Why Bonds Good for the Earth Now Carry a ‘Greenium’

(Bloomberg) -- Green bonds are back: Issuance of the environmentally friendly securities reached a new high in September, totaling more than $50 billion, after the pandemic slowed sales in the first part of the year. Following Germany’s first green bond, the pace is set to increase further, thanks to the European Union’s plans to sell as much as 225 billion euros ($265 billion) of the securities. Meanwhile, the European Central Bank has announced that it will buy a new kind of environmentally targeted security called sustainability linked bonds. Signs are emerging of a tangible “greenium” for investors in bonds deemed green — while doubts persist over how much of a difference the designation actually makes in terms of environmental impact.

1. What do green bonds finance?

Their proceeds can go toward new or existing projects that are meant to have positive environmental or climate effects. The field covers energy, transport, waste management, building construction, water and land use.

2. How fast is the green bond market growing?

The total of all green bonds sold in the first three quarters of 2020 exceeded $200 billion, about 12% more than in the same period of 2019, which itself was a record year. Sales slowed when the pandemic first struck but later surged as companies and governments found strong investor demand. That’s propelled total issuance over $1 trillion, a landmark of sorts, though still just a sliver of the more than $100 trillion bond market.

3. What’s the financial impact for investors and sellers?

There’s evidence of a premium for green bonds, the so-called greenium, reflecting both scarcity and investor demand. One global green bond index returned 7.5% through Sept. 30, compared with 5.74% on a similar index that also contained non-green bonds. As terms on green bonds improve, analysts now speak of a “brownium” penalty for conventional notes. But bringing a green bond to the market can also entail additional costs to cover getting an external opinion and report annually on the use of proceeds.

4. Who decides whether a bond is green?

It’s complicated. Many borrowers say they follow the Green Bond Principles, guidelines on disclosure and transparency, endorsed by the International Capital Market Association in 2014 to bring transparency to the market. A slew of companies offer services to independently assess, verify or certify a bond’s green bona fides. They include Climate Bonds Initiative, a non-profit which created the first green-bond standard in 2010, as well as specialized firms such as Paris-based Vigeo Eiris, Amsterdam-based Sustainalytics, and the Norwegian climate research institute Cicero. (Bloomberg LP, the parent company of Bloomberg News, provides ESG data, analytics and indexes via the Bloomberg Terminal and data license services.) For the future, the EU is creating a Green Bond Standard, which will build on current market practice and Europe’s own new system for defining what’s green or not, the so-called taxonomy for sustainable finance. However, the new standard will be voluntary, rather than legally binding.

5. Just how green are green bonds?

It can sometimes be difficult to say given uncertainty over standards and inconsistent verification. The perception of what’s green can differ between the companies offering ratings, and between countries. China, the world’s biggest carbon emitter and one of the biggest green-bond issuers, in the past faced criticism for using green bonds to finance “brown” projects such as coal-burning power plants. A recent study from the Bank for International Settlements suggested companies with green bonds didn’t have noticeably better records on emissions than those without.

6. Do green bonds have competition?

Yes. Sustainability-linked bonds, where the proceeds don’t have to be dedicated to a green cause but where the interest rate is tied to a companywide environmental target, are being watched closely. The hope is that they could open up the market tied to environmental, social or governance (ESG) goals to many more borrowers, because the proceeds aren’t tied to a particular project. This has already happened in the loan market, where green loans are now massively outpaced by loans linked to specific ESG targets. Prospects for growth increased recently when the ECB said it could start to include sustainability-linked bonds in its collateral and bond-buying programs.

7. Who sells green bonds?

The U.S. is the largest source overall, led by the mortgage giant Fannie Mae, which repackages home loans that meet environmental criteria, and local governments selling notes to finance infrastructure such as sewerage upgrades. Poland was the first sovereign borrower in 2016, followed by France, Belgium, Ireland, the Netherlands and Germany. Companies are also in the market, such as Daimler and Volkswagen, to fund electric car projects. Green bonds have entered riskier parts of the debt market including high-yield bonds and lower-rated bank debt.

8. Who buys green bonds?

In general, it’s the same as the rest of the bond market — institutional investors including pension funds, insurance companies and asset managers. In 2015, France became the first country to require institutional investors to report how they consider environmental factors. New green-bond funds have recently been set up by firms including Pimco and Robeco. The EU is likely to encourage asset managers across the bloc to integrate sustainability requirements into investment decisions as part of its work to eliminate false environmental claims, also known as greenwashing.

The Reference Shelf

• Bloomberg News articles on green bonds breaking the trillion-dollar mark and on “brownium” penalties for conventional notes.
• A QuickTake on sustainable investing and one on sustainability-linked bonds.
• How to use Bloomberg’s green loan principles table.
• Bloomberg NEF analysis of external reviews for green bond.
• For Bloomberg NEF’s sustainable debt tool.
• Expectations for China’s green debt market.

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