Instrument Overview
Climate bonds can mobilize resources from domestic and international capital markets for climate change adaptation, renewables and other environment-friendly projects. They are no different from conventional bonds, and their unique characteristic is the specification that the proceeds be invested in projects that generate environmental benefits. In its simplest form, a bond issuer will raise a fixed amount of capital, repaying the capital (principal) and accrued interest (coupon). The issuer will need to generate sufficient cash flows to repay interest and principal [1].
Why it matters for cities
Cities are at the frontline of climate change impacts and play a crucial role in achieving global climate goals. They require substantial and sustained investment in infrastructure to enhance climate resilience, reduce emissions, and promote sustainable urban development. Climate bonds provide a valuable financing mechanism to fund these projects without burdening public budgets, while also attracting private capital. By issuing climate bonds, cities can accelerate progress on climate action plans, signal their environmental commitments to stakeholders, and unlock new funding avenues for long-term, green infrastructure.
Key features
- Proceeds are earmarked specifically for environmentally beneficial projects.
- Functions identically to a conventional bond in terms of repayment (principal + interest).
- Usually adheres to voluntary standards such as the Green Bond Principles for transparency and accountability.
- Can involve third-party verification or certification of green credentials.
- Performance metrics are often similar to those of traditional bonds.
- Issuers are required to publicly report on the use of proceeds
How It Works
- Bond Issuance: A city (or other issuer) raises capital by issuing bonds to investors, who receive regular interest payments (coupon) and the return of principal at maturity.
- Project Allocation: Proceeds are allocated to projects with clear environmental benefits, such as renewable energy, energy efficiency upgrades, or climate adaptation measures.
- Transparency & Reporting: Issuers typically report on the environmental impact and the use of proceeds, fostering investor trust and demonstrating accountability.
- Investor Attraction: Green bonds appeal to socially responsible investors and institutions with ESG (Environmental, Social, Governance) mandates.
- Verification (Optional): Issuers may choose to have bonds certified or verified by third parties to boost credibility and attract more investors.
Benefits & Challenges for Cities [1]
Benefits
- Investor demand for green bonds is high.
- Bonds support significant upfront investment into larger and longer-term investments.
- Similar performance as regular bonds (including risk profiles).
- Green bonds can help diversify the investor base.
- Positive marketing outcomes for green bond issuers and investors.
- Green bond preparation and issuance promote collaboration between different government departments.
- Potential for longer bond tenors than traditional bonds.
Challenges
- Green bonds require public reporting of the use of proceeds and can involve other optional verification processes.
- Green bond secondary markets are less developed than those for traditional municipal bonds.
- As with regular bonds, prices fall when interest rates rise, and some green bonds are callable (meaning the bond must be paid off early).
Use Cases
Paris Climate Bond [2]
Right at a moment when international climate efforts were concentrated at COP21 taking place in Paris in 2015, the city issued the Paris Climate Bond (PCB)1 to finance and re-finance projects in climate mitigation and adaptation. The PCB constitutes an innovative tool to reach the goals of the city of Paris´ ambitious Climate Action Plan, which aims to make Paris a carbon-neutral and climate-resilient city by 2050. It functions in line with the ‘Green Bond Principles’, which are voluntary process guidelines that recommend transparency and disclosure and promote integrity in the development of the green bond market (ICMA, 2018). The bond has a size of EUR 300 million, a term from 2015 to 2031, and targets private investors who are interested in seizing this investment opportunity while funding sustainable actions in the city of Paris. Investors receive a coupon of 1.75% per year (ClimateADAPT, 2016). The Paris Climate Bond aims to fulfil four main goals: Greenhouse gas (GHG) emission reductions, improvement of energy efficiency, renewable energy production, and climate change adaptation (Climate Bonds Initiative, 2015; ClimateADAPT, 2016).
The case constitutes a good practice for a variety of reasons: The city of Paris has involved different knowledgeable stakeholders to secure a well-informed implementation of the bond. In addition, the political will to push for ambitious climate policies in Paris has been continuously strong, which helped to foster its burgeoning green bond market. Lastly, a transparent reporting structure has attracted investors as they can easily assess the impacts of their investments.
When to Use It
- When funding large-scale, long-term infrastructure projects aligned with climate action or sustainability goals.
- When a city has strong political support and coordination across departments to ensure successful implementation.
- When there’s a need to diversify funding sources beyond taxes and traditional municipal bonds.
- When aiming to boost investor confidence and visibility by aligning with global green finance standards.
- When seeking to mobilize private capital for public climate priorities, especially in the context of national or international climate agreements (e.g., COP commitments).
References
[1] https://citiesclimatefinance.org/financial-instruments/instruments/climate_bond
[2] 191025_gpd_parisclimatebond_web.pdf