Instrument Overview
Fixed-income financial instruments (bonds) which are used to fund projects with positive environmental or climate benefits. They follow the Green Bond Principles stated by the International Capital Market Association (ICMA), and the proceeds from the issuance are to be used for the pre-specified types of projects [1].
Why it matters for cities
- Green bonds can be a low-cost, long-term and diversified source of capital compared with traditional bank loans.1 By bundling projects into one investment, bonds provide economies of scale and attract new investors. Private-sector demand for green bonds is outstripping supply, which is helping many issuers to achieve low interest rates and suggests that the scale of private capital ready for cities to utilise could be significant.
- Issuing a green bond can draw attention to your city’s climate priorities and climate mitigation and/or adaptation strategy, and make the city more attractive to investors.
- Green bond issuance can help to develop your city’s financial and risk management processes and increase collaboration between its environmental and finance departments, therefore improving the systems needed to raise funding in future.3, 4 Bonds tend to become cheaper with experience.
Key features
- Risk Profile: Green bonds carry a similar risk profile to conventional bonds, based on the issuer’s overall creditworthiness. They are generally low-risk, but reputational risks may arise from poor environmental reporting or greenwashing.
- Maturity: Green bonds typically have maturities ranging from 5 to 30 years, aligning with the long-term nature of infrastructure projects. This allows cities to match debt terms to project lifespans.
- Repayment Terms : They feature standard fixed-income terms: periodic interest payments and principal repayment at maturity. Repayments are made from the issuer's general funds or designated revenue streams, not project-specific returns.
- Scalability: Green bonds are highly scalable and can fund single large projects or bundles of smaller initiatives. Cities can issue them repeatedly under a green bond program or framework to support ongoing climate goals.
How It Works
Green bonds are fundamentally the same as conventional bonds: a loan made by an investor to an organization to finance a project, with the investor receiving the principal amount at the end of the loan’s life, in addition to interest payments (depending on the loan terms) throughout the loan’s term [2].
The key differentiator between a green bond and a conventional bond is the underlying project that is financed with the proceeds. Green bonds are issued exclusively to finance projects that positively impact the environment. On the other hand, conventional bonds are primarily issued to finance general projects, general working capital purposes, or refinance existing debt [2].
Green bonds are commonly used to finance the following types of projects [2]:
- Energy efficiency projects
- Renewable energy projects
- Pollution prevention and control projects
- Natural resources and land management projects
- Clean transportation projects
- Wastewater and water management projects
- Green building projects
Benefits & Challenges for Cities [3]
Benefits:
- Value-enhancement: The evidence suggests that the issuer enjoys significantly higher returns at the announcement, indicating investors' positive expectations of the green bonds' contribution to the shareholder value.
- Lower cost of capital: green bonds are suitable for raising capital in large-scale investment projects.
- Safety: green securities are considered safe financial instruments with low riskiness, as they can accurately predict companies' cash flows due to their fixed rate of return.
- Price: the pricing of green bonds is advantageous and generous due to their "greenium effect" - a premium for being a green financial instrument.
- Diversified and increased investor base: green companies are attractive to sustainable investors that can greatly diversify their shareholders' variety towards ESG.
Challenges:
- More expensive to issue than traditional bonds.
- Typically heavily oversubscribed by investors searching for sustainable investment options and relatively few green bonds issued each year.
- Lack of green contractual protection for investors, so-called greenwashing.
- The quality of reporting metrics and transparency is not always good.
- Issuer confusion and fatigue.
- Perceived lack of pricing incentives for issuers
Use Cases
Municipal Green Bond for Climate Resilience in the Water Sector in Cape Town, South Africa
In 2017, the City of Cape Town wanted to highlight its green credentials and issued a green bond to leverage private capital to support its pipeline of water projects. The green bond was certified by the Climate Bonds Initiative (CBI) and achieved an ‘Excellent’ rating from Moody’s for its governing process and how proceeds are being used, managed, and reported (this includes having comprehensive criteria for an investment project that are selected and measurable impact of results). The verification of the CBI standard was undertaken by an external assurance provider both pre- and post-issuance of the bond. In total, the bond raised 1 billion Rand (approximately USD 67 million) mainly from financial institutions. Transaction costs borne by the city involved consultancy fees for the assurance process, certification fee for CBI, and originator fees (as per the normal bond process) [4].
When to Use It
- For large, climate-aligned infrastructure projects.
- During construction or to refinance completed green projects
- When clear environmental benefits and budgets are defined.
- To attract ESG investors and diversify funding.
- To align with climate action or net-zero plans.
- To bundle multiple small green projects under one bond.
- Best used during construction or operation, when project scope, costs, and environmental benefits are clear.
References
[2] Green Bond - Overview, How It Works, History, Advantages
[4] https://www.climatepolicyinitiative.org/wp-content/uploads/2023/06/Improving-Local-Enabling-Conditions-for-Private-Sector-Climate-Investments-in-Cities.pdf (Pp. 8, Case Study 4)