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How Green Bonds Work?

How Green Bonds Work?

 

Stakeholders around the world are worried that the Earth’s biodiversity is being destroyed irreversibly. People have a shared conviction that the natural world on Earth has been irreversibly harmed. This is true that we are all affected by climate change. It’s also true that the planet will soon vanish from dwindling natural resources, such as oil and other fossil fuels. It is therefore imperative that corporations begin to invest in environmentally friendly ventures. Business people all over the world are worried about future returns from investing in green projects. The green bonds idea has thus been implemented to help organizations, without exerting excessive pressure on their budgets, and control their push towards sustainability. After all, businesses prefer to be cost-effective rather than environmentally friendly.

 

What is it?

A green bond is mainly a debt financial instrument. It is not financially very different from other bonds. In this debt financial instrument, there is fixed income and pays as per coupon rate. These bonds are unique as they are used exclusively to finance green projects and green initiatives. This can be a new green project built from scratch or an existing project turned into environmentally friendly standards. In 2007, the European Investment Bank opened the world in issuing green bonds. At first, the major problem was issuance size as these bonds issuance size was very small. More investors and organizations have shown attraction in this financing instrument over a period of time. As a result, these bonds now have a healthy primary and secondary market.

 

Benefits:

Worldwide investors queue to purchase green bonds. All these can be seen by the fact that almost all the green bond issues till today’s date observed an over-subscription. The most obvious benefit of green bonds is that they provide financing at relatively small levels for environmentally friendly projects. Secondly, as part of corporate social responsibility, investors are willing to invest in these ventures. They could even point out that they have invested in improving the environment that gives them excellent goodwill in the local community and local market.

Finally, it is easy to track all the green projects that are carried out worldwide. This makes reporting easier in all global summits and provides data and by this world leaders can make choices rather to invest in these ventures or not. Investment in these ventures is subject to various tax cuts. These tax exemptions vary from country to country. However, almost every country that has signed environmental agreements such as the Paris Agreement tends to get tax benefits.

 

Issuance Process:

The first step in issuing green bonds is to identify the project. It is important that a third party examines and certifies the project. This ensures that the project is based on low emissions of carbon. The bond issuer has to define projects that obtain funds from the issuance of green bonds clearly. Things must also ensure that even activities that are not directly linked to the project and are not in any manner polluting the environment. The projects list must then be forwarded to a third party verifier. These companies are usually world-renowned credit rating agencies.

They test the details provided by the issuer and then confirm that the ventures/projects are indeed environmentally friendly. This certificate is required for bonds to be referred to as green bonds. The developer will keep track of the environmental effects of the project continuously. Even if the project in the middle of its operation is not compliant, the same must be reported to the standard board. In the absence of these details, legal action against the misrepresentation by investors can be undertaken.

 

Challenges:

Firstly, even though the issuer can receive funding at a lower interest rate, it needs to make a substantial investment at an early stage. Issuance of green bonds have long and tedious process. Multiple parties have to participate in the issuance process and all these parties must therefore be paid. This offsets the perks of financial support for smaller projects and small ventures. Green bonds can therefore be used cost effectively only if the project have a massive scope and bond issuance size is very big.

Furthermore, there is no simple grading scheme that determines project is completely green. For these problems, different agencies have multiple interpretations. A series of standard guidelines and terminologies is needed to develop green bonds. Bonds that provide greater environmental benefits will have greater tax benefits and less financing costs. Only then, the big companies and investors can invest funds enormously in these projects and ventures.

In a nutshell, green bonds are a revolutionary concept in order to fund environment friendly ventures and projects. Nevertheless, they are still in an evolving stage and must be further recognized.

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