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“Green” Bonds: Potential for the Marketplace to Reflect the Value of Environmental Goods




A new policy from the US Department of Labor discourages investors from considering environmental impacts in their management of retirement plans. But research from RFF’s Richard Bernknopf indicates that, in contrast to the implications of the new rule, incorporating “green” bonds into the market offers financial benefits that are worth considering.


Recently, the US Department of Labor under the Trump administration finalized a policy that discourages investment fund managers from considering environmental impacts in their financial decisions related to retirement plans. While the department slightly modified its initial proposal after it provoked controversy among environmentalists, investors, and even a working group convened by the Commodity Futures Trading Commission, a Biden administration likely would rethink the revised regulation entirely.


Richard Bernknopf, a Resources for the Future (RFF) university fellow, recently published research that suggests environmental goods have value in the marketplace; thus, the Department of Labor’s new policy ultimately could reduce the available funds to retirees. Here, Bernknopf elaborates on his research, describes his reaction to the Department of Labor’s rulemaking, and explores the potential for “green” bonds to play a larger role in the marketplace going forward.


We use empirical data to make the case for two types of bonds—a sustainable forestry zero coupon bond and a traditional annual coupon bond—that place a value on wood products and related ecosystem services in forests. Both of these bond types can be introduced into the market readily and profitably.


Essentially, what we were after in the paper is: How do you set a price, and how do you estimate the risk of the return? One of the things about dealing with bonds is that you have three parts: you’ve got the current price, the yield, and the final price, and there’s an equals sign in there. So, if one thing changes, the other two have to change in kind. What we were interested in was: How would somebody make an investment if this type of security were available?


Please describe an experimental case study from your recent paper that led to your conclusions.

We compare two types of managed forests—monoculture eucalyptus and polyculture hardwoods—and their outputs of marketable timber products in terms of three ecosystem services: carbon sequestration, water quality, and recreational duck hunting. The two forest types produce different quantities of marketable goods and have different impacts on ecosystem services, as well.


Monoculture eucalyptus forests are incredible in terms of how much carbon they sequester, but they don’t do as well across the other categories. With polyculture forests—which in our case included five species of hardwoods—you see more ecosystem service benefits but less carbon sequestration. Where it makes sense to invest depends on what the investor’s goals are.


Broadly, the interdependency of the ecosystem services and the timber products showed positive impacts in terms of carbon sequestration, reduced nitrate retention (i.e., an increase in water quality), and minimal changes to recreational duck hunting—no matter the forest.


In issuing this rule, the US Department of Labor has claimed that investments that factor in environmental, social, and governance (ESG) criteria are financially risky. How does your research relate to this rule and the Department of Labor’s conclusions?


The Department of Labor is saying that you can’t estimate the return or the risk, and that it’s a biased investment. What we’re saying is just the opposite: we can make those estimates, because we base everything on the quantities produced. We’re not saying there’s a demand for this kind of bond; we’re saying that if we can produce all these services in these quantities, they should be internalized into the market—into our conceptions of the value of the forest—as opposed to what’s called an externality.


And importantly, we find that you can internalize these ecosystem services into the market as just one publicly traded bond. It doesn’t have to involve independent income streams. And it goes along with the notion that, with time, the services increase in value, whereas the wood is discounted in value. Why bother ever cutting down the hardwood forest? Because if I have to cash in on the present value in a hundred years, it doesn’t amount to a lot. Instead, I get my benefits from the ecosystem services.


The only three system ecosystem services we incorporated are indirect uses. In other words, they are substitutes for what’s in the market. In the case of water quality, you wouldn’t have to clean up the water. And in the case of hunting, the services amount to no access fees, or not having to travel so far to a forest to get recreation. And then, of course, there’s the carbon sequestration.


When I started this research, I had wondered: Why would we not want to include these environmental attributes when they’re there? There’s no question that they’re there, but we don’t price them in. That’s what got me started on this. So, we noticed that people are willing to pay for more ducks. People are willing to pay for cleaner water. People are willing to pay for carbon being sequestered. So, how do we combine those into an asset?


A report commissioned by the Trump administration’s Commodity Futures Trading Commission (CTFC) recently looked into how climate change will impact financial markets. That report recommended that the Department of Labor should not go through with implementing its proposed restrictions on ESG investing. How does your research relate to the CFTC panel’s conclusions?


I agree with the CFTC working panel: these ecosystem services should be included in investments. The essence of my research is finding a way to calculate the benefits of these services.


I’ll note, too, that we found negative correlations between some of the three ecosystem services—which says you can’t just sum things up. Their interdependency is extremely important. Regardless of those occasional negative correlations, the impacts are always positive on the net return. If somebody said to you, “I’ll double your yield on your return on investment,” how could you say no to this return? Including environmental assets into the portfolio can lead to these higher returns.


Who is impacted most by your research?


All financial investment actors could be impacted and could benefit from the inclusion of ecosystem services in asset valuation. And instead of having separate markets for timber-based products and each ecosystem service, a portfolio approach combines them into one marketed security. Putting everything together would reduce transaction costs, too.


Given the results of your work, what would you recommend to investors and investment managers? If pension fund managers want to make a return on their investment that rivals the return they’d see with “green” bonds, can alternative investment strategies match ESG profits?


We’re saying that including ecosystem services does impact the total return of the assets positively, and anybody who’s interested in green bonds or any kind of environmental return should be interested in our recent paper.


Should investors favor green bonds over other types of strategies? Again, it’s based on personal preferences.


One of the things that I felt as a small investor looking into buying a green bond was that there was very little for me to look at in the first place. With this research, I thought that if I could demonstrate that valuing environmental goods is similar to the way that normal markets work, then why not include them as a publicly traded bond? How do I make it easy for people to buy into something that they would like to be part of? After doing all the math, and coming up with a way to calculate the net return on investment, we show that it’s possible.


If I want to buy a green bond, can I? What are the next steps?


This research is so different from anything else that anybody’s written on the subject, so I’m looking forward to getting more feedback. This is the point of research: we’re trying to get a conversation going over the really good possibility that we could affect how these markets operate in the future. And some recent heartening news is that JPMorgan has announced that it has sold $1 billion worth of green bonds.


I just don’t think that the barriers are too high for environmentally based green bonds. If you care about climate change and other issues associated with how we are land stewards, and atmospheric stewards, and water stewards, then you would want to have some mechanism that makes it easy for people to invest—to avoid the downside, the risk, of not counting the environment in these kinds of assets. That’s the whole idea behind this work: to make it easy for people to invest their money in something that they feel good about.


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