TL;DR

Climate bonds are a type of debt financing that allows corporations and governments to raise funds for climate adaptation and mitigation projects, without giving up ownership.
Government, aka sovereign, bonds have great potential to drive climate action forward, especially in emerging markets.
To prevent greenwashing and ensure projects move forward as promised, the market needs transparent and consistent standards that are easy to track and comparable across different markets.

A brief introduction to bonds

Bonds are a type of debt financing issued by governments, corporations, and other organizations as a way to raise money. When an investor buys a bond, they essentially loan money on the promise that it will be paid back by the issuer within a fixed period and with interest.

Instead of borrowing a large sum from one lender, smaller sums are raised from a pool of many investors. Bonds have the benefit of being temporary, so a company is not giving up any permanent equity in order to raise funds. There are essentially two types of bonds based on the “creditworthiness” of the issuer:

Investment grade bonds: Issuer has a strong credit rating and low risk of defaulting.
High-yield bonds (aka junk bonds): Higher risk of the issuer defaulting, so a higher interest rate is offered in compensation for investors taking that risk.

Climate bonds

Climate bonds are a type of green bond. Green bonds are earmarked for environmentally friendly projects such as renewable energy, energy efficiency, sustainable agriculture, clean transportation, and pollution prevention. Climate bonds are specifically issued to finance projects that address climate change and its impacts, so the focus is not just on sustainability but also on reducing emissions and building resilience to the effects of climate change.

There is no guarantee that the project being financed will be green, except that interest rates are usually tied to targets, so there is a financial penalty if the seller is not achieving their goals. Overall, the “greenness” of the bond is voluntary, and there is no universally accepted system of certification and validation for these projects.

The first green bond, “The Climate Awareness Bond” or CAB, was issued in 2007 by The European Investment Bank (EIB). The CAB set the standard for green bonds and raised $600 million to be used towards renewable energy and energy efficiency projects.

<aside> ⚠️ The World Bank is a major issuer of green bonds. From 2008 to 2022, it issued over 200 bonds, equivalent to approximately $18 billion.

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Sovereign bonds

Sovereign bonds are those issued by the governments of a country to raise money for various projects. The overall sovereign bond market is much larger than the private bond market, but the reverse is true for green bonds. Still, sovereign green bonds make up more than 20% of the Bloomberg MSCI Green Bond Index*, up from 7% at the end of 2017.

Sovereign green bonds have massive potential to push forward climate action and sustainable development agendas, but progress on the commitments can be difficult to track. The same kind of ESG data that would be available to track progress for a company is not available at the country level, and investors primarily rely on self-reported data.

Source: MSCI, 2023