By Jaime Diaz Rio Varez, Research Analyst at MainStreet Partners
The term ‘greenium’ refers to the instance when investors pay more in exchange for the green or sustainable credentials of a bond, compared to a similar, non-green, equivalent debt instrument by the same issuer.
Over the past three full calendar years (2019-2021), this phenomenon has been evident in the fixed income market, with more than one in every two bonds analysed by Climate Bonds Initiative (CBI) displaying lower yields (higher prices) at issuance on their green bonds, compared with their regular equivalents.
At first glance, then, it might seem as simple as “green = lower-cost financing for companies and higher price for investors”. But there is growing nuance to the ‘greenium’, which bears examining.
1. The appetite for green bonds does not appear to be slowing. In 2021 sustainable UCITS bond funds attracted €102bn of net new assets, a third more than traditional UCITS bond funds, which saw flows of €69bn. Sustained green bond demand could drive the persistence of the ‘greenium’ in the market.
2. The supply of green bonds is also likely to follow a similar path. Global issuance of green bonds reached $140 billion in the first five months of 2022, following a record 2021 where almost $500 billion in green bonds were issued (double the amount in 2020). Research from CBI shows a consistent pattern of larger order books for green bonds compared to their non-green counterparts since 2019. In the past three full calendar years (2019-2021) the order books (i.e. demand) for EUR-denominated green bonds was 3.4 times the amount issued (i.e. supply), compared to 2.7x for traditional bonds.
3. Green bonds remain a ‘high-demand’ instrument in the fixed income universe. CBI’s research highlights that ‘green’ investors are hungrier than ever for green bonds. The average percentage of newly issued bonds allocated to Green Funds investors rose to 66% in the last six months of 2021, up from 50% in 2020. Green Funds investors tend to hold-on more to their positions since they are required by prospectus to maintain a minimum percentage of green debt in their funds.
4. But there are disparities across sectors and geographies. For example, for sectors that have an abundance of green bonds, such as utilities and banks, the ‘greenium’ tends to be less visible as demand reaches a balance. Other new sectors, or governments, which may have not issued green bonds previously may receive larger-than-average demand for their green bonds. Perhaps one of the most notable ‘greenium’ examples in the past year came from Denmark’s recent inaugural green bond. Denmark issued its debut green bond with the same maturity and coupon as a non-green conventional bond, it’s so-called twin bond. Pricing data shows that the green bond priced at a 5-basis points premium compared to its twin bond.
5. The ‘greenium’ has also been virtually non-existent in the Chinese onshore green bond market, even though China was the second-largest issuer of green debt in 2021. Compared with traditional green bond guidelines, Chinese green bond issuers can use up to 50% of the proceeds raised to finance non-green activities, compared to the 5% recommended by the International Capital Market Association’s Green Bond Principles. The transparency and impact of environmental projects are therefore key credentials for the success of green bonds.
What does all this amount to?
These statistics demonstrate the increasing discernment of investors when it comes to green bonds – the ‘greenium’ is not a foregone conclusion.
As scrutiny of the asset class builds – strengthened by a growing regulatory presence requiring clear evidence of green and sustainable criteria – bond investors will favour greener projects and greener issuers. This should, in turn, further incentivise less-green issuers to transition more quickly.
In the meantime, careful evaluation of green bonds and their use of proceeds will help investors determine if they are paying a ‘greenium’ for good reason.
It’s important to remember the Green Bond market has yet to face an environment of rising interest rates. The effect of tightening global monetary policy and of global geopolitical instability has already been hostile to fixed income deal-making and could also hinder the ‘greenium’ phenomenon.
In the first four months of 2022 global issuance of Green, Social, Sustainability and Sustainability-Linked Bonds was 41% lower than in the same period of 2021. Green bonds, specifically, were down by a similar percentage, while Sustainability-Linked bonds were the only ‘responsible’ fixed income area that has seen more issuance in 2022 compared with the same period last year (+35%).