Green Bonds

How effectively do green bonds help the environment?

Today, many investors want to invest their money in a way that has a positive impact on the environment. One means of achieving such an impact could be green bonds. They are bonds issued by governments or corporates, with the commitment to invest the money in projects that benefit the environment. The majority of green bond proceeds are used for projects that lower CO2 emissions. The sheer numbers suggest that green bonds can indeed make a difference: issuance is around 500 billion dollars per year.

Looking at issue amounts, however, is insufficient to determine whether financial markets provide an effective contribution to climate change mitigation. Consider the company Apple. It has issued several green bonds to finance investments in renewables and other carbon reducing projects. Given the comfortable financial position that Apple is in, one can imagine that Apple did not need the money raised through green bonds to finance the green projects it wanted to pursue. Possibly, investors could have made a bigger impact on the environment by giving the money to companies that find it more difficult to get funding for green projects.

This is the motivation for a research conducted by Ulm financial economist Gunter Löffler and his co-author Mona ElBannan from the German University in Cairo (GUC). For a comprehensive, international sample of non-financial corporates, they examine whether higher green bond issue volumes are associated with bigger future carbon reductions. As the two find out, there is indeed a positive association on average. The results are consistent with the interpretation that funds from green bond issuance enable firms to invest in projects that lower their carbon emissions.

However, causality is difficulty to establish. The observed empirical patterns could also be due to other effects. To shed more light on the plausibility of direct financing effects, Mona ElBannan and Gunter Löffler investigate whether the correlation between emission volume and CO2 reduction is particularly strong for companies with financial constraints. This is exactly what they find in the data. For this subset of firms, the alternative targeted financing option that green bonds offer is likely to be more valuable when compared with other firms.

However, the authors also find that for companies in good financial health, there is no association between green bond volume and CO2 reduction. Thus, it is not obvious that providing additional financing through green bonds to such companies makes a difference for the environment. The analysis therefore suggests that investors who are concerned about the impact of their investments can benefit from screening issuers according to their financial situation. This helps investors do something for the environment with their money, and it helps the environment by directing funds to projects that would not otherwise be realized.

The research „How effectively do green bonds help the environment?” is available as a working paper. For their research, the authors received financial support from a project of the DAAD (German Academic Exchange Service) and the BMBF (Federal Ministry of Education and Research).