Investors willing to pay for transparency of green bonds also profit from secondary market performance versus vanilla instruments.
Green bonds are continuing to show pricing benefits when compared to vanilla equivalents in new study of market performance.
The Climate Bonds Initiative’s recent ‘Green Bond Pricing in the Primary Market H1 2021’ study analysed 56 €- and 19 US$-denominated benchmark-sized green bonds with a total value of US$75.9 billion between January and June 2021.
It discovered that on average green bonds achieved higher book cover and greater spread compression than vanilla equivalents.
Investors describing themselves as green were allocated two thirds of the deals, and issuers that incorporated the EU taxonomy eligible project categories into their green bond frameworks noted that this helped to attract ‘dark green’ investors.
Overall, the green labelled market stood at US$227.8 billion in the first half of this year, more than double the volume of the first half last year which was hit by the pandemic.
The Climate Bonds Initiative now forecasts the market to reach its half a trillion in green in a single year by end-December 2021.
Benefits for both sides
The ‘greenium’ has advantages for both issuers and investors, said report.
Greenium refers to the higher price investors are willing to pay for green or other sustainability-related bonds, compared with conventional debt. This largely results from demand outstripping supply, but can also reflect a willingness by investors to pay more for greater transparency and certainty over how fundraising proceeds are spent.
This is typically outlined in advance and monitored throughout the lifetime of the bond, via a series of targets or KPIs, sometimes linked to financial penalties if these are not met in the form of a coupon step-up.
Concerns have arisen of some issuers potentially exploiting the greenium. A survey in July from the European Leveraged Finance Association and the Loan Market Association finding that high yield investors are worried that issuers are reaping lower fundraising costs from sustainability-related bond and loan structures without having to meet agreed ESG targets. Investors pointed to the practice of issuing bonds which are callable or redeemable before performance against the sustainability metrics outlined in prospectuses are due to be reported.
Overall, however, the Climate Bonds Initiative said the greenium is an “excellent outcome for any issuer because it means that it costs less to fund its green bond compared to its vanilla debt”.
In the first half, the €- or US$- denominated green bonds of five sovereign issuers were added to the Climate Bonds database – Germany, France, Chile, Indonesia, and Hong Kong.
In May 2021, Germany priced its third green bond, a Bund with a maturity of 2050 and an initial size of €6 billion. It exhibited consistently lower yields over the sample period between May and June when compared to a vanilla twin.
In early June 2021, Indonesia priced its fourth US$-denominated green Sukuk, a US$750 million issue maturing in 2051.
Secondary market performance
The Climate Bonds Initiative added that green bonds can also offer investors more flexibility in the secondary market which may help to justify the greenium, where present.
“In the immediate secondary market, green bonds performed well, on average tightening more than indices after seven days, and both indices and comparable baskets after 28 days, emphasising that green bonds can offer value to both issuers and investors,” the study said.
“Seven days after pricing, 46% of green bonds had tightened more than comparable vanilla baskets, and after 28 days this increased to 57%,” it added.
“Institutional investors are looking for quality green debt product and this structural trend in demand has only intensified. 2030 targets and net zero commitments will drive corporate transition and new investment opportunities. Policymakers face continued pressure to green the financial system in addressing the climate emergency. These factors will continue to combine and drive more greenium in debt capital markets,” said Climate Bonds Initiative Chief Executive Sean Kidney.
“What has changed over the last 12 months is that more investors have stated their own net zero targets, and all are now committed to stronger reporting regulations. Green bonds support these objectives. A growing majority of issuers report impact indicators like emissions avoided, which enhances the utility of green bonds in an allocation. Together with improved secondary market liquidity and increased issuer diversification, including the sovereign issuance boom, this has fuelled strong demand and supported a greenium in many cases,” added Francois Millet, Head of Strategy and ESG, Lyxor ETF.