The German government announced last month the preparation of its first green bond, as the cornerstone European Union issuer becomes the latest example of accelerating use of bonds to address environmental and social challenges. 

Germany’s debut green bonds would likely be issued next year, according to the announcement from the Ministry of Finance. Germany, which started a Sustainable Finance Committee between the finance and environment ministries in June, is assessing whether to issue classic standalone green bonds or to try a new approach that attaches them to other bonds as a security. 

The trajectories of the green bond market and its smaller social do-good cousin, the impact bond market, indicate the challenge of measuring outcome and structuring financial instruments that adhere to social impact principles. Since German bonds have traditionally played a central role in the European debt market, the move into environmentally-focused debt could potentially create a new benchmark for the market. 

Financial vehicles are increasingly used as tools to achieve social and environmental goals. Green bonds have accelerated along a more traditional trajectory, while impact bonds have been implemented on a more fragmented scale, showing the challenge of measuring outcomes. 

Green Bond Dominance

In a way, green bonds are more straightforward and more accessible to investors.

“Green bonds are fixed-income instruments, the proceeds of which are earmarked to fund climate change solutions,” Emily Gustafsson-Wright, senior fellow at the Brookings Institution, told Karma in an emailed response to questions. “The issuing loan entity guarantees loan repayment plus a rate of return.” 

“This differs from impact bonds in that investors only get repayment and return if outcomes are achieved,” said Gustafsson-Wright, who focuses on impact bonds.

The World Bank and other development banks have been the primary issuers of the green bonds; from 2008 to 2018, the World Bank alone issued 147 green bonds worth more than $11 billion. The Climate Bonds Initiative, which tracks green bond policies globally, identified 17 countries with green bond initiatives led by the central government. 

In 2017 France became the first AAA-rated country to become an issuer of green bonds, and the governments of Belgium, the Netherlands, and Poland have since followed suit. 

This is one of the reasons why the green bond market dwarfs impact bonds. The global green bond market soared to more than $167 billion in 2018 from $2 billion in 2012, with individual bonds to address local and regional climate or environment-related projects averaging around $107 million. The $400 million impact bond market is significantly smaller, and the average bond size is just $3 million. 

Impact Bond Measurement is a Challenge

While it’s possible for an impact bond to address an environment or climate-related challenge, such a structure requires outcomes-based payments, unlike a green bond.

“It is encouraging to witness the growth of the green bond market and its role in promoting and financing the transition to climate-compatible development, as evidenced by this landmark sovereign debt issuance,” Ben Cohen of Quantified Ventures told Karma in an email. 

Quantified Ventures managed an environmental impact bond in Washington, D.C. that addressed damage from stormwater runoff. “As Germany and other sovereign issuers weigh their options, they should also consider more rigorous green financing mechanisms such as environmental impact bonds, which directly link financial returns to measured environmental outcomes,” Cohen wrote. 

In 2013, Germany became the first country in continental Europe to launch an impact bond when Bavaria adopted the model to address unemployment and disconnect among at-risk youth. Although the bond was considered a success in that it achieved its target outcomes, it became clear that Germany’s robust social welfare system made it difficult to adapt on a wider scale

“In these countries [with robust social welfare systems], the idea of paying a return to the private sector is controversial,” noted Gustafsson-Wright. “There [also] seems to be a relatively weaker culture of monitoring and evaluation in these countries, making a shift to an outcomes focus more difficult.”

The ability to measure specific outcomes is both the appeal and the challenge for impact bonds. They are touted less for their ability to fund a specific solution, as green bonds do, and more for their potential to unlock systems-wide change by forcing a consideration of how programs could be managed and measured more effectively. Gustafsson-Wright added that this can make it difficult to offer a straightforward “yes” or “no” on the question of whether impact bonds are successful. 

Her analysis measures success on a handful of criteria, she wrote earlier this year, including demand, reaching populations, outcomes and returns, efficiency, and effects on the wider ecosystem.

Earlier this month, South Africa, a recent entrant to the impact bond market, began reporting the largely positive results from its multi-year effort to better connect youth from lower-income households with employment and training opportunities in high-growth sectors like technology. 

Because that impact bond achieved its target outcome of 600 placements within the first year of measurement, the bond will scale within South Africa to include additional service providers and outcome funders. This makes it successful on a few of Gustafsson-Wright’s measures, but only time will tell if the impact bond market will reach the same heights as green bonds.

“We don’t know if these outcomes would have been achieved in the absence of an impact bond since no rigorous evaluation of the mechanism has been done,” she said.