Green Bonds are Ready For a Comeback

The bond market sneezed in 2022, and green bonds caught the same cold. Fortunately, according to some analysts, green bonds are in the position to rebound this year. In the case of municipal green bonds, that provides new opportunities for cities to make climate-resilient investments in their future, and corporate citizens are among those to reap the benefits.

What are green bonds?

Assets in global sustainable and green bonds reached $516 billion at the end of 2022, an elevenfold increase over the past decade, according to a recent analysis from Morningstar. Verizon, one of the largest corporate green bond issuers in the U.S., made headlines this week with its fifth billion-dollar green bond since 2019. 

So, what are green bonds anyway, and why do they matter in the world of finance? As with any bond, green bonds are issued by companies and governments as a way to raise money. Investors purchase the bond, and they're paid back later with interest. But in the case of green and sustainability-linked bonds, the funds are specifically earmarked for projects that positively benefit people and the environment. 

As Fidelity described in a 2021 white paper, green bonds reflect a broader focus on socially and environmentally beneficial goals among U.S. investors. “This trend toward sustainability, commonly demonstrated through reusable bags, hybrid cars and renewable energy sources, has also gained popularity in the municipal bond market through the issuance of green bonds," the white paper reads. "Municipal green bonds, issued by state and local governments to fund environmentally beneficial capital projects, are not currently a large percentage of total municipal bond issuance, but have recently gained significant traction."

The municipal green bond trend is relatively new. Massachusetts kickstarted the movement in 2013, and green bonds are still a small part of the overall municipal market, which totaled $470 billion in 2020. Municipal green bond issuance tripled over a rolling five year-period ending in 2020, with an impressive 40 percent jump between the final two years to reach a then-record of $14 billion, according to Fidelity's analysis. 

Despite the strong showing, Fidelity emphasized that green bonds are a new phenomenon. “[It] is too soon to determine if there will be a consistent cost advantage” for issuers, investors or municipalities over the long run, Fidelity found, though the firm did make note of “the intangible environmentally friendly purpose for which the bonds are issued has its own intrinsic value.”

A comeback for green bonds

Fidelity’s outlook was prescient. In February of last year, S&P Global explored the possibility of a jump to $60 billion for municipal green bonds in 2022. However, when the dust settled after a tumultuous economic year, a mixed picture emerged for bond markets overall.

“Up until 2022, green bond funds experienced a relatively sanguine period of positive returns and low volatility compared with conventional bond products,” Morningstar wrote. “That relationship flipped, however, last year, as green bond funds experienced steeper losses and higher volatility in 2022.”

Still, the picture for green bonds was more rosy than the overall bond market, which took a beating amidst economic uncertainty last year. "Net inflows into global sustainable bond funds slowed down in 2022 but remained positive, while traditional bond funds experienced massive outflows in the challenging market environment," Morningstar found. 

Further, it appears that a rebound is taking shape. In January of this year, S&P Global took another look at the global situation for corporate green bond issuance. Although issuance dropped steeply from 2021 to 2022, S&P described the context of a broader slowdown in bond issuance overall, driven by “volatile markets, inflation, rising interest rates and geopolitical uncertainty.”

S&P painted a more optimistic picture for 2023, based largely on supportive policies in China and the U.S., where the new federal climate and energy legislation promoted by President Joe Biden provides for $386 billion in spending over the next 10 years and a $265 billion increase in tax incentives.

S&P also cited Charlotte Edwards, a head of environmental, social and governance (ESG) research at Barclays, who expects growth in corporate green bond issuance to increase 30 percent this year, rebounding to 2021 levels.

A new threat for municipal green bonds

Here in the U.S., the renewed activity in the municipal green bond area could be hampered by partisan Republican policies designed to thwart ESG investment under the umbrella of the “woke capitalism” canard.

For example, last week in Florida, Republican Gov. Ron DeSantis signed anti-ESG legislation that prohibits some ESG bond sales outright and prevents state office holders from considering ESG goals.

In addition to raising potential legal liabilities for financial officers, Reuters took note of how the new law could negatively impact municipal bonds. “Lawyers and credit analysts said the new law could deny municipalities access to large pools of ESG-mandated capital," Isla Binnie and Ross Kerber of Reuters reported, citing Thomas Torgerson, co-head of global sovereign ratings at DBRS Morningstar.

Those concerns are well founded. In Texas, the city of Anna lost more than $277,000 on a bond sale last year after Republican Gov. Greg Abbott signed anti-ESG legislation into law. The loss was attributed to a drop in competition following the new law, which precluded the highest bidder.

Based on a Wharton analysis of the Texas law, the firm Econsult Solutions, Inc. anticipates millions more in losses for other states considering anti-ESG legislation, including Kentucky, Louisiana, Missouri, Oklahoma and West Virginia as well as Florida.

Signs municipal green bonds are ready to turn the corner 

Municipalities in states that are free of partisan interference can expect to fare better, along with their taxpayers, residents and businesses.

For example, the city of Turlock, California, has gained a significant new corporate citizen thanks to a $63 million municipal green bond issued by the California Public Finance Authority. The company in question is Divert, Inc., which describes itself as “an impact technology company on a mission to Protect the Value of Food.”

In April, Divert broke ground on its new facility in Turlock, which will convert food waste into carbon-negative renewable energy. In addition to helping California meet its climate goals, the new facility will create new jobs in Turlock and help the company’s retail and food industry clients improve their sustainability profiles by cutting down on food waste.

Divert clients can also anticipate bottom-line benefits from data collected through the waste-to-energy operation. The overall plan also encompasses a food donation program, helping to reduce food waste at the starting point.

Another example involves community choice aggregation, which is the means by which municipalities can join forces to lobby their utility for more clean energy. 

Only a handful of states have aggregation laws on the books, and one of them is California. Earlier this year, the California Community Choice Financing Authority issued municipal green bonds totaling almost $1 billion to the state’s largest community choice aggregator, Clean Power Alliance. The Alliance projects its renewable energy costs to decrease by an average of $8.3 million per year over the initial eight-year period of the bonds. The savings will be passed along to ratepayers.

It's unfortunate that businesses and residents in some Republican-led states will have to pass on opportunities like these, but that is a problem that corporate leaders can — and should — take up with their elected representatives.

Image credit: Akil Mazumder/Pexels