{"id":175979,"date":"2021-03-31T19:34:00","date_gmt":"2021-03-31T23:34:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/trading-lessons\/financial-products-benefits-risks\/"},"modified":"2024-01-18T09:03:21","modified_gmt":"2024-01-18T14:03:21","slug":"financial-products-benefits-risks","status":"publish","type":"trading-lessons","link":"https:\/\/www.interactivebrokers.com\/campus\/trading-lessons\/financial-products-benefits-risks\/","title":{"rendered":"Financial Products: Benefits &#038; Risks"},"content":{"rendered":"<p>Now that you have been introduced to how some ESG-related issues have impacted different business sectors and ways in which you may factor those variables into your investment decisions, we will now address certain financial products, whose primary focus is on ESG.<\/p>\n<p>ESG investments \u2013 or \u2018green assets\u2019 \u2013 have been recently growing in number, as well as type. Examples of these include:<\/p>\n<ul>\n<li>Green bonds,<\/li>\n<li>Social bonds,<\/li>\n<li><a href=\"https:\/\/www.icmagroup.org\/assets\/documents\/Regulatory\/Green-Bonds\/June-2020\/Sustainability-Linked-Bond-Principles-June-2020-171120.pdf\">Sustainability-linked bonds<\/a>, and<\/li>\n<li>Certain exchange-traded funds<\/li>\n<\/ul>\n<p>But what differentiates these products from one another, and how are they aligned with corporate or government goals that address ESG-related concerns? Moreover, what are the benefits and risks of investing in these types of products?<\/p>\n<h3><img decoding=\"async\" class=\"alignnone size-medium wp-image-4159 lazyload\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/001_Energy.jpg\" alt=\"\" width=\"960\" height=\"540\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 960px; aspect-ratio: 960\/540;\"><strong>Green Bonds<\/strong><\/h3>\n<p>Green bonds have become increasingly popular financial instruments, which are intended to finance projects that are designed to benefit the environment, including climate concerns.<\/p>\n<p>According to the <a href=\"https:\/\/www.climatebonds.net\/about\">Climate Bonds Initiative<\/a>, there are <a href=\"https:\/\/www.climatebonds.net\/market\/explaining-green-bonds\">several types of green bonds<\/a>, including \u201cUse of Proceeds\u201d bonds, which peg their proceeds to fund green projects. These types of bonds are typically backed by the issuer\u2019s balance sheet \u2013 for example, the European Investment Bank\u2019s \u201c<a href=\"https:\/\/www.eib.org\/en\/investor_relations\/cab\/index.htm\">Climate Awareness Bonds<\/a>\u201d are backed by the EIB.<\/p>\n<p>There are also \u201cUse of Proceeds\u201d revenue bonds or asset-backed securities (ABS). Issuers that sell these products typically fund their debt service through the revenue streams generated by these projects, while investors have recourse to their debt through the fees and taxes the issuer collects as collateral.<\/p>\n<p>The State of Hawaii, for example, has issued <a href=\"https:\/\/www.fitchratings.com\/research\/corporate-finance\/fitch-rates-hawaiian-electric-co-revenue-bonds-a-25-09-2019\">special purpose revenue bonds<\/a> to help achieve its 100% renewable target by 2045. The deal is backed by fees on the state\u2019s utility electric bills.<\/p>\n<p>Other types of green bond issuance include project bonds, where the debt is backed only by the project\u2019s assets and balance sheet, certain covered bonds, as well as certain ABS issuance \u2013 which may be backed by pools of green projects such as solar leases or green mortgages.<\/p>\n<p><img decoding=\"async\" class=\"alignnone size-medium wp-image-4160 lazyload\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/002_GBP_ICMA.jpg\" alt=\"\" width=\"960\" height=\"540\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 960px; aspect-ratio: 960\/540;\">The <a href=\"https:\/\/www.icmagroup.org\">International Capital Market Association<\/a> (ICMA) oversees and helps to develop the so-called <a href=\"https:\/\/www.icmagroup.org\/assets\/documents\/Regulatory\/Green-Bonds\/Green-Bonds-Principles-June-2018-270520.pdf\">Green Bond Principles<\/a>, a set of voluntary best practice guidelines first established by a consortium of investment banks in 2014. These guidelines highlight the required transparency, accuracy and integrity of information that issuers will disclose and report to stakeholders, with its four core components comprising:<\/p>\n<ul>\n<li>Use of Proceeds,<\/li>\n<li>Process for Project Evaluation and Selection,<\/li>\n<li>Management of Proceeds, and<\/li>\n<li>Reporting<\/li>\n<\/ul>\n<p>As these Green Bond Principles don\u2019t detail what \u201cgreen\u201d should entail, issuers are typically left to determine its definition. However, categories for green projects generally involve areas such as:<\/p>\n<ul>\n<li>Energy<\/li>\n<li>Buildings<\/li>\n<li>Transport<\/li>\n<li>Water management<\/li>\n<li>Waste management &amp;&nbsp;pollution control<\/li>\n<li>Nature-based assets, including land use, agriculture and forestry, as well as<\/li>\n<li>Information technology &amp; communications (ICT)<\/li>\n<\/ul>\n<p>The global focus on climate change, coupled with supportive fiscal and central bank policies for the broader credit markets, appear to have spurred a rise in green and sustainability-linked bond issuance.<\/p>\n<p>Moody\u2019s Investors Service, for example, recently observed that <a href=\"https:\/\/www.moodys.com\/research\/Moodys-Sustainable-bond-issuance-hits-record-high-in-Q3-as--PBC_1253782\">green debt types<\/a> are \u201cevolving,\u201d with green capital instruments as one of the \u201cemerging areas to watch.\u201d<\/p>\n<p>To date, green bonds have been issued by governments such as Germany, Sweden, and the Republic of Chile, as well as supranational organizations such as the EIB, and the Japan Finance Organization for Municipalities.<\/p>\n<p><img decoding=\"async\" class=\"alignnone size-medium wp-image-4161 lazyload\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/003_ECB.jpg\" alt=\"\" width=\"960\" height=\"540\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 960px; aspect-ratio: 960\/540;\">The European Central Bank also recently decided to invest in the euro-denominated <a href=\"https:\/\/www.ecb.europa.eu\/press\/pr\/date\/2021\/html\/ecb.pr210125~715adb4e2b.en.html\">green bond investment fund<\/a> for central banks introduced by the Bank for International Settlements. With this investment, the ECB contributes, within its mandate, to global efforts to promote environmental objectives \u2013 including the <a href=\"https:\/\/ec.europa.eu\/clima\/policies\/eu-climate-action\/2030_ctp_en\">EU climate goals<\/a>. The <a href=\"https:\/\/www.bis.org\/press\/p210125.htm\">BIS green bond fund<\/a> invests in renewable energy production, energy efficiency and other projects intended to improve environmental conditions.<\/p>\n<p><img decoding=\"async\" class=\"alignnone size-medium wp-image-4162 lazyload\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/004_BIS.jpg\" alt=\"\" width=\"960\" height=\"540\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 960px; aspect-ratio: 960\/540;\">Also, on the corporate front, <a href=\"https:\/\/www.smfg.co.jp\/english\/sustainability\/materiality\/environment\/procurement\/\">Sumitomo Mitsui Banking Corporation<\/a> touts that it \u201cregularly issues green bonds.\u201d The Japanese bank has allocated most of the proceeds from its sales to wind and solar energy projects in Japan and the UK, as Japan grapples with meeting its <a href=\"https:\/\/www.mckinsey.com\/~\/media\/mckinsey\/business%20functions\/sustainability\/our%20insights\/meeting%20japans%20paris%20agreement%20targets%20more%20opportunity%20than%20cost\/meeting-japans-paris-agreement-targets.ashx\">Paris Accord goals<\/a> on reducing greenhouse gas emissions. And among US-based issuers, <a href=\"https:\/\/www.apple.com\/newsroom\/2021\/03\/apples-four-point-seven-billion-green-bond-spend-is-helping-to-create-one-point-two-gigawatts-of-clean-power\/\">tech giant Apple<\/a>, real estate investment trust <a href=\"https:\/\/www.dukerealty.com\/corporate-responsibility\/environmental\/\">Duke Realty<\/a>, and <a href=\"https:\/\/newsroom.bankofamerica.com\/press-releases\/environment\/bank-america-issues-fifth-corporate-green-bond-2-billion\">Bank of America<\/a> have also issued green bonds.<\/p>\n<h3><strong>Social Bonds<\/strong><\/h3>\n<p>Meanwhile, the ICMA also recently released voluntary process guidelines for issuing <a href=\"https:\/\/www.icmagroup.org\/assets\/documents\/Regulatory\/Green-Bonds\/June-2020\/Social-Bond-PrinciplesJune-2020-090620.pdf\">social bonds<\/a>, which apply their sale proceeds solely to finance eligible social projects such as affordable basic infrastructure \u2013 this could mean clean drinking water, for example, as well as greater access to education, healthcare, or financing. Other social projects may include affordable housing, sustainable nutrition, and those whose aims are to reduce income inequality.<\/p>\n<p>France\u2019s <a href=\"https:\/\/www.cades.fr\/index.php?option=com_content&amp;view=article&amp;id=388&amp;Itemid=169&amp;lang=en\">Caisse d\u2019Amortissement de la Dette Sociale<\/a> (CADES) \u2013 the French government agency responsible for amortizing the country\u2019s social security debt \u2013 recently sold $5 billion worth of 10-year social bonds to eager investors. <a href=\"https:\/\/www.cades.fr\/pdf\/communiques\/uk\/2021\/CP_12janv2021_VA.pdf\">This sale<\/a> generated more than US$10 billion in orders among more than 130 investors, including 40% ESG investors.<\/p>\n<p>While the costs of purchasing these bonds typically rely on the issuer\u2019s credit rating, you may want to analyze whether certain investments \u2013 project bonds, for example \u2013 will generate sufficient income to cover the required debt service over the lifetime of the bond, or for however long you decide to hold it.<\/p>\n<p><img decoding=\"async\" class=\"alignnone size-medium wp-image-4163 lazyload\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/005_Interest-Rate-Risk.jpg\" alt=\"\" width=\"960\" height=\"540\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 960px; aspect-ratio: 960\/540;\">It is also important to note&nbsp;that since these bonds have&nbsp;an&nbsp;inverse&nbsp;relationship&nbsp;with U.S. Treasuries, the interest rate risks faced by holders of government debt, including maturity-related price sensitivities to interest rate changes, are also inherent in these types of debt holdings. Moreover, the longer a bond is held to its maturity, the more exposure you, as an investor,&nbsp;have to&nbsp;interest rate risk, as well as to fundamental changes that may lead to credit rating downgrades or defaults.<\/p>\n<h3><strong>Other Green Assets<\/strong><\/h3>\n<p>Other asset classes, such as exchange-traded funds (ETFs), may offer you exposure to investment-grade green bonds, such as the <a href=\"https:\/\/www.ishares.com\/us\/products\/305296\/ishares-global-green-bond-etf\">iShares Global Green Bond ETF<\/a>, which primarily holds sovereign debt including from France, the Netherlands, the U.S., and Germany, as well as corporate bonds in the banking and electric sectors.<\/p>\n<p>In fact, there are several ETFs that focus on ESG concerns, managed by companies like BlackRock, Van Eck, Vanguard, State Street, Invesco, and WisdomTree, among others.<\/p>\n<p>BlackRock has also introduced <a href=\"https:\/\/www.ishares.com\/ch\/institutional\/en\/themes\/sustainable-investing\/esg-screened-etfs\">ESG Screened ETFs<\/a>, which excludes companies that are tied to controversial weapons such as biochemical or nuclear weaponry, as well as those that violate UN Global Compact principles, profit from thermal coal, produce civilian firearms, or manufacture and sell tobacco, or extract oil sands.<\/p>\n<p>Naturally, you can also look to invest in products that may be critical to the supply chains of companies focusing on ESG initiatives, such as <a href=\"https:\/\/www.miningmagazine.com\/innovation\/news\/1396195\/the-race-to-put-platinum-in-evs\">palladium or platinum<\/a> for use in lithium-ion battery production for electric cars, or individual company stocks, where the company\u2019s operations are concentrated on reducing carbon emissions, for example, by providing solar or wind power.<\/p>\n<p>But remember, whichever product you decide to invest in, conducting due diligence can only help better inform your investment decisions, and factoring-in as many variables as you can into your analysis can help you draw a more objective picture of the risk landscape.<\/p>\n<p>There are numerous variables that illustrate how committed an entity may be to addressing ESG concerns, which we will address in our next lesson.<\/p>\n<h3><strong>Other Developments &amp; Resources<\/strong><\/h3>\n<ul>\n<li><a href=\"https:\/\/www.youtube.com\/watch?v=wgOs1C1q24A\">EIB \u2013 What is a Green Bond?<\/a><\/li>\n<li><a href=\"https:\/\/www.youtube.com\/watch?v=i3gIJrABLSc\">The World\u2019s First Green Bond<\/a><\/li>\n<li><a href=\"https:\/\/www.youtube.com\/watch?v=Uyee_UKRbVc\">BIS \u2013 Green Bonds<\/a><\/li>\n<li><a href=\"https:\/\/www.tradersinsight.news\/traders-insight\/securities\/esg\/smfg-sells-green-bonds-as-climate-change-gains-ground\/\">SMFG Sells Green Bonds As Climate Change Gains Ground<\/a><\/li>\n<\/ul>\n","protected":false},"excerpt":{"rendered":"<p>This lesson details certain types of ESG-focused financial products, including green bonds, social bonds, and exchange-traded funds (ETFs).<\/p>\n","protected":false},"author":899,"featured_media":221405,"parent":0,"comment_status":"open","ping_status":"closed","template":"","meta":{"_acf_changed":false,"footnotes":""},"contributors-categories":[13576],"traders-academy":[13125,13128,13132],"class_list":{"0":"post-175979","1":"trading-lessons","2":"type-trading-lessons","3":"status-publish","4":"has-post-thumbnail","6":"contributors-categories-interactive-brokers","7":"traders-academy-beginner-trading","8":"traders-academy-level","9":"traders-academy-trading-lesson"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v27.3) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>Archives | Traders&#039; Academy | IBKR 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