Municipalities could benefit from issuing more green bonds

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Editor's note:

This paper was presented at the 2018 Municipal Finance Conference on July 16 & 17,2018. The conference is a collaboration of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy, the Brandeis International Business School’s Rosenberg Institute of Public Finance, Washington University in St. Louis’s Olin Business School, and the University of Chicago’s Harris Institute of Public Policy. It aims to bring together academics, practitioners, issuers, and regulators to discuss recent research on municipal capital markets and state and local fiscal issues.

A green bond is one whose issuer commits to using 100 percent of bond proceeds for environmentally friendly purposes. For instance, municipalities can use green bonds to fund projects focused on renewable energy, clean transportation, sustainable water management, or climate change adaptations, among others. In a paper to be presented at the 2018 Municipal Finance Conference at Brookings, Malcolm Baker and George Serafeim of Harvard Business School, Daniel Bergstresser of Brandeis International Business School, and Jeffrey Wurgler of the NYU Stern School of Business find that yields at issue for green municipal bonds are on average 0.06 percentage points below yields paid on otherwise equivalent bonds. The paper, “Financing the Response to Climate Change: The Pricing and Ownership of U.S. Green Bonds,” provides an overview of the U.S. municipal bond market covering 2,083 municipal bonds labeled green by Bloomberg, and another 643,299 ordinary municipal bonds, issued between 2010 and 2016. The annual issuance of bonds identified as green rose from less than $500 million a year (or less than 0.18 percent of total annual municipal issuance) in 2010 to 2013 to over $2 billion in 2014, and totaled $6.5 billion (or 1.9 percent of total municipal issuance) in 2016. Most environmentally sensitive projects, such as pollution control and mass transit, are still funded by ordinary bonds, as the table below shows. Therefore, municipalities could, and perhaps should, already be issuing green bonds in far greater numbers, the authors say. Volume of issuance of green and ordinary bonds by use of proceeds, 2010-2016

Use of proceeds

Green ($ M) Ordinary ($ M)
Mass/Rapid Transit 1,480 27,100
Pollution Control 19 10,200
Land Preservation 0 505
Water and Sewer 5,210 170,000
Other 5,928 1,618,355
Total 12,637 1,826,160

Source: Baker, Bergstresser, Serafeim, and Wurgler (2018).

[A] subset of investors are willing to give up returns in order to hold green bonds, and municipalities could save money by issuing green rather than ordinary bonds.

This is important for municipal bond issuers because investors may be willing to accept lower returns in order to hold bonds identified as socially responsible. After controlling for such bond features as size, maturity, rating, and use of proceeds, they find that yields at issue on green bonds are around 0.06 percentage points lower than those on ordinary bonds. This suggests that a subset of investors are willing to give up returns in order to hold green bonds, and that municipalities could save money by issuing green rather than ordinary bonds. The effect is much stronger for the 6.6 percent of green bonds that go through a costly external certification process and are registered with the Climate Bonds Initiative. Therefore, the authors say, green bond issuers might benefit from getting their bonds certified, particularly if certification becomes more standardized and affordable as the market expands. The authors also find that investment funds whose names indicate that they are socially responsible hold 13.5 percent of outstanding green bonds, but just 0.6 percent of ordinary bonds.  The ownership of green bonds, particularly small, AAA-rated ones, is more concentrated than the ownership of similar ordinary bonds. The authors argue that as the impact of climate change becomes more apparent, green bonds will likely become an important way to fund the response, and one that municipalities should embrace as a cheaper alternative to issuing ordinary bonds.