STORY: Governments, banks and businesses say financial markets can play a crucial role in driving the shift to a lower carbon world.

One of the ways to raise funds for environmentally beneficial projects are through so-called green bonds.

Over the past few years, their market share has grown

and spawned a broader industry of sustainability bonds that seek to change borrowers’ behavior.

Let’s take a closer look at how they work.

The many shades of green bonds

Green bonds involve a company or government raising money for projects considered to be kinder to the planet.

For example, an energy giant might raise money to build a renewable power plant.

In 2021, companies borrowed record sums via sustainable bonds: issuance totaled nearly $860 billion.

Borrowers like the market because it can raise funds at more attractive rates.

But green bonds also offer a slightly lower yield - or “greenium” as it's known - than conventional debt.

Greenwashing risk

Critics say green bonds can do little to address a company's wider environmental impact

and may allow some of the biggest players to claim green credentials without fundamentally changing their business models.

Sustainability-linked bonds

Sustainability-linked bonds, or SLBs, comprise a newer and smaller market than green bonds.

Companies and governments can use money raised from SLBs for anything, including general corporate purposes.

SLBs are tied to a company's sustainability targets.

If they don't meet them, the company must pay a higher interest rate.

But critics say those penalties are very small, and the sustainability targets themselves lack ambition and are too easy to meet.

Trillions in transition finance

Highly polluting companies say they need trillions of dollars to reduce their carbon emissions.

Transition bonds have been mooted as a possible solution for companies in sectors such as energy and transportation.

Advocates are also pushing for wider acceptance of a labelled transition product to finance decarbonization efforts.

So what’s the hold up?

Financial products that help brown companies go green are a trickier concept to sell to the market.

And without clear standards or guidelines for transition bonds, investors and bankers are wary of greenwashing accusations.

Social bonds, SDG bonds and more

Beyond bonds focused on environmental outcomes, lie pools of money for related goals around social equity or fair living standards.

A "sustainable development goal bond" - or SDG - raises money for a project to improve public health.

They include initiatives like reducing air pollution from burning fossil fuels.

A social bond could fund an affordable housing project that rehouses people displaced by a climate-driven wildfire or flood.

But overall, social impact is hard to measure and social bonds also tend to be less liquid, making them less attractive for investment funds.