Green bonds have become an increasingly prominent feature of the fixed income universe, with the UK the latest European country to issue such debt.
The UK deal – for £10bn of green debt maturing in 2033 – was a global record for a green bond sale, attracting more than £100bn of orders. It is also priced at a premium (approximately 2.5 basis points) relative to conventional debt – the so-called ‘greenium’.
This is a trend that has been progressively materlialising for some time, reflecting the imbalance between supply and demand. But the size of the greenium can vary and change over time, a dynamic we have observed through researching the universe of sovereign, quasi-sovereign and corporate green bond issues. This can have important ramifications for investors in the green bond market.
Paying a slight premium for a green bond can concern investors but they should benefit from a better risk-adjusted return over the long term. By providing potentially lower funding costs for green projects, issuers are investing in the transition to a low-carbon economy and should be better fit to address the risks and opportunities that arise in a transitioning world.
The greenium is, however, another argument for investors to take an active and dynamic approach. As in any fixed income market, investors want to avoid expensive issues and gain additional performance from those bonds whose value (or greenium) rises after purchase. Green bonds offer a way for investors to contribute to financing the energy and ecology transition, and active management ensures they can do so most effectively and with the highest return on their investment.
Evaluating the greenium
Germany issued its debut green bond in September 2020 and, as the country uniquely matches each green issue with a conventional bond with the same maturity, gave us the first ever direct price comparison. At issue, the green bond priced 1 basis point more expensive than its conventional twin. Interestingly, that greenium has today grown to more than 6 basis points.
This move has not been linear: in fact, the greenium moved significantly over December last year and over the summer this year. What we have observed from primary market activity is that when the level of issuance declines, the greenium increases.
Germany is only one issuer, of course, and few markets offer such a clean comparison. But by researching every segment of the universe, we have calculated what should be the theoretical price of green bonds versus their conventional counterparts. Assessing Euro and Dollar senior green bond issuance, which accounts for almost 90% of the universe, we can clearly see that there is indeed a greenium, but it is not structural, and it is not equal everywhere.
Taking the universe as a whole, we estimate the greenium is 3 basis points to 3.5 basis points, with variations within that. For sovereign debt, we find that the greenium is around 7 basis points; for corporate debt it is around 4 basis points; and for quasi-sovereign is around 2 basis points.
Dig a little deeper and the picture becomes even more nuanced. Within corporate debt, there is a significant difference between a sector like utilities, where the greenium is around 2 basis points, and the automotive sector, where it is around 11 basis points.
This disparity largely reflects the number of green bonds and issuers in each sector. In utilities, financials and quasi-sovereigns, there is no lack of green bonds, so if there is an issue that is expensive compared to its conventional peer, investors will simply choose one priced closer to its twin.
However, this dynamic is far less apparent in sectors where there are fewer options. In automotive, for instance, there are only few bonds in the green bond benchmark, so investors seeking to enhance diversification with this sector’s debt have little choice but to pay a higher price.
We see the same pricing dynamic in sovereign bonds, which can be similarly scarce and thus relatively expensive. For instance, there are only two bonds in France, one in Belgium and one in the Netherlands.
Within corporate sectors, the greenium can be affected by the regularity of issuance from single issuers. A green bond from an issuer that has not been active on that market for some time could prove to be relatively scarce and hard to find in the secondary market, translating into a larger greenium.
Conversely, a recurring green bond issuer is likely to see its greenium come down reflecting a better supply and demand balance. It is clear that the more issuance from an issuer, the smaller the greenium.
The greenium is here to stay
This disparity will persist. Some parts of the universe will converge as increasing numbers of bonds are issued, but these will be balanced by bonds issued by companies that have not yet entered the market: it is reasonable to expect those in the automotive, retail or consumer goods sectors, for instance, to become major issuers over time. At first, these bonds are likely to trade at a significant premium, keeping the overall greenium broadly at around its level now.
Supply is likely to come increasingly from sovereigns, as highlighted by the recent Spanish and UK issuances. While Germany continues to build a green bond curve, most countries in Europe will also use green bonds to as part of their laudable commitments to combat climate change. Sovereigns have accounted for 20% of total green bond issuance in 2021, with more than 15 different countries participating in the market, which is significant when you consider that the first sovereign issuance was in 2016.
On the corporate side, banks and utilities will continue to issue a steady supply of green bonds. But the real growth should come from new sectors such as automotive, telecoms or consumer goods, with additional issuance from the real estate sector. And we expect to see much more issuance from the US, which could become a real engine of growth if we consider that the US corporate bond market is three times the size of Europe’s.
