What are green bonds and why is this market growing so fast?

This article was first published in October 2021 and updated in November 2023.

Tackling the climate crisis won’t come cheap. The United Nations’ Intergovernmental Panel on Climate Change estimates that limiting the temperature increase to 1.5°C, the goal of the Paris Agreement, will require over $3-6 trillion of investment every year to 2050.

To raise those vast sums, governments and corporations are increasingly turning to green bonds.

Green bonds work like regular bonds with one key difference: the money raised from investors is used exclusively to finance projects that have a positive environmental impact, such as renewable energy and green buildings.

With countries around the world stepping up their efforts to reduce carbon emissions, the market for green bonds is booming. This rapid growth was first highlighted in October 2021, when the European Union (EU) issued about $14 billion of the bonds – the largest deal ever at that time.

The first green bonds were issued in 2007. The market grew slowly for nearly a decade, but then it started to take off. Global green initiatives such as the Paris Agreement on climate change and the UN Sustainable Development Goals have helped spur this expansion.

Strong demand for green bonds is also driving growth, with major investors from asset managers to insurers and pension funds keen to scoop them up.

In November 2023, Brazil sold its first-ever green bond, intended to support President Luiz Inacio Lula da Silva's ambitious plans to safeguard the Amazon.

Turbo-charged by this combination of political resolve and investor appetite, the green bond market is expanding rapidly. Annual issuance could hit $1 trillion in 2023, according to S&P Global. That’s a big milestone, though it’s still just a niche in the overall global bond market, which has been estimated at about $130 trillion. So there’s plenty of room for green bonds to keep on growing.

The first green bond was issued in 2007 by the European Investment Bank, the EU’s lending arm. This was followed a year later by the World Bank. Since then, many governments and corporations have entered the market to finance green projects.

The US is the second-largest source of green bonds, led by the government-backed mortgage giant Fannie Mae. Corporations from Apple to Pepsi and Verizon have got in on the act. State and local governments have also turned to green bonds to pay for infrastructure projects.

China takes the top spot currently, with green bond issuance of more than $85 billion in 2022.

Greenwashing – making false or misleading claims about the green credentials of a company or financial product – is a major challenge for the market in green bonds and other sustainable investments.

Regulators and the industry itself are working hard to address this issue.

Many borrowers adhere to guidelines called the Green Bond Principles, which have been endorsed by the International Capital Market Association to help bring transparency to the market. There’s also a range of companies that offer to assess and certify bonds.

The EU is taking transparency a step further with its voluntary European Green Bond. This is intended to help the market grow by giving investors the information they need to assess and compare securities that claim to be green.

For all the urgency around tackling the climate crisis, the fossil fuel industry raked in far more financing than green projects in the years following the signing of the Paris Agreement. That changed in 2021, according to Bloomberg Green, indicating that we may be at a tipping point in the fight to save the planet.

The green bond market continues to grow rapidly, according to the World Economic Forum's report, Fostering Effective Energy Transition 2023, which noted $270 billion worth of issuances in 2020.

Sustainable investment looks set to continue its breakneck growth as governments put climate concerns front and centre. These plans include the European Green Deal and US President Joe Biden’s infrastructure framework.

Green bonds will remain a crucial element in this push towards sustainability, providing financing for major projects around the world.