In the wake of the Covid-19 pandemic, governments and businesses will focus their attention on rebuilding, including a move to more environmentally sustainable economies. As a result, issuers of all types are using green bonds to finance projects related to environmental initiatives.

On a steady upward trajectory over the past few years, green bonds are a growing category of fixed-income securities that raise capital for projects with environmental benefits, such as renewable energy or low-carbon transport. Although they make up only a small fraction of the total global bond market—about 4 per cent—green bonds reached a record high of nearly US$270 billion by the end of 2020. New issuance could reach US$400-$450 billion this year, according to a report by the London-based non-profit Climate Bonds Initiative, which promotes investment in the low-carbon economy. Due to strong demand relative to the wider bond market, green bonds have shown comparatively strong resilience during pandemic-related market volatility.

“The green bond market is growing very quickly,” says Angus Young, senior lecturer and research fellow at Hong Kong Baptist University’s Department of Accountancy and Law, and Centre for Corporate Governance and Financial Policy. He adds that by not including green bonds in a fixed-income portfolio allocation, investors could be missing an opportunity for asset diversification.

As the green bond market grows and evolves, Young says the most important among the questions investors need to consider is: what makes a bond green? Unlike conventional bond issues, which typically do not include specific reporting on the use of proceeds, when an organisation issues green bonds it is expected to provide assurances that the capital raised is allocated to projects as intended, in areas such as renewable energy, public transportation, energy efficient buildings and manufacturing processes, agricultural land management, waste management and water.

For an investor looking to green bonds, another major question concerns the yields and financial risks they expect to carry. An important feature of green bonds is that while proceeds are raised for a stipulated green project, repayment is tied to the issuing company and not the success or failure of the project.

While surging green bond issuance means more choice for investors, it also means they need to be more discerning to avoid greenwashing—issuers exaggerating their green credentials or the intended use of the green bond funding, or even operating in ways out of sync with the concept of sustainability.

Apart from large rating agencies, currently investors have limited access to a homogeneous way of evaluating the individual elements of green bonds, which can vary widely by industry. There is no global consensus on standardisation or the types of capital projects, green definitions and verification that fit within the scope of green bonds.

“Because the fund managers have done the research and can serve as a safeguard against greenwashing, one of the easiest ways for investors to get into green bonds is through investing in green bond funds,” says Young. Another way for investors to avoid investing in greenwashing schemes in Hong Kong is to look out for funds that have a Green Finance Certification, developed by the Hong Kong Quality Assurance Agency.

Many of the world’s leading political and economic authorities, including former Bank of England governor and United Nations special envoy for climate action and finance, Mark Carney, are estimating as much as US$2 trillion to US$3 trillion-plus of capital will be needed annually for the next 30 years to mitigate the worst climate-related and other environmental scenarios. With the bond markets expected to provide a large proportion of that funding, the future for green bond looks positive.

See also: 4 Female Investors Who Are Using Their Capital To Drive Positive Social Change