Green bond issuance grew to record levels in 2020 in spite of the pandemic, indicating robust investor appetite for investment vehicles that actively contribute to the fight against climate change. Lyxor’s Head of ETF Strategy, ESG and Innovation François Millet explores why some of these bonds exhibit a “greenium”, and whether investors are really willing to accept lower yields in order to make a difference.
How is the green bond market evolving as we come out of the COVID19 crisis?
The COVID-19 pandemic has highlighted the role the investment community can play in a sustainable and green recovery and the policy narrative has placed a strong emphasis on “building back better”.
According to Climate Bonds Initiative (CBI) as at the end of May 2021, USD 150 Bn of green bonds have already been issued, building on a record 2020 which saw USD 178 Bn worth of green bonds added in H2, almost double the USD 91.6 Bn added in H1.
A key development of the green bond market in 2021 is the explosion of the sovereign green bond segment. From being non-existent four years ago, 2020 has seen inaugural issues from Germany and new issues from Italy joining the pool of existing sovereign issuers in 2021.
The Sovereign segment will be bring further credibility and add liquidity to the green bond market, sending a strong signal that will incentivise more corporates to finance investments through green bonds.
The EU has committed to reaching net zero by 2050 and is combining this ambition with a digital transition and post COVID-19 recovery. European Commission President Ursula von der Leyen confirmed EU plans to issue EUR 225 Bn in green bonds over the next few years. To achieve a climate-neutral Europe by 2050, the EU is about to announce its “Fit-for-55” package of measures supporting the European Green Deal and the revised objective of reducing emissions by 55% by 2030.
The CBI expects strong growth out of the US given the Biden Administration’s commitment to tackle climate change. His administration has already demonstrated its determination by re-joining the Paris Agreement, and with the appointment of a high profile, experienced team.
In late September 2020, Chinese President Xi Jinping announced a target for China to become carbon neutral before 2060. China, which is responsible for 30% of the world’s greenhouse gas emissions, is also already the second largest country of issuance for green bonds (after the USA) with cumulative issuance of USD 130 Bn. This commitment will likely require multiples of that investment.
Such commitments could galvanize a substantial shift into green bonds by both issuers and investors.
Are investors prepared to pay a higher price for Green Bonds – a so-called “greenium”?
Green bonds can be said to exhibit a greenium if they are issued at a higher price and therefore offer a lower yield compared to outstanding debt. However, there is no reason why a bond being green should impact its price, since green bonds rank on equal footing with bonds of the same payment rank and issuer. And according to CBI data, even when a greenium is present because bonds incur costs such as Second Party Opinions and Certification, these differences tend to be negligible.
There are several reasons why investors would buy bonds exhibiting a greenium. For example, investing in Green Bonds can be seen as an active decision by investors to “do their bit” and allocate capital in a way that makes a significant difference in the fight against climate change. Green Bonds also tend to exhibit lower volatility than conventional bonds, making them a more attractive proposition for many investors. When a company issues green bonds, it is also making a statement that it is at the forefront of transition, and investors work on the basis that such companies should carry less risk going forward.
The number of Green Bonds exhibiting a greenium, however small, is growing, and investor appetite is growing with it. CBI data shows that, between 2016-2019, a greenium only materialised in 22% of EUR green bond issuance and 14% of USD issuance. In H2 2020, The CBI calculated yield curves for 33 out of the 54 bonds in its sample. Within this sample 52% priced inside their yield curve, therefore exhibiting a greenium. In H2 that proportion rose to 79%, suggesting robust investor appetite.
In 2020, more than two-thirds (70%) of EUR green bonds achieved larger oversubscription than vanilla equivalents in 2020, while three-quarters of EUR green bonds experienced larger spread compression compared to vanilla equivalents, according to the CBI.
How can an industry such as auto-making illustrate the greenium?
Across the auto industry, The Climate Bonds Green Bonds Database includes 28 green bonds from the auto sector from ten issuers, with a total current size of USD 9.9 Bn. In a segment of the market where investors are desperate to add sector diversification, they have all been very well received.
But these represent a tiny fraction of the potential market. As of February 2021, there were 90 auto companies with 2465 bonds outstanding amounting to USD 719 Bn.
There is ample evidence that the auto industry’s Green Bonds market is accelerating. In Q3 2020, four high profile auto companies issued debut green bonds, all exhibiting a greenium, to help finance their transitions away from Internal Combustion Engine (ICE) vehicles. These included EUR benchmark deals from autos Daimler, Volkswagen, and Volvo.
Volkswagen, which is in pole position as the largest issuer of green bonds in the industry, issued a pair of green bonds on the 16th of September, having delayed the planned launch from March to avoid the COVID-19 chaos.
Both bonds priced inside the Volkswagen conventional yield curve driving off with a greenium, with a financing framework that specified two sustainability projects: electric vehicles based on the modular electric drive toolkit (MEB) and charging infrastructure. Volkswagen reported that around 69% of the 8-year, and 74% of the 12-year bond was allocated to socially responsible investors.