22 Jun 2021

Why would investors pay a "greenium" on green bonds?

greenium
Left-side-image

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 global green bond market evolving as we come out of the COVID-19 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 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 galvanise 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.

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 2,465 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 and towards Battery Electric Vehicles (BEVs) and/or Fuel-Cell Electric Vehicles (FCEVs). These included EUR benchmark deals from automakers Daimler (holding the Mercedes Benz brand), Volkswagen, and Volvo. 

automaker

 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 2020, 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.  

Source for all data unless otherwise indicated: Climate Bonds Initiative, Green Bond Pricing in the Primary Market: July – December 2020

The Climate Bonds Initiative published its H2 2020 report on green bond pricing in the primary market, sponsored by Lyxor. The report shows evidence of increasing investor demand for quality, labelled green bonds, as evidenced by the high proportion of bonds priced inside their yield curves – the “greenium”.

Read the full CBI report on green bond pricing

green bond pricing

Learn more about green bonds in our first podcast episode, “Banking on a greener future”, featuring Danske Bank and Climate Bonds Initiative

Lyxor podcast

The day is coming when a company’s fortunes will depend on the size of its carbon footprint, the global warming scenario it implies and its willingness to address broader societal issues, just as much as ordinary financial metrics. The best investment decisions keep this bigger picture in mind.

Our recent insight piece explains how simple it is for fixed income investors to take direct climate action in their portfolios using green bonds. And our first podcast episode illustrates how impactful they can be with real-life case studies from Danske Bank’s green bond issuance.

Investing in our unique range of green bond ETFs or ESG corporate bond ETFs could help you secure a brighter financial future for those you advise or those you love.

As always, you can visit our ESG Hub to learn more about Lyxor’s ESG bond ETF range.

This article is for informative purposes only, and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote any companies mentioned in this article. Capital at risk. Please read our Risk Warning below.

Risk Warning

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

Except for the United-Kingdom, where this communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658, this communication is issued by Lyxor International Asset Management (LIAM), a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2014/91/EU) and AIFM (2011/61/EU) Directives. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority). Lyxor International Asset Management (LIAM) is registered in the public register of the Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten) as a manager (beheerder) of a UCITS.

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.