Will the waning ‘greenium’ kill the green bond market?

Green bonds’ breakout year is good news for investors, but issuers are seeing decreasing incentives

Green bonds are having another good year. Issuance so far in 2021 has smashed all records: the first quarter saw the same amount of capital raised from green bonds as the whole of 2016, and the market could reach $450bn – some 7% of global debt issuance – by the end of the year, according to some estimates.

However, there is one factor threatening to slow soaring levels of issuance: the dwindling ‘greenium’.

Greeniums represent the most tangible benefit of a green bond for an issuer. High investor demand in a smaller market allows many kinds of ESG debt, particularly green bonds, to price with a lower coupon than their non-green equivalents of the same maturity. A report by ING at the start of June found Euro-denominated green bonds were 1-3bp cheaper than equivalent vanilla debt, with dollar issuers enjoying savings of 5-8bp. The highest greenium uncovered by the report was 33bp for an undisclosed US utility issuer.

While a few basis points either way might not seem like much, for large issuances and long maturities the savings stack up. Germany’s 30-year green bond in early May saw a saving of 2bp against its conventional twin issued at the same time. With €6bn raised from the issue, this works out to savings of €36m across the life of the bond. While corporate deals – where the greenium has seen its largest decline – are usually smaller and have shorter tenors, greeniums of several basis points still amount to a significant saving.

Green issuers have not always seen a premium. In the earliest days of the green bond market, issuers would instead often pay more to issue a green bond, especially with the additional costs associated with second-party opinions and disclosure. 

According to Padhraic Garvey, ING’s Regional Head of Research for the Americas and author of its greenium report, an underdeveloped market and low investor interest in sustainability meant that issuers struggled to gain interest.

“I guess back then it was a bit quirky and that’s why it traded with a discount as opposed to a premium”, he says.

While green issuers have since enjoyed cheaper debt, there are signs that the gap is closing once more. In may, the Association for Financial Markets in Europe (AFME) raised the alarm during a report which found that the greenium for Euro-denominated corporate green bonds had tightened “closer to virtually 0bp in April 2021”, while greeniums for Euro-denominated corporate ESG bonds more generally were down 8bp on last year, hovering around 1bp. 

AFME’s findings were backed up by researchers at ING, who found a 2bp greenium for Euro-denominated issues, down from 6bp a year ago. An HSBC report also found the average greenium for non-financial corporates was hovering at around 1.5bp.

‘Europe has had extreme supply-demand technicals in the marketplace… We’re starting to see that slowly break down’ – Nuveen’s Jessica Zarzycki

The major cause of this decline seems to be the swing between supply and demand. The Climate Bonds Initiative found that in the second half of 2020, Euro green bonds were on average 4.2 times oversubscribed versus 2.9 times for vanilla equivalents. For USD-denominated notes, this was 3.5 times for green versus 3.3 times for vanilla. But with issuance levels rising, investors have a wider variety of potential investments and so demand for individual issuances drops.

“Europe has had extreme supply-demand technicals in the marketplace,” says Jessica Zarzycki, a Portfolio Manager in the global fixed income ESG/impact investing team for US asset manager Nuveen. “We’re starting to see that slowly break down, where you’re not paying a premium to get involved in these [green] bonds because there is such a significant amount of issuance in this space”.

This is good news for investors, who are keen to avoid ‘paying up’ for green paper, but less so for issuers. The question remains whether the effort and expense of a green bond is worth it to an issuer if the direct financial benefits are dwindling. A disappearing greenium could well put potential issuers off the asset class.

Green bond issuers must go through the often arduous process of drawing up a framework, and then pay for it to be assessed by an external reviewer. Post issuance, the funds raised are usually kept separately from other capital, and the issuer is encouraged to produce a report on the proceeds’ allocation (according to figures from the Climate Bonds Initiative, 77% of issuers, representing 88% of issuance volume, report on the use of proceeds). 

This can amount to a significant burden for an issuer, both financially and in terms of resources and expertise. At the latest annual meeting of the Green and Social Bond Principles, Roberto Fernandez Albendea, Director of CSR and Reputation at Spanish utility Iberdrola, said the week leading up to its debut green bond in 2014 was “terrible”. “I was at the time part of the investor relations team and it was a little bit crazy”, he said.

But the saving on bond coupons isn’t the only financial benefit that a company sees from issuing a green bond. Research by the Harvard Business Review in 2018 found that in the two days around a green bond announcement, company stock returns were 0.67% higher than the normal market return. The research also claimed that green bond offerings were associated with a 2.4% increase in a company’s long-term value.

And ING’s Garvey says broader benefits still exist to incentivise issuers. 

“I spoke one on one to a number of corporates [while writing the ING report] and said to them: ‘Surely this is a bit of a pain? You’ve got all this work you have to do before you do a deal, and you’ve got all this post deal work’. But I got considerable pushback against that.” 

He says that companies were keen to issue green bonds because of a broader desire to decarbonise, and because they observed “a lot of positive qualitative feedback to our overall brand image”.

“There is a genuine feeling among treasurers that there are really positive ancillary benefits to being seen to be doing things green,” he says.