Green and Sustainable Finance: Markets and Instruments
What green finance is
Green and sustainable finance channels capital to environmental and social objectives. Core instruments include green bonds (proceeds earmarked for eligible projects, e.g. ICMA Green Bond Principles: use of proceeds, project evaluation, management of proceeds, reporting), sustainability-linked bonds (SLBs) (proceeds general; pricing tied to sustainability performance targets/KPIs), transition bonds, social bonds, and sustainability bonds.
Key distinction: use-of-proceeds vs performance-linked
A green bond's greenness depends on what the money funds; an SLB's depends on whether the issuer hits targets, with a coupon step-up penalty if missed. Traps: assuming SLBs are earmarked; assuming a green label guarantees impact.
Markets and mechanisms
Beyond bonds: green loans (Loan Market Association principles), sustainability-linked loans, blended finance, carbon markets (compliance vs voluntary), and green equity funds. Taxonomies (e.g. EU Taxonomy) define which activities count as sustainable, addressing greenwashing. Greenwashing is a central supervisory concern.
Worked example
An SLB pays 3.0% but steps up 25 bps if it misses its Scope 1+2 reduction KPI by 2027. The investor bears performance risk; the issuer's incentive is to hit the target. Contrast a green bond, where coupon is unaffected by project outcomes.
Traps
- Confusing green bonds (earmarked) with SLBs (target-linked).
- Ignoring the role of second-party opinions and verification.
- Treating voluntary carbon credits as equivalent to compliance allowances.