multilateral organizations and some governments are able to de-risk green bonds and reduce capital costs for green investments (Braga and Semmler, 2019).

Another motivation for public and private agents to issue green bonds is the diversification of their investor base. With recent investor declarations,<sup>11</sup> there is a perception that demand for green bonds currently exceeds supply,<sup>12</sup> and some evidence that green bonds helped sovereigns attract new investors who had not previously invested in those countries.<sup>13</sup> Lastly, green bonds have a communications role. Many sovereigns and corporates have made long-term climate commitments. Issuing green bonds can help signal that these commitments are more than cheap talk. But so can (implicit) carbon pricing.

# **Interaction effects of carbon pricing and green bonds**

When carbon pricing and green bonds are implemented jointly, they have interaction effects, which vary depending on the type of carbon pricing used. Two major options are available for implementing carbon pricing: ETS and taxes. Much literature analyzes their respective advantages; here we focus only on these interaction effects.

Green bonds are more successful when climate change mitigation projects have higher private returns. These returns rise with carbon pricing, which creates a level playing field for low-carbon investments over high-carbon alternatives, by ensuring that the social cost of pollution is factored into private costs of production. Thus, a sufficiently high CO2 price supports the successful market introduction of green bonds. Climate bonds are only partly an alternative to carbon pricing if they require carbon pricing for their market success. However, if carbon pricing takes off, we can expect green bonds to thrive as well.

The interaction effect between the value of green bonds and carbon prices is more ambiguous for ETS than for carbon taxes. An ETS puts a cap on emissions, and emissions leakage can occur when green bonds finance climate change mitigation projects for industries covered by the cap. Mitigation achieved through bonds reduces the scarcity of emissions permits under the cap, reducing the price of those permits

> 11The United Nation‘s “Principle for Responsible Investment”, the “Climate Action 100+”, and the “Investor Group on Climate Change” (IGCC) respectively have been adopted by 2,200, 42, and 170 investors which own or manage USD 80 trillion, USD 33.6 trillion, and USD 26 trillion in assets.

> 12A recent survey with 540 large investors reported that only 14% of them believed that current supply of ESG fixed income products is sufficient for the market, and that only 6.6% are satisfied with the current bond market penetration of ESG disclosures (RBC Global Assessment Management 2018).

> 13Given that green bonds attract new socially responsible investors and asset managers, several issuers report the diversification of their investors base as a benefit of this type of security (OECD 2017, GIZ 2018). We can also observe this benefit for some governments and sovereign bond issuers (Climate Bonds Initiative 2018). Poland, for instance, issued its first sovereign green bond in 2016 and reported that around 61% of the investors were green investors, most of them new to the Poland market. France issued a green bond on January 2017 and foreign investors accounted for 63% of the volume issued, while the nonresident holders have a share of only 55% in the total French government debt (Moody’s 2018). At the local level, the State of Massachusetts in the United States (World Bank 2015) and the Transport for London in the United Kingdom (Climate Bonds Initiative 2016) also attracted new green individual investors for their base. Green bonds appear to be attracting new long-term oriented investors that value environmental issues (Flammer 2018) and are a diversification opportunity for investors that currently rely on equity and energy assets, as those co-move weakly with the green bonds market (Reboredo 2018).

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