more about financed emissions see our article here.
Green bonds are robust financial instruments that drive positive environmental impact through adherence to standards like the GBP and the CBI Taxonomy. These guidelines shape best practices for issuers, ensuring transparency in project financing. Green bonds also play a crucial role in tax reporting, offering incentives for environmentally sustainable projects and emphasizing the need for adherence to recognized standards. Moreover, they contribute significantly to measuring financed emissions, enabling companies to assess their environmental impact and make informed decisions. In essence, green bonds stand as a pivotal force in aligning financial practices with environmental goals, embodying a commitment to sustainable development and responsible investing in the global financial landscape.