It’s a brilliant concept. A growing number of investors want to make money while also doing good. They want their portfolios, or at least a portion of their portfolios, to be “ESG” (environmental, social, and governance)-friendly. Why not tell them that if they buy your bonds, the money will be used to install solar panels, for example? Why not demonstrate that their money will have a good “effect” on something like the environment? This should increase the number of people interested in the bond, lower borrowing costs, and improve everyone’s reputation.
That is, in essence, the concept of “green bonds.” Alternatively, “social relationships” may be used to assist the needy. To safeguard coral reefs, you may use “blue bonds.” These thematic linkages have limitless potential. According to some estimates, they were issued in the amount of $200 billion just last year. But, in actuality, does it all work out? There are advantages and disadvantages, as well as evolution.
Pros of green bonds
They are trending
When a public figure or a corporate CEO goes to the bother of committing to an extra expenditure, they are demonstrating to the rest of the world how serious they are about it and how willing they are to make it a priority. They’re also talking about budget stability: this one thing won’t be reduced during bad weather. And they’re implying that they’ll be scrutinized in everything else they do—transparency is contagious. All of this is generally part of a larger plan, such as environmental protection in the case of green bonds. It’s a good approach to use money to influence policy.
You can get others to join the cause
It’s worth noting that sending a signal of commitment may assist others join the cause. This is very valuable to multilateral institutions like the World Bank. Their entire existence is dependent on a “theme”—in the Bank’s case, eradicating poverty via sustainable development. Their internal mechanisms are put up for public accountability and review. When they sell bonds, the revenues are readily linked to theme outcomes. This provides investors with a ready-made impact provider.
It takes the topic of diversity into consideration
This takes us to the topic of diversity. Bond buyers are becoming an alternative source of capital for borrowers who can act on the ESG agenda as more and more bond buyers compete to be — or be seen as — ESG friendly. It’s not a tiny option: since the United Nations-sponsored “Principles for Responsible Investment” were established in 2006, the number of signatories has increased by a factor of twenty, to over 2,000. They handle around $80 trillion in assets.
Cons of green bonds
Green bonds are not expensive
To begin with, green bonds are not less expensive—you do not save money by agreeing to spend the revenues in a certain manner. Why? ICMA says that is because investors analyze your “credit rating” to determine what interest rate they will charge you; they look at how likely you are to repay them. Your creditworthiness is unaffected by whether you spend money on solar panels or oil drilling, at least not in the near run.
Money is fungible
Money, on the other hand, is fungible. You could assume you’re funding the purchase of solar panels, but if the borrower’s government or firm already has the funds to pay for them, you’re really freeing up their resources to do something else. Green bonds might be used to fund national monuments or commercial vehicles. They won’t, hopefully. However, you can’t rule it out until you review the borrower’s whole spending plan before and after you lend. This in-depth reporting may be time-consuming and expensive.
Negative implications of green bonds
Third, the combination of bond buyer pledges and fiscal austerity may have unanticipated negative implications. A government may pledge to spend more on a worthwhile project, such as cleaning up dirty beaches. However, if it also has a budget deficit ceiling—which it may need to keep the economy in check—forcing greater spending on beaches may mean cutting down on, example, sanitation. Parliamentarians, not bankers, should determine if this trade-off is right or wrong.
It is difficult to determine the effect
Fourth, determining “effect” is difficult. Even when the proceeds of a bond can be proved to raise a specific expenditure (bonuses for great teachers, for example), establishing that the additional spending has the intended effect (higher student test scores) is difficult. Experiments and control groups are required. Proper assessments cost time and money, and the findings may be unsatisfactory or unavailable before the bonds mature. Will investors be disappointed and shut their checkbooks or, worse, sue the next time around? There is no instance of bondholders suing a nation or a company to court for failing to meet expenditure commitments, according to this writer. However, it is theoretically feasible.
It can get expensive
Fifth, tying bond revenues to particular government spending (a.k.a. “ear-marking”) might result in more costly financing, or even underfunding, over time. Investors will be able to pick and choose whatever parts of the fiscal budget they fund if purpose-specific bonds become more common. Schools, hospitals, and road upkeep are all possible candidates. Who wants to pay for tax collection, regulation, and incarceration, though? Shouldn’t the bonds that aren’t as desired pay a greater interest rate? It’s not clear.
With those advantages and disadvantages in mind, would you suggest these bonds to the ordinary government, firm, or institution? Yes, but only if you confine them to a tiny percentage of your overall funding, use them exclusively for items that are really vital to you, and keep an eye on how the market evolves. The cost-benefit analysis of using this sort of financing will gradually favor it. Common standards will emerge across the board, from design to disclosure, and investors will feel more at ease with them. Some tasks will be delegated to experts; credit rating organizations may one day offer “green ratings.” There will be valuable track records and brands established. It’s best to remain tuned.
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