Wind turbines at sea

The sustainable finance market – an overview

The sustainable finance market in Europe has seen dynamic growth in the past few years. In Germany, for example, the volume of sustainable investment rose by more than 70% between 2014 and 2018. Green corporate finance and project finance aim to reduce greenhouse gas emissions. They also serve as a way of investing in innovative, low-carbon technologies. There is a huge need for investment in sustainable projects, according to the October issue of the Bundesbank’s Monthly Report, but it is unclear how the strong market growth observed recently will continue to develop.

Investors face uncertainty

The experts attribute this to various factors relating to both the demand and supply sides of the market as well as the real economy. For example, it is not yet clear what conditions need to be in place for sustainable investment strategies to also be financially worthwhile for investors. After all, these strategies do narrow the range of investments available to investors in the first place. This typically means that an investment has a worse ratio of risk to return. On the other hand, though, there is the chance that sustainability analyses will make investors aware of previously neglected risks – such as those resulting from climate change. Although there is a broad consensus among academics that these risks will have negative repercussions for the economy, the exact form they will take is still unclear.

What is a green bond?

The basic difference between a green bond and a conventional bond is the use of the proceeds for an earmarked purpose. In 2014, the International Capital Markets Association (ICMA) published the Green Bond Principles (GBP), which are voluntary process guidelines for issuers of green bonds. Before issuing a green bond, issuers must ensure that it is aligned with the four core components of the GBP. One of these components, for instance, concerns the use of proceeds from issuing a green bond. In addition, the guidelines identify various Green Project categories, all of which relate to environmental protection issues. These include, for example, renewable energy, clean transportation, energy efficiency, etc. Despite the GBP, there is still no uniform definition of green projects. This means that the range of green bonds available in the market remains relatively limited at present. 

Looking at the supply of green bonds in the market, it can be seen that these were initially issued predominantly by development banks and government-backed entities such as the Kreditanstalt für Wiederaufbau (KfW). Over the past few years, however, private financial institutions – particularly mortgage banks – and also the public sector have issued more green bonds. It is not yet known how the issuance of a green bond affects its yield. Whether or not it is also financially worthwhile for the issuer depends, for example, on whether investors are willing to pay more for a green bond than a conventional bond, given the same level of credit risk. The current academic research does not come to any clear conclusions. A Bundesbank analysis arrives at the same result. “Comparing conventional and green bonds of the two issuers [KfW and the European Investment Bank (EIB)] does not reveal a clear pattern in terms of yield spreads,” the report states.

According to the authors, further growth in the market will depend, not least, on enterprises and their willingness to revamp product ranges in a sustainable way, make more sparing use of natural resources and reduce environmentally harmful emissions. Because this kind of reorientation will require extensive investment, based on estimates made by German industry, there would also have to be engagement from private investors.

Sustainable finance for retail investors as well

How can incentives to promote sustainable economic growth be created? The Bundesbank’s experts believe this is a task for politicians. Amongst the examples highlighted in the report are the efforts made by the European Commission, which is working on a reliable and transparent classification of financial products. The Commission is also planning to introduce a common “taxonomy”, containing a consistent classification of sustainable economic activities, which will be applicable to sustainability labels for financial products, for instance, or for the EU green bond standard. The Bundesbank economists believe that efforts such as these are a step in the right direction towards enabling financial market participants to accurately assess the opportunities and risks of different investments and thus reducing the aforementioned uncertainty. They also lower the risk of investors being misled about how sustainable their investments are. Sustainable investments are therefore likely to be open to retail investors as well, according to the report. A glance at the global numbers shows that this is worth pursuing: despite appreciable growth rates, outstanding green bonds so far only account for just under 2% of the international bond market as a whole.

Socially responsible, sustainable and green investment – an overview

Socially responsible investment

This term typically encompasses the assets of all investors who have publicly committed to considering sustainability factors. However, there is no scrutiny of the degree to which they actually follow through on this commitment at the level of the individual investments or portfolios. Instead, the sole focus is on the commitment made at the institutional level, which means that the design of specific sustainability criteria is of lesser importance.

Sustainable investment (sustainable finance)

Sustainable investment (often also referred to as sustainable finance) factors environmental, social and governance (ESG) criteria into individual investment decisions. ESG criteria constitute good corporate governance requirements such as transparent measures to prevent bribery and corruption as well as environmental and social aspects such as environmentally friendly production and strict workplace safety and health protection standards. Sustainable finance is therefore not confined to climate and environmental protection issues, but also encompasses social aspects and questions about the composition and quality of management at firms in which investments have been or will be made.

The capital raised by issuing sustainable or green bonds therefore always has to be allocated to relevant projects based in areas such as renewable energy, environmental protection, social housing construction or education.

Green finance

Green finance is a sub-category of sustainable investment and only takes into account environmental aspects. Wind farms are one example of green finance.

Who are the holders of green bonds?

By holder group

Investment funds
Insurance companies'
Pension funds
General government

23,9 Mrd. Euro
23,4 Mrd. Euro
5,3 Mrd. Euro
2,9 Mrd. Euro

By country

In Europe, investors in France (€21.6 billion) and Germany (€19.5 billion) hold the largest volumes of green bonds. In France, insurance companies hold a large share of green bonds: 67% of all the green bonds held by French investors, in fact. The Netherlands claims third place as it, too, holds a relatively high volume of green bonds (€10.0 billion). Banks, in particular, play a very important role in the Netherlands, holding 86% of green bonds. Luxembourg ranks fourth, with stocks amounting to €6.7 billion. There, the share of green bonds held by investment funds is particularly high at 84%.