Green bonds for people, planet and development

Danae Kyriakopoulou looks at the significance of the recent issuance by the UK and Colombia of their first sovereign green bonds.

To ensure economic prosperity remains compatible with efforts to contain the rise in global temperatures to well below 2 degrees Celsius, as committed in the Paris Agreement, all finance must align with net-zero objectives. Capital flows will need to be redirected from climate-harming activities to sustainable investments in mitigation, adaptation and resilience.

Since the introduction of the asset class in 2007, green bonds have become a critical instrument for supporting such investments. And while they remain a small part of the overall fixed income market at US$300 billion issued in 2021, their momentum is strong. In September, the UK and Colombia became the latest countries to issue their first sovereign green bond, bringing the total number of countries that have done so to 18, with cumulative issuance exceeding $130 billion.

The two issuances share two key elements of success. First, both were heavily oversubscribed. Offers were almost five times more than the amount initially offered in the case of Colombia, and around 10 times for the UK’s green gilt. Second, investors were willing to pay slightly higher prices for the transactions compared with similar conventional bonds. This green premium, or ‘greenium’, translates into savings for public finances through lower financing costs.

Each was also important in its own right: Colombia’s bond was the second ever in Latin America, following two issuances by Chile in 2019 and 2021. Unlike Chile, where the issuances were in dollar and euro, Colombia’s green bond was issued in local currency.

Issuing debt in foreign currency can help attract international investors, and financial investments in developing and emerging economies are increasingly global. But doing so means that when negative economic shocks hit, borrowers are often doubly hit with an increased debt burden from currency depreciation. Issuing green bonds in local currency supports the development of domestic sustainable capital markets and helps shield borrowers from currency risk, contributing towards the dual objectives of net-zero carbon emissions and development.

The UK’s first green gilt was pioneering on another dimension, as it was “the first among comparable sovereign issuers to report on both the environmental impact and the important social co-benefits of green expenditures financed by green gilts”, according to the UK Treasury.

This innovation reflects the increasing realisation that in addressing the climate crisis we do not just need a transition, we need a so-called ‘just transition’. While climate-aligned economic development can have a net-positive employment effect, benefits are not always widely spread in the absence of policies that ensure they are. Workers in ‘dirty’ industries could end up worse-off in a green transition if unsupported. Skewed returns for green infrastructure in high-income regions could exacerbate regional inequalities.

The UK’s green gilt was innovative in that it was designed to simultaneously support climate action and social renewal, particularly through ‘levelling up’ regional inequalities. Potential social co-benefits outlined in the Government’s green financing framework range from targeted support for small and medium-sized enterprises and microenterprises, including for technological modernisation, to improving access to sustainable transport systems, employment creation and energy-efficiency savings.

Looking ahead, further proof of success from Colombia and the UK’s green issuances will lie in their ability to encourage wider green bond activity in both countries. Recent sovereign green bonds in Ireland and Belgium both acted as a template for further issuance. With the UN climate change conference COP26 in Glasgow set to begin on 31 October, this is a good opportunity for local government and the private sector to follow the sovereign example and contribute to mobilising and scaling up finance towards climate and development.

This commentary was first published in The Banker and is reproduced here with permission.