Is there a ‘greenium’ in green bonds?
What’s happening? The Climate Bonds Initiative (CBI) has found that investors are paying more for green bonds compared to equivalent conventional bonds. The CBI looked at 56 euro-denominated and 19 USD-denominated deals that took place in H1 2021, finding that green bonds regularly had higher prices compared to their vanilla (or basic) equivalents. The CBI said that because of investor interest, corporate sustainability drives and pressure on governments to act on climate, there would continue to be a “greenium” in debt markets. (Responsible Investor)
Why does this matter? As we have previously outlined, when used as intended green bonds have the power to fight climate change by helping firms and governments raise money for green projects. However, they are proving popular, and the surge in investor demand for these securities has had side effects. Aside from greenwashing becoming more of a problem, the bonds have also been found to be trading at a premium compared to regular bonds.
What’s causing the greenium? It’s likely that green bond premiums reflect a prevalence of demand over supply. Green bond issuance has surged in recent years, but demand has still outpaced it. In the US green bonds are on average oversubscribed 4.7x compared to 2.5x for vanilla bonds, and in Europe green bonds were oversubscribed 2.9x compared to 2.6x for vanilla bonds.
The CBI report also concluded that increasing liquidity in the green bond market could also be a factor behind the greenium. Bid/offer spreads (the difference between highest bid price and lowest offer price) were narrower every month in 2021, which suggests a higher number of buyers and sellers. This higher liquidity in green bonds is likely to be a result of a lack of supply, according to the CBI.
Will supply catch up with demand? In September alone there have been major issues of both sovereign and corporate green bonds. Verizon issued its third $1bn green bond, Walmart issued a $2bn green bond and the UK made headlines by raising £10bn ($14bn) for its inaugural sovereign green bond.
However, investor demand is still likely to outpace new issuance for the foreseeable future. As guidance develops, such as the EU’s green bond standard, investors will have more information and confidence to invest in green bonds that are having real-world impacts. With the UK requiring pension funds to disclose climate risks in line with the Taskforce on Climate-related Financial Disclosures (TCFD), we could see more pension funds looking to invest in green bonds to limit their environmental impact.
Green bonds or greenwash? Taking a step back, we can ask: have green bonds been effective or are they just overpriced, greenwashed assets that sound good but have no actual impact? Well, a recent report from the European Securities and Market Authority (ESMA) found that companies that issued green bonds have decarbonised faster than non-green bond issuers. In the energy sector, for instance, between 2009 and 2019 the carbon intensity of green bond issuers fell by 88%, compared to 27% for non-green issuers.
This research could suggest that countries that issue sovereign green bonds may decarbonise faster than those that don’t – particularly as the transparency of the securities improves.