There is growing evidence that green bonds are attracting a ‘greenium’ amid strong investor demand, a report by the Climate Bonds Initiative (CBI) has found.
The findings are likely to fuel controversy about the market, as many observers argue that investors should not be ‘paying up’ for green bonds because they typically carry the same risk characteristics as ‘vanilla’ bonds issued by the same issuer.
According to CBI data, $132 billion of green bonds were issued during the last six months of 2019 by corporates and supranational, sub-sovereign and agency (SSA) issuers.
The report, however, focuses on the most liquid portion of the green bond market. Consequently, only those denominated in US dollar or euro – comprising almost three-quarters of total issues during the period – and with an original issue size above $500 million were analysed.
In total, the report – authored by CBI research analyst Caroline Harrison – studied 49 green bonds with a combined value of $36 billion. Of these, 36 bonds worth a cumulative €23.5 billion ($26 billion) were issued in euro and the remaining 13 issues worth $10 billion were in US dollar.
The CBI research demonstrated that both euro and US dollar-denominated ‘green’ bonds were considerably more oversubscribed by investors than their ‘vanilla,’ conventional bond equivalents.
Euro-denominated green bonds were, on average, 2.8 times oversubscribed and US dollar-denominated bonds by 2.7 times. In contrast, vanilla bonds were 2.0 times oversubscribed for euro issues and 1.9 times oversubscribed for US dollar notes.
The CBI highlighted that two first-time green issuers saw particularly high oversubscription levels.
In October, Santander issued a €1 billion green bond which was 5.4 times oversubscribed. Meanwhile, the €750 million green bond issued in October by Assicurazioni Generali – the first from a European insurance firm – was 4.3 times oversubscribed.
Investor demand helped to strengthen pricing for green bonds, according to the report – both euro and US dollar green issues saw their spreads tighten more than their conventional vanilla peers.
For euro issues, the spread tightened 13.3 basis points (bp) for green issues during pricing, compared with 12.9bps tightening for their vanilla equivalents. In US dollar, the green spread tightened 13.7bps, compared with 11bps for the vanilla equivalents.
“Both euro and US dollar green bonds appear to have performed well compared to vanilla peers during the book building phase,” said Harrison. “Demand remains robust and, as long as there is a shortage of green labelled bonds, we expect this to continue.”
Looking at the secondary market, the CBI found that 63% of the green bonds in its sample had seen their spread tighten in the seven days following pricing, with 73% exhibiting tightening after 28 days. In addition, 60% of green bonds had tightened more than their vanilla equivalents after seven days, and 56% after 28 days.
“In the immediate secondary market, green bonds tightened by a greater magnitude, on average, than both comparable vanilla baskets, and indices,” Harrison said. “The results of our analysis indicate that demand for green bonds remains robust.
“This scenario is ideal and can please both treasurers and investors alike.”
For the 19 issues for which yield curves could be built, the CBI reported that seven were priced within their yield curve – that is, exhibited a ‘greenium’ – by having a lower yield compared with outstanding debt from the firm.
Only three were issued with the normal ‘new issue premium’ in which buyers receive extra yield from a new issue compared to established issues trading on the secondary market.
This means 36% of those analysed in the second half of 2019 had a ‘greenium’, and just 16% exhibited a new issue premium, said the CBI.
CBI data indicated that the number of issues demonstrating a ‘greenium’ during the last six months of 2019 was higher than the average since 2016. The CBI said between 2016 and 2019, 22% of euro issues and 14% of US dollar issues analysed had exhibited a ‘greenium’.
However, the CBI admitted that there was no underlying reason why green bonds should provide cost benefits to their issuers.
“There is no reason why a bond being green should impact its price, since green bonds rank pari-passu (on equal footing) with bonds of the same rank and issuer,” Harrison said.
“There is no credit enhancement to explain pricing differences and issuers of green bonds incur costs such as third-party review and certification, although these are typically negligible,” she continued. “Green bonds and vanilla equivalents are subject to the same market dynamics such as supply, rate expectations, and geo-political issues.”
Last month, former Bank of England governor Mark Carney pointed to the ‘greenium’ as a perk for sovereign bond issuers of green bonds. Meanwhile, counterparts at the Dutch central bank – De Nederlandsche Bank – warned that such pricing potentially indicated a market ‘bubble’ for the assets.
Nonetheless, some market participants have called for caution when judging the relative pricing of green bonds to their conventional peers.
Turning to the investors, CBI said 25 of the 49 issuers analysed during the period provided the split between the buyers declaring themselves as ‘green’ and those not.
Of those who provided such data, an average of half the amount raised was issued to self-declared ‘green’ investors. The CBI did caution, however, that there is no widely used methodology for defining a green investor.
Overall, Harrison said the “strong demand” for euro-denominated issues – and thus strong pricing – is likely to continue to be driven by a number of trends.
These trends include the “steady growth” of funds looking for labelled green bonds, either through an explicit mandate or rising investor preference.
In addition, Harrison argued that the “stealth mainstreaming” of green bonds was now underway. With green bond issues growing in size, they are increasingly becoming eligible for inclusion in mainstream bond benchmark indexes. Bonds included in these benchmarks indexes must be considered for inclusion by passive funds that track the indexes, even if the fund has no specific green preference.
In the US, however, the trajectory of demand and pricing of green bonds is less certain.
“The USD green bond market remains broadly isolated from these pressures at present,” Harrison said.
“The climate agenda and its ramifications for investors have received less exposure in North America compared to other regions,” she added. “Consequently, while investors may be prepared to explore green bonds, they are largely unwilling to pay more for the label while there is no requirement for them to do so.”
Channels:Green Bonds
People:Caroline Harrison
