Carbon pricing initiatives and green bonds: are they contributing to the transition to a low-carbon economy?

ABSTRACT

Transitioning to a low-carbon economy while promoting sustainable development requires behavioural changes and mobilization of significant investments. Key instruments being used for that include carbon pricing initiatives, such as carbon taxes and cap-and-trade policies, and, more recently, green bonds. Although the literature has provided some evidence on emission reduction associated with carbon pricing initiatives, there is a lack of investigations on the environmental performance of green bonds; and only theoretical models describe the potential benefits of combining both. Aiming to fill this gap, this study uses regression analysis and annual data for 150 countries between 1990 and 2019 to assess how carbon pricing initiatives and green bonds relate to carbon dioxide (CO₂) emissions. This paper makes two main contributions. First, it examines how two climate instruments, carbon pricing and green bonds, relate to CO₂ emissions. Previous research has focused only on individual instrument assessments and mainly on carbon pricing. Second, this paper empirically analyses whether there are interaction effects of the two instruments, an assessment not previously undertaken. The results suggest that the implementation of nationwide carbon pricing initiatives is associated with an 11% reduction in CO₂ emissions on average. By comparison, green bond issuances are associated with an average 14% reduction in CO₂ emissions. Further, no statistically significant interaction effects between carbon pricing initiatives and green bonds were observed. The results must be cautiously interpreted and cannot be attributed solely to the instruments studied since heterogeneous effects, biases from distinct sources, and the existence of complementary policies might influence the results.

Key policy insights

• Carbon pricing initiatives, such as carbon taxes and cap-and-trade schemes, and green bonds are being used to promote the transition to a low-carbon economy.

• Investigation into green bonds and their impact on emissions is scarce and to date, only theoretical models analysed potential interaction effects of their combination with carbon pricing.

• The results show an average of 11% reduction in CO₂ emissions associated with carbon pricing initiatives and of 14% reduction in CO₂ emissions associated with green bonds issuances.

• While the results show promise in the emission reduction performance of these two instruments, caution in interpreting these results is advised as complementary policies, biases from distinct sources, and evidence of heterogeneous effects make it challenging to disentangle the effect of individual policies.

KEYWORDS:

• carbon pricing
• green bonds
• emissions

Acknowledgements

The author would like to thank Professors Dr. Nora Gordon and Dr. Krista Ruffini for their essential contributions to this investigation.

Notes

1 Supranational institutions include organizations that operate in multiple countries, such as the European Investment Bank, the World Bank, and the African Development Bank.

2 https://carbonpricingdashboard.worldbank.org/

3 This study excludes green bonds issued by supranational institutions^, or with missing information for amount or issuance date. Green bonds issued in 2008 and 2009, associated with the United States in the Bloomberg database, were excluded due to being issued by supranational institutions, according to the World Bank (2014).

4 The Green Bond Principles are a voluntary set of frameworks that outline best practices for the issuance of green bonds. They are established by the International Capital Market Association and widely followed by the market. The latest version of the Green Bond Principles is available at: https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles_June-2022-280622.pdf

5 Among the possible green activities cited are renewable energy, energy smart technologies and energy efficiency, green buildings and infrastructure, agriculture and forestry, clean transportation, sustainable water and wastewater management, and eco-efficient products, production technologies and processes.

6 Renewable resources comprehend: hydro, solid and liquid biofuels, wind, solar, biogas, geothermal, marine, and waste.

7 For the interested reader, de Chaisemartin and D’Haultfœuille (2021) and Roth et al. (2022) offer comprehensive overviews of the recent econometric literature advances.

8 10 countries have green bonds issuances switching on and off between 1990 and 2019 and, thus, are not considered as having a staggered treatment.

9 When including other controls, a considerable portion of 2 × 2 difference-in-difference estimation fails, and some groups of countries that either implemented carbon pricing initiatives or issued green bonds are not considered even with a balanced panel. Further research is needed to allow the inclusion of additional covariates.

10 https://www.greenbondtransparency.com/