Journal of Sustainable Finance & Investment

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The green bond market: a potential source of

climate finance for developing countries

Josué Banga

To cite this article: Josué Banga (2019) The green bond market: a potential source of climate
finance for developing countries, Journal of Sustainable Finance & Investment, 9:1, 17-32, DOI:
10.1080/20430795.2018.1498617

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Published online: 13 Jul 2018.

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JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT
2019, VOL. 9, NO. 1, 17–32
https://doi.org/10.1080/20430795.2018.1498617

The green bond market: a potential source of climate finance

for developing countries
Josué Banga
Department of Economics, Université Grenoble Alpes, Grenoble, France

ABSTRACT ARTICLE HISTORY

This paper examines the potential of green bonds in mobilizing Received 2 February 2018
adaptation and mitigation finance for developing countries. Accepted 6 July 2018
Building upon a theoretical approach, it identifies the key drivers
KEYWORDS
of the green bond market over the last few years and the barriers Green bonds; minimum size;
that impede its appropriation by developing countries. The results transaction costs;
suggest that the rise of green bonds is a fact in developed and development banks;
emerging countries, backed by an increasing climate-awareness developing countries
from investors. However, in developing countries, the market
remains incipient, and its full potential seems to be
underappreciated. The lack of appropriate institutional
arrangements for green bond management, the issue of minimum
size, and high transactions costs associated with green bond
issuance, are the key barriers to the development of green bonds
in developing countries. In order to cope with these challenges,
this paper suggests an efficient use of multilateral and national
development banks as intermediary institutions for local green
bond management. Furthermore, local governments are required
to provide local green bond issuers with guarantees aimed at
covering the transaction costs associated with green bond issuance.

1. Introduction
The transition to a resilient and lower-carbon economy requires significant investment
from both public and private sectors. Recent climate summits have revealed that
finance is critical for the implementation of Intended Nationally Determined Contri-
butions (INDCs), in which nearly 200 countries have publicly outlined their intentions
in terms of greenhouse gas reduction. For many developing countries, these intentions
are highly dependent on the pledges of developed countries to provide them with USD
100 billion annually for their adaptation and mitigation projects (UNFCCC 2009).
However, the current economic turmoil that prevails in most developed countries (King
2017) and the lack of common understanding about the balancing between adaptation
and mitigation finance (Pickering et al. 2015) suggest that developing countries are unli-
kely to achieve their emission reduction targets by solely relying on those pledges. Rather,
developing countries must also explore new financing mechanisms, such as green bonds if
their commitments should be respected.

CONTACT Josué Banga [email protected]

© 2018 Informa UK Limited, trading as Taylor & Francis Group
18 J. BANGA

As innovative financial instruments, green bonds provide an opportunity to tap into

new pools of private capital to finance green projects (EY 2018).
The term ‘green bonds’ refers to bonds whose proceeds are used to finance environ-
mentally-friendly projects (Mercer 2015), such as renewables, water and energy
efficiency, bioenergy, and low carbon transports (Campiglio 2016).
So far, there is no universal definition of green bonds, though a growing consensus has
emerged on what they are intended to do (OECD 2017; German Development Institute
2016). For the purpose of this paper, a green bond should be defined as a fixed-income
financial instrument for raising capital to finance or refinance eligible green projects
(OECD 2017; ICMA 2017).
As such, green bonds are of significant importance to both investors and policy makers.
On one hand, governments need access to affordable and reliable financial resources in
order to fulfill their commitment under the 2015 Paris Agreement, which aims to hold
the increase in the global average temperature to well below 2° Celsius above pre-industrial
levels (United Nations 2015). In the other hand, investors are increasingly encouraged to
adapt their business models to create a not only financial value but also social and environ-
mental values (Schoenmaker 2017).
During the 2008 financial crisis, green bonds were a concept of limited interest to inves-
tors (United Nations Secretary-General 2015; German Development Institute 2016), since
environmental projects were deemed risky and non-profitable by traditional investors
(Wharthon 2015). Surprisingly, there has been an exponential growth in green bond issu-
ance since then, attributable to an increased awareness from traditional investors about the
benefits of green investments (Shishlov, Morel, and Cochran 2016) and the potential
impacts of climate change on financial assets (Carney 2016; Mercer 2015; Schoenmaker
2017; Caldecott 2017).
Investors’ appetite for green bonds has therefore grown rapidly (Pham 2016), as they
realize that climate change is a new investment return variable, which deserves significant
attention (Mercer 2015). Many investors, especially those in the carbon-intensive sectors
of the economy, have now become very reactive to climate-related technologies, such as
carbon capture and sequestration (CCS). More importantly, an increasing number of
investors began to incorporate climate change risk assessments into their investment strat-
egies (Byrd and Cooperman 2018).
The European Investment Bank (EIB) was the first multilateral development institution
to issue a climate-awareness bond, worth USD 1 billion, in 2007. A year later, the World
Bank issued a second green bond to finance climate mitigation and adaptation projects
in its countries of operations. Since then, municipalities, commercial banks and some of
the world’s largest companies followed in the same direction. For instance, green bond issu-
ance has grown drastically from USD 1 billion in 2007 to USD 895 billion in 2017, of which
USD 674 billion were self-labeled green bonds, and USD 221 billion of certified labeled
green bonds, according to the Climate Bonds Initiative. Certified green bonds refer to
bonds that completed a certification process to receive the green label, which means that
all their proceeds must be used to finance the green projects for which they have been
issued. In contrast, self-labeled green bonds are bonds labeled as green by the issuer but
not attested by an independent reviewer, as is the case for certified green bonds.
Since 2014, there have been significant efforts aimed at making green bond standards
more popular to investors (Ceres 2014). Yet, the size and scope of the green bond market
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 19

remain negligible compared to the global fixed-income market (Franklin 2016; Moody’s
2017). Furthermore, the development of the green bond market is only perceptible in
some developed and emerging countries.1 In many developing countries, however, the
market remains incipient, and its full potential seems to be underappreciated. According
to the Climate Bonds Initiative, only USD 2.2 billion of total flows in the green bond
market, have been directed towards cities in developing countries compared to USD 17
billion in developed countries (Climate Bonds Initiative 2016).
The objective of this paper is to analyze the rise of the green bond market over the last
few years, by putting an emphasis on its key drivers and the barriers that prevent devel-
oping countries from exploiting this new yet growing source of climate finance. Beyond its
analytical contribution, this paper aims to push forward the literature on green bonds.
The remaining of the paper is structured as follows. Section 2 shows recent trends in the
green bond market. Section 3 identifies relevant barriers that prevent developing countries
from taking advantage of that market. Section 4 discusses the findings and provides a set of
policy recommendations aimed at helping developing countries overcome these barriers.
Section 5 concludes.

2. Recent trends in the green bond market

Green bonds provide an opportunity for long-term and sustainable infrastructure
financing. Previously carried out by multilateral development banks (MDBs), namely
the World Bank and the European Investment Bank, green bond issuance has promptly
spread to other traditional investors, such as institutional investors, commercial banks,
municipalities, and some of the world’s largest companies. Investments in this new and
growing segment of fixed-income markets have increased more than ten-fold over the
past five years and is expected to reach USD 1 trillion by 2020, as the demand for
green bonds continues to rise (CBI and HSBC 2017).
The launching of the Green Bond Principles (GBPs)2 in 2014, which now involve a con-
sortium of more than 200 financial and non-financial institutions, has only strengthened
the emergence of green bonds. According to Climate Bonds Initiative’s database,3 the total
number of green bonds issued has increased from one in 2007 to more than 2000 issued
green bonds in 2017, a spectacular annual growth of more than 113% during the same
period. In 2017, the United States, China, and France accounted for 56% of global
green bond issuance (see Figure 1).
Developing countries, however, are excluded from this growing source of climate
finance they need to implement their adaptation and mitigation projects. A thorough
analysis of the Climate Bonds Initiative’s database shows that only a small handful of
investors and governments from those countries have issued green bonds so far. Never-
theless, a growing number of them are progressively looking after the market,4 which is
drawn by several factors.

2.1. The key drivers of the green bond market

Without claiming to be exhaustive, this subsection identifies several forces that have been
decisive for the development of the green bond market in developed and emerging
countries over the last few years.
20 J. BANGA

Figure 1. Top ten issuers of green bonds, January-November 2017. Data source: Climate Bonds
Initiative.

First, with few exceptions, green bonds are inherently similar to conventional bonds in
terms of structure. Their deals carry the same risk/return profile like any conventional
bond issued in the fixed-income market. The pricing and yield to maturity of green
bonds are indeed akin to that of conventional bonds. Recent empirical studies showed
that there is a strong correlation between the yield to maturity (YTM)5 of green bonds
and that of conventional bonds (Wanke 2017). Figure 2 depicts this correlation for green
bonds and conventional bonds issued by the German Development Bank (KFW) and Apple.
The fact that green bonds are ranked pari passu with conventional bonds in terms of
yield to maturity, is to some extent a key element that boosts investor’s appetite for
green bonds. Furthermore, investors have realized that investing in environment-related
projects, does not necessarily jeopardize return on investment.
The main difference between green bonds and conventional bonds is that unlike the
latter the proceeds of the former must be entirely allocated for environmentally-friendly
projects (CBI and HSBC 2017). Moreover, green bonds often require a more complex-
issuance process, since their deal typically involves at least three market players, whose
roles are discussed in the next subsection.

Figure 2. Yield to maturity: green bond vs. conventional bond. Data Source: Bloomberg as of 1/31/
2017.
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 21

The recent rise of the green bond market also stems from two mutually re-enforcing
arguments. The first is due to an increased understanding about the potential links
between climate change and financial stability.
Investors and policy makers have indeed become increasingly aware of the potential
risks climate change poses to businesses and the financial sector as a whole (Carney
2016; TCFD 2017). This climate-awareness has led to the implementation of preventive
measures, such as climate risk stress tests aimed at assessing the exposure of financial insti-
tutions to climate change risks (Battiston et al. 2017; Mercer 2015). The ultimate goal of
these tests is to ensure that the whole financial system is resilient to climate change
impacts. This is why some authors urge investors to move from the shareholder model
which focuses on profit maximization only, to the stakeholder model which aims to
create not only a financial value but also social and environmental values (Schoenmaker
2017). As Weber (2018) suggests, the adoption of voluntary sustainability codes of
conduct could help create a more sustainable financial system, in which environmental
risks are well recognized and managed. By doing so, investors could sensibly reduce
their exposure to climate change risks, thereby limiting their potential capital loss due
to stranded assets, as a result of climate change impacts. Stranded assets are ‘assets that
have suffered from unanticipated or premature write-downs, devaluations or conversions
to liabilities’ (Caldecott, Howarth, and McSharry 2013).
It is therefore important that investors include environmental-social-governance (ESG)
criteria into their investment decision-making. The incorporation of such criteria within
financial markets’ structures is becoming increasingly obvious as rating agencies such as
Moody’s, Standard & Spoor, and Barclay’s MSCI have started to establish green bond stan-
dards and indexes aimed at assessing the environmental impacts of their clients’ portfolios.
The second argument is political in nature and derives from the 2015 Paris agreement,
signed in December 2015. At the Paris climate conference (COP 21), nearly 200 countries
have adopted a binding climate deal aimed at cutting down greenhouse gas emissions in
order to limit global warming 2° Celsius above pre-industrial levels, with 66% of prob-
ability by the end of this century. Furthermore, during the 2016 G20 summit held in
Hangzhou, the world’s political leaders have agreed to ‘support the development of
local green bond markets and promote international collaboration to facilitate cross-
border investments in green bonds’ (G20 2016). This historic political support for
climate action has sent positive signals to investors, thereby strengthening the green
bond market development, especially in advanced and emerging countries. Figure 3, for
instance, highlights the positive response of financial markets to the ratification of the
Paris climate agreement. This figure shows that the S&P 500 renewable energy index
over-performed the STOWE global coal index shortly after the ratification of the Paris
agreement, thereby highlighting the importance of policy support in scaling up the
green bond market.
Last but not least, the development of the green bond market arguably stems from the
consequences of ‘unconventional monetary policies’ implemented by the world’s major
central banks in the aftermath of the 2008 financial crisis. The failure of monetary auth-
orities to achieve economic recovery through accommodative monetary policies has
resulted in low-interest rates and hungry for yield, especially in advanced economies
(King 2017). Consequently, institutional investors, ‘such as pension funds and insurance
companies are coming under pressure to find ways of making their savings products more
22 J. BANGA

Figure 3. Reaction of financial markets to Paris climate announcement. This figure shows how the rates
of green (S&P 500 renewable energy index) and brown (STOWE Global Coal Index) companies
responded to the ratification of the Paris climate agreement. Source: Adapted from DNB (2017).

attractive and reduce the rising costs of pension provision in the face of falling real interest
rates’ (King 2017, 32). Such a pressure has led many institutional investors – who hold
nearly USD 100 trillion in assets (Arezki et al. 2016) – to look for new investment oppor-
tunities such as those of the low-carbon transition, which also match their investment hor-
izons. As one of the major market players in the fixed-income markets, institutional
investors have realized that sustainable investing can preserve wealth and provide reliable
streams of revenue, while reducing volatility in the equity markets. This increased climate-
awareness and the low-interest rate environment prevailing in most developed countries
have led institutional investors to recognize green bonds as a portfolio diversification
instrument.

2.2. Typology and the functioning of green bonds

Depending on the use of proceeds, it is possible to currently distinguish between four
specific types of green bonds, all of which are consistent with the Green Bond Principles:
standard green use of proceeds bonds, green revenue bonds, green project bonds, and
green securitized bonds (ICMA 2017).
A standard green use of proceeds bond is a debt obligation with recourse to the issuer in
the case of default on interest payment or return of principal. The proceeds of such a bond
should be tracked with a specific sub-account or by the issuer following an internal process
that links the issuer’s lending and green investments. While purchasing such a bond, it is
recommended that the issuer makes known to investors the intended types of eligible
investments for the balance of unallocated proceeds (Ceres 2014). Green revenue bonds
are non-recourse-to-the-issuer debt obligations, for which the credit exposure in the
bond is to the pledged cash flows of the revenue streams, fees, and taxes (ICMA 2017).
The proceeds of that bond could go to related or unrelated green projects. Next, a
green project bond is a bond issued for a single or pooled green project(s) for which
risks are entirely bore by the underwriter, with or without potential recourse to the
issuer (Ceres 2014; ICMA 2017). Finally, green securitized bonds are collateralized by
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 23

one or more specific green projects. They include but are not limited to covered bond and
asset-backed securities (ICMA 2017). In the event of default of payment, green securitized
bonds could provide recourse to the issuer only to the underlying assets. The repayment of
such bonds usually depends upon the cash flows generated by these assets. It could be, for
instance, the charge paid by consumers to use infrastructures that have been set up thanks
to the proceeds of the green bond (Kaminker and Stewart 2012).
Given the lack of universal standards and definition for green bonds, it is likely that
their characteristics (i.e. coupon and maturity) may differ from one issuer to another
(Flaherty et al. 2017). Nevertheless, the goal remains the same, which is to finance
green projects.
The process of issuing a certified green bond involves at least three major market
players, including the issuer, an independent reviewer, and the underwriters as highlighted
in Figure 4 below.
The process then begins when an issuer or a project developer sets up a green project. In
the project document, the issuer should itemize, as much as possible, the expected positive
impacts of its project on the environment. In order to avoid overestimations or underes-
timations of such impacts, an independent reviewer who is a specialist of environmental
impact assessment, is required to confirm whether the project is actually environmentally-
friendly. The role of the independent reviewer is to carry out a quantitative and qualitative
assessment of the project, based on the following criteria suggested by ICMA (2017).

(1) The use of proceeds: prior to issuance, a legal document must specify how the pro-
ceeds of the bond will be used.
(2) A technical assessment of specific risks and opportunities tied to the project and the
creditworthiness of the green bond issuer.
(3) The monitoring, reporting, and traceability requirements: several reports are regularly
produced to monitor both the project and the use of the proceeds in order to make
sure that the green bond proceeds are being allocated in accordance with the Green
Bonds Principles.

Figure 4. The process for issuing a certified green bond involves three markets players with specific
roles. Source: author’s construction.
24 J. BANGA

Failures in complying with these requirements could result in the exclusion of the issuer
from the green bond market. Once the second opinion attests the green nature of the
project to be financed, the issuer is allowed to issue a certified labeled green bond in
order to raise funds in the debt capital market. Green bond underwriters then provide
capital to the issuer for a certain period of time at a fixed or variable interest rate
(German Development Institute 2016). This tripartite process of green bond issuance
could entail some significant transaction costs, as argued in the next section.
It is worth noting that Figure 4 below is made simplistic for illustration purposes. In
practice, however, this process may vary from one market to another.
Although the green bond market is quickly growing, its size still remains small com-
pared to the global fixed-income market (Franklin 2016; Moody’s 2017). According to
S&P Global, green bonds represent only 1.4% of the total fixed-income market (S&P
Global 2017). Furthermore, the market is mainly polarized in developed and emerging
economies. According to the Climate Bond Initiative data, China represented over 40%
of the global green bond issuance in 2016, while regions such as Asia (excluding China)
and Africa accounted for less than 6.5% of global green bond issuance in 2007-2016.
These figures suggest that the green bond market faces many challenges that jeopardize
its development in developing countries.

3. Barriers to the green bond market in developing countries

Although green bonds have the potential to attract significant private climate finance for
developing countries, their adoption is still plagued with several barriers. These obstacles
range from institutional to market barriers and are deemed to be the most challenging for
the development of the market. This section elaborate on these barriers, while recognizing
that their importance may vary across countries.

3.1. Institutional barriers

Green bonds foremost require technical skills for monitoring and assessing of their use of
proceeds throughout the project’s lifecycle. Many developing countries, however, lack
such technical skills which are essential to ensure that projects are implemented in accord-
ance with the Green Bond Principles.
A recent survey by the G20 Green Finance Study Group revealed that the lack of knowl-
edge of existing international practices in green bond transactions was reported by respon-
dents (up to 74%) as an important barrier for the development of the green bond market
(GFSG 2016). This is particularly true in many developing countries, where this knowl-
edge gap could also be exacerbated by the fact that the benefits of green bonds have not
yet caught policy-makers’ attention, as well as bond issuers and investors. The lack of com-
monly agreed standards for green bonds (OECD 2017) and their relative newness could
justify this gap of knowledge.
Next, inappropriate institutional arrangements in some developing countries do not
enable the emergence of green bonds. Often, different ministry departments with
different mandates and skills are pursuing different, if not conflicting goals in the
implementation of the government’s policy. As a result, environmentally-friendly projects
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 25

in countries where voters do not show strong support for climate policies (Obradovich and
Zimmerman 2016), are likely to become less of a priority.
Pickering et al. (2015)’s argument that there is often a disagreement among ministries
in developed countries about the balance between adaptation and mitigation finance for
recipients countries, also holds for developing countries regarding the country’s develop-
ment priorities and the mandates of different ministry departments. These divergences of
priorities and mandates may result in diminished policy influence of Environment Min-
istries, meaning that an effective coordination between the Ministry of Finance and that of
Environment, is essential for the development of government-based green bond issuance
and the emergence of local green bond markets. However, institutional barriers are com-
pounded by market barriers that hinder the development of green bond in developing
countries.

3.2. Market barriers

There are three important market barriers, which dampen the development of the green
bond market in developing countries: the issue of minimum size, the currency of issuance,
and high transaction costs associated with green bond issuance.
The issue of minimum size refers to the minimum value that a green bond should bear
to be appealing to green bond underwriters.
If green bonds offer an opportunity to tap into private capital for sustainable infrastruc-
ture financing, one of their major constraints, is that their size must be large enough to be
appealing to green bond purchasers, such as those of the Green Bond Underwriters League
Table (GBULT). The GBULT includes some of the world largest banks such as Citi, HSBC,
JP Morgan or Bank of America Merrill Lynch, as well as some institutional investors who
are managing trillions of dollars in assets. For these investors, the size, tenure, and liquidity
of green bonds are key elements that they consider before lending their money (EY 2018;
Chiang 2017; Duru and Nyong 2016). According to Franklin (2016), bond investors like to
see at least USD 200 million equivalent in liquidity before lending their money, while for
the world’s major rating agencies such as Moody’s, green bonds must have a minimum
value of USD 250 million to be eligible for index inclusion (Chiang 2017).
It is worth noting, however, that many green projects implemented in developing
countries, are of small size and do not comply with the minimum size required by inves-
tors for a green bond transaction. In many of those countries, the low population density,
coupled with high poverty rates usually makes standalone small projects more cost-
effective than large-scale projects, especially in rural areas (UNCTAD 2017). However,
the size of the vast majority of these small scale projects barely exceeds USD 10 billion
on average, suggesting that the minimum size required by investors could ultimately
stand as an important barrier to market entry for developing countries. Figure 5, for
instance, displays both the costs of different green projects implemented in selected devel-
oping countries and the minimum size required by investors. The underlying projects are
coordinated and implemented by the World Bank and the United Nations Development
Programme (UNDP) under the Least Developed Countries Fund (LDCF). For comparison
purposes, this Figure 5 has been adjusted to display the annual cost of China’s pollution
abatement projects (USD 310 billion) as well as the cost of the Green Wall Initiative
(GWI), which is a regional green projects of Sub-Saharan African countries. It can be
26 J. BANGA

Figure 5. Green projects in developing countries do not match the minimum size required by green
bond underwriters in the green bond market. Data source: Author’s construction based on the Least
Developed Countries Fund data.

easily observed that the cost of individual projects is well below the minimum size that
GBULT members require for green bond transactions.
Next, transaction costs refer to costs incurred by the issuer to get a green label certifi-
cation from the independent reviewer and to produce regular documents showing the allo-
cation of the green bond proceeds throughout the project’s life cycle. Such transaction
costs could prove to be significant (EY 2018), especially when a creditworthiness survey
of the issuer is required alongside the technical assessment of the potential impact of its
project. According to Kaminker, Kidney, and Pfaff (2016), the relatively high cost of
obtaining a second opinion or third-party assurance could range from USD 10 to 100
thousand dollars. These transaction costs from pre-issuance to post-issuance could ulti-
mately stand as an important barrier for small green bond issuers.
Finally, a non-negligible barrier to the spread of green bonds in developing countries is
likely the currency of issuance. A review of the Climate Bonds Initiative’s database shows
that, between 2005 and 2017, investors have mainly use the Renminbi (32%), the US dollar
(26%), and the Euro (20%) to issue green bonds. These figures suggest that developing
countries -the majority of which have unconvertible currencies- must issue their green
bonds in international currencies, should they desire to raise large amounts of capital in
international financial markets. This financing mechanism, however, presents both the
lenders and the borrowers with a currency risk, as the revenue flows of the project to
be financed typically relate to local currencies (Edwards 1983).
It must be recalled that the currency risk is not new to developing countries, nor is it
specific to the green bond market. Eichengreen and Hausman (1999) neatly termed this
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 27

issue the ‘original sin’ to characterize the fragile structure of developing countries’ financial
markets that undermines their ability to borrow abroad due to the inconvertibility of their
currency or to borrow long-term domestically due to the dearth of domestic long-term
credit instruments (UNCTAD 2007). Nevertheless, it suggests that the implementation of
local currency-based green bond issuance could be beneficial for developing countries.

4. Avenues for scaling up green bond issuances in developing countries

The green bond market is experiencing many challenges in developing countries that
hinder its development. However, recent trends suggest that appropriate policy measures
could help address these challenges and enable the market to take root.
Some market analysts have suggested a ‘green stripping’ system to cope with the issue of
minimum size (Franklin 2016). Under such a framework, an issuer could issue a bond
aimed at financing both green and brown projects rather than issuing a one hundred
percent green bond. In that case, only a fraction of the proceeds of that bond- the
green stripe – should be used to finance the green project.
Although the green stripping system is a possible remedy to the issue of minimum size,
this paper argues that it is only suitable for investors who are familiar with the market and
have a good creditworthiness. However, the high debt service ratios of developing
countries reduce their creditworthiness, thereby increasing their perceived probability of
default (Edwards 1986). Since issuers’ creditworthiness is one of the key elements that
investors consider before lending their money, it is likely that the green stripping
system may not fit as the best solution for developing countries.
Moreover, the green stripping strategy could give rise to greenwashing behaviors.
Greenwashing occurs when an issuer promotes green-based projects in order to raise
funds in the green bond market, but actually operates in a way that damages the environ-
ment. Greenwashing ‘sins’ could have, therefore, profound negative effects on investors’
confidence on green bonds, thereby hampering the market development. Lax and uncer-
tain regulations (Delmas and Burbano 2011), as well as monitoring failures throughout the
project’s lifespan, are the key drivers of greenwashing behaviors.
Given the unsuitability of the green stripping strategy as a solution for developing
countries and the problems it may give rise to, this paper calls for the implementation
of local green bond markets based on a top-down approach, in which local governments
play a central role. Such a role should consist of promoting local green investments and
providing guarantees for local green bond issuances. For instance, the government
could cover all the transaction costs associated with green bond issuance, so that the
cost of issuing a green bond is on par with that of issuing a conventional bond.
The issue of minimum size is, however, just the tip of the iceberg. The core issue is that
developing countries have a very limited access to national and international capital
markets. According to the World Bank, less than 20% of the largest cities in developing
countries have access to local capital markets, and only 4% have access to international
capital markets (World Bank 2013). Furthermore, projected population growth (UN-
DESA 2017) suggests that most of climate change adaptation and mitigation projects in
developing countries will be the responsibility of cities. This means that local governments
need access to reliable and affordable green finance to implement their clean projects of
the future.
28 J. BANGA

Beyond the importance of an effective coordination between Ministries of finance and

environment, it is important that multilateral and national developments banks act as inter-
mediaries for green bond issuance and management in developing countries. Development
banks are indeed able to borrow from financial markets on favorable terms due to their excel-
lent credit ratings (UNFCCC Standing Committee on Finance 2016). This fundraising
capacity makes them able to lend funds to their developing countries clients on more favor-
able terms than they would get from other lenders (Campiglio 2016). However, as argued in
previous sections most green projects implemented in developing countries are of small sizes,
meaning that development banks would need to adopt a pooling strategy to cope with the
market minimum requirements for green bond transactions. By pooling small size projects
or focusing on regional-scale projects, such as the Green Wall Initiative, multilateral devel-
opment banks could raise finance in more favorable terms and fund green project sponsors,
who otherwise would not have access to capital at an efficient cost (RCB 2017).
Another possible way to fill the green investment gap in developing countries could be,
for instance, the establishment of green investment banks. According to OECD (2014), a
green bank is a public or quasi-public entity established to facilitate private investment
into domestic low-carbon, climate-resilient infrastructures. A well-designed green
banking model could indeed be an effective tool for channeling private investments
towards adaptation and mitigation projects. However, given the high costs of setting up
a new bank, the dearth of capital, and the shortfall of skilled human resources in develop-
ing countries, making efficient use of existing multilateral and national development banks
as well as existing climate funds, is undoubtedly the best solution. In the short to medium
term, it is important to not only further research on the technical implementation of the
green banking model but also to improve data collection for future empirical-based
research on the green bond market in developing countries.
Although the paper has reached its aim, which is to examine the rise of the green bond
market over the last few years and the key barriers that undermine its rise in developing
countries, one should not overlook its major limitations. First, by treating developing
countries as a homogenous whole, the paper neglects their diversities in terms of green
bond intake, intuitional arrangements, and economic features. Second, the paper does
not capture all the barriers to the green bond market development in developing countries.
As the market grows, new barriers may unfold, while the barriers highlighted in this paper
may become less important. Finally, the relative dearth of academic literature on green
bonds was challenging for the author in embedding the paper within a theoretical frame-
work. Nevertheless, it has the benefit of drawing at least the attention of policy makers and
investors in developing countries, as well as rolling the red carpet out for future research.

5. Conclusion
Green bonds are quickly growing and are expected to reach record levels over the next few
years. Factors such as similarity in terms of yield to maturity between green bonds and
conventional bonds, increased climate-awareness from investors, the commitment of
policy makers to counter climate change, and the current macroeconomic environment
in most developed countries have underpinned the development of green bonds over
the last few years. As innovative financial instruments, green bonds provide a historic
opportunity to direct private finance towards low-carbon investments.
 JOURNAL OF SUSTAINABLE FINANCE & INVESTMENT 29

While companies and local governments in developed and emerging countries are
increasingly issuing green bonds to finance their adaptation and mitigation projects, a
set of institutional and market barriers are preventing developing countries from appro-
priating the full benefits of green bonds. The lack of knowledge about how green bonds
work, inappropriate institutional arrangement for green bond management, the issue of
minimum size, the currency of issuance, and high transaction costs associated with
green bond issuance are the key barriers that hamper the development of green bonds
in developing countries.
The results suggest, however, that with the right measures developing countries could
take full advantage of green bonds to finance their adaptation and mitigations projects, as
part of the Paris climate agreement. Potential measures include an effective coordination
between ministries of finance and environment, an efficient use of multilateral and
national development banks as intermediary institutions for green bond management,
the provision of guarantees by local governments for green bond issuance, as well as
the promotion of local green bond markets, in which domestic investors could issue
local currency-based green bonds. By doing so, developing countries could enhance the
development of green bonds, thereby hastening the achievement of sustainable develop-
ment goals.

Notes
1. Emerging countries are defined here as countries with high levels of economic development
and potential for rapid industrialization. They include but are not limited to the top 20 emer-
ging markets ranked by Bloomberg Market Magazine in 2013. Available here: https://www.
bloomberg.com/news/photo-essays/2013-01-31/the-top-20-emerging-markets.
2. According to the International Capital Market Association, GBPs are voluntary process
guidelines that recommend transparency and disclosure and promote integrity in the
green bond market. They aid investors by ensuring availability of information necessary to
evaluate the environmental impact of their green bond investment.
3. The Climate Bonds Initiative is a London-based not-for-profit international organization,
which has been tracking the green labeled market since 2009. It annually produces a
report highlighting the state of the green bond market across the world.
4. In 2017, there were ten new entrants to the market, among which the majority are developing
countries: Argentina, Chile, Fiji, Malaysia, Lithuania, Nigeria, Slovenia, Singapore, United
Arab Emirates, and Switzerland.
5. The Yield to Maturity is the internal rate of return of an investment in a bond if that bond is
held until the end of its lifetime.

Acknowledgement
Many thanks to three anonymous referees for extensive comments on the earlier draft. The author
also wish to thank the Least Developed Countries Section’s Team of the United Nations Conference
on Trade and Development for insightful comments. However, the contents of this paper do not
necessarily reflect the views of the United Nations Conference on Trade and Development.

Disclosure statement
No potential conflict of interest was reported by the author.
30 J. BANGA

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