Climate change is the challenge of our century and the decarbonization of our energy system is crucial to limiting its long term effects on our planet and the wellbeing of future generations. Policy makers can play a critical role in facilitating the transition to cleaner sources of energy, but green policies alone are not enough.
In fact, the European Commission has estimated that over the 2020-2030 period, financing the energy transition in Europe will require annually almost EUR 379 billion of investments in the energy sector. However, the resources currently available to the public sector are vastly insufficient to cover these costs. Accordingly, the financial sector can play a key role in supporting the energy transition, attracting investments toward research and infrastructures development.
The role of green finance
Nevertheless, nowadays the involvement of the private sector in financing the energy transition is still limited and the market presents a vast and urgent financial gap between the number of climate-friendly investments currently available and those needed. Within this context, green finance can play an important role in connecting capital to the challenges of climate change, potentially supporting the transition to a low-carbon economy.
While there is no universal definition, ‘green finance’ identifies all those products and services focusing on environmental issues, where the ‘green’ aspect relates to the financed asset, as in the case of investments in clean energy projects. While green finance is still a small portion of the financial market as a whole, one of its products has already established itself as one of the most successful instruments within the market: green bonds.
The success of green bonds
Much like traditional bonds, green bonds enable the issuer to collect capital in return for a fixed periodic interest and full repayment at maturity, but are designed specifically to raise capital for new or existing green projects and are employed mainly to finance green infrastructure projects requiring a large amount of capital that can grant a stable cash flow in the long run.
The market for green bonds has expanded rapidly: in 2019, green bonds issuance reached USD 257.7bn worldwide, recording a 51% growth in comparison to the previous year. A number of factors can explain their success: on the one hand, they enjoy a ‘tax-exempt’ status and, on the other, they are often employed to finance technologies that are not yet widely employed or fully developed, presenting higher levels of risk and, therefore, higher returns.
While green bonds were initially employed only by governments and development banks, recently corporations have also begun issuing them, expanding and diversifying the market. One of the most prominent examples is Apple, which in 2019 issued a USD 2.2 billion green bond aimed at supporting a number of activities reducing its carbon footprint.
Green bonds: do they work?
There are a number of benefits associated with the employment of green bonds. Indeed, they already enabled a number of environmentally-friendly projects around the world to collect capital, promoting innovation and technological development in key sectors. Moreover, they have the potential to positively influence the market promoting transparency enhancing disclosure standards and increasing investors sensibility toward environmental issues.
However, while the interest for green bonds is growing rapidly, some critics have also highlighted the size of the green bonds market is still limited, making it hard for investors and policy makers to fairly assess the potential impact of green bonds in supporting the financing of the energy transition. Moreover, the lack of universal and internationally agreed definition of ‘green’ bonds has also been identified as a barrier, increasing the risk of ‘greenwashing’ practices.
Therefore, facilitating access to the resources available in the financial market, green bonds have the potential to play a critical role in financing the energy transition, but the development of clearer rules and of alternatives financial tools are essential to decarbonize the energy system at a large scale.
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Deborah Scaggion is a Commercial Associate at Aurora Energy Research. She has a strong interest in the energy sector. More specifically, she is passionate in the energy transition, a topic on which she currently researches and writes.