Greenium (a contraction of green and premium) is the negative spread difference between a green and conventional bond, in other words, the yield that investors are willing to give up in order to hold a green bond rather than a conventional bond with similar maturity, whose proceeds are not specifically earmarked for green projects.
For years greenium was purely a subject for academic studies but recent market developments, on the back of the surge of green bond issuances, accompanied at the same time by an exponential increase in dedicated sustainability-related funds and portfolios, indicate that greenium has become part of reality and it is here to stay, at least for the time being.
Was it always the case?
SSAs (Sovereigns, Supranational and Agencies) were, without a doubt, the leaders in this segment creating a blueprint for sustainable bonds in the capital markets. Some of you may have already heard the story of the Swedish pension funds, that called the World Bank as they were looking for ways of investing in sustainable projects. That is how the first World Bank’s green bond became a reality in 2008. At the time, portfolios focused on responsible investments were a niche investor base rather than the rule, and many of those SSA issuers, when meeting investors during their roadshows and enquiring on the appetite for green bonds, quite often heard the same sort of answer – “… We are as green as the (generous) spread on your bonds...!”. Nowadays, the tables have turned, investors are taking an active role in their search for green/sustainable bonds and are the ones asking the questions around the issuers’ sustainability frameworks. They go beyond the trivial question around the companies’ carbon footprint and challenge these companies in terms of their concrete plans on achieving the net-zero target, and how they will align with the Paris below 2°C commitment.
Growing demand from institutional investors is one of the driving forces supporting the emergence of greenium.
What used to be a niche is now becoming a widely established trend. The competition among asset managers in raising funds for their new or recently converted SRI (Socially Responsible Investment) funds is fierce. On top of that, all the raised capital needs to be deployed across eligible instruments so that the race to get hold of those new green / social / sustainable / sustainability-linked bonds has become even more contested.
What prompted the change?
Perception of what the fiduciary duties of investment managers are, have changed, or more precisely, have adjusted to the current environment and to their clients’ new and more sustainability-focused needs and aspirations. While in the past, managers solely strived to increase financial returns for their beneficiaries (therefore excluding ESG factors), the perception of fiduciary duty in the industry, and from regulators’ point of view, has seen an important shift. ESG factors are considered, at present, financially material and even more in the medium/long term, which is often the investment horizon for many institutional investors. Time and academic studies are supporting, more and more, the argument that green portfolios can enhance yields and mitigate risks, as the companies they invest in, are less exposed to changes in regulations and risk of fines. Black swan events are tail events that despite their low probability of occurrence can have a major impact on a company’s bottom line, not to mention on the environment, as the case of the 2010 Deepwater Horizon oil spill in the Gulf of Mexico, that is estimated to have cost BP more than $ 65bn (and the environmental disaster was incalculable).
The fact that more and more investors start integrating ESG considerations in their investment mandates is also a driving force for many managers that start including responsible investment as part of their strategic asset allocation.
How material is greenium?
What we have seen even in those early years, when green bonds were still a nascent asset class, was that they perform better in a downturn. It makes sense, as in a sell-off asset managers that need liquidity would rather sell their conventional bonds and keep the green shelf as is, given that it would be more difficult to source these once the tide turned. So greenium surfaced in a more sporadic way even in those early days.
The difference nowadays is that greenium is much more of an inherent feature of this asset class with the caveat that it is not static nor uniform across issuers. Greeniumis dynamic and varies not only with time, but also across maturities, seniority/ranking, ratings, across sectors and even within a specific sector, where there could be significant differences between issuers based on how credible and sound their sustainable financing frameworks are, in the eyes of investors.
In-depth, the report of the green bond primary market in H2 2020 done by CBI demonstrated the existence of greenium for the majority of the green bonds they’ve analysed (looking at a sample of the 33 more liquid green bonds issued in H2’20, 19 exhibited greenium while 7 were priced at fair value). Despite the bumpy March 2020, CBI’s H1 2020 report showed similar results with more than half of the bonds they’ve analysed pricing inside their conventional yield curves.
An interesting example in the sovereign space is Germany’s debut green bond last year. The issuer opted for the rather unique -at least so far- twin bond approach, which means that the green bond issuances are done alongside a conventional bond and both shelves share the same maturity and coupon. The green bond can be switched at any time into the conventional one and as a consequence enjoy the same liquidity but, in any case, with an outstanding of €6.5bn, liquidity is clearly not an issue for this inaugural green issue. All those features make the comparison between the two shelves a lot easier for asset managers. In the case of Germany, the huge book of orders allowed the inaugural 10y green Bund to price 1bp tighter than its brown equivalent. What is even more interesting is the relative performance of the bond, since issuance in the graph below, that shows that the initial 1bp of greenium has increased further and currently is slightly over 5bps, or in terms of price equivalent c.50 cents for a 100 bond’s par value.
Graph 1: 10Y bund yield evolution - greenium
Similar performance is observed in the new 5y Green BOBL, that followed in November 2020, and that remained somehow off the radar of some investors, mainly since it was priced the day after the US Presidential elections. The bond was priced with 1.5bp initial greenium and as shown in the Graph 2 below, currently that spread is hovering in the 2.75bps area.
Graph 2: 5y BOBL yield evolution - greenium
Where is greenium heading?
One thing that has been put to manifest is that demand outstrips supply by far, which should further support the performance of green bonds in relative terms.
On the regulatory side, in Europe, we will be paying closer attention to ECB’s Strategic Review, that should be completed in H2 this year, as sustainability and climate change are expected to be key points. ECB and other Central banks have been criticized and challenged on their pandemic asset purchase programs as they have bought billions of bonds of companies in high-carbon industries in their push to shield the economy from the COVID-19 crisis. Bank of England has already announced that they will inform about the proposed changes of their Corporate Bond Purchase Scheme in the coming months, aiming at implementing the new approach before the end of this year.
Looking at the old continent, Christine Lagarde is one the key figures that has been advocating for more actions to tackle climate change, and she has stressed on numerous occasions that it is one of the top priorities in ECB’s agenda. So any tweak to current monetary policy in favour of green bonds, could have an important impact on both primary and secondary markets, and therefore on greenium. ECB has a wide range of tools available within its scope, some more likely to be used than others. Just as an example, the central bank could opt to “green” its collateral framework and change the haircuts of green instruments for collateral purposes. Another potential tool could be to skew asset purchases to benefit green issuers. Considering the sheer size of its asset purchase programmes, the European regulator would have to carefully weigh any tilts in favour of green and sustainable bonds, as the asset class, despite its blazing recent growth and new record highs in terms of volume, which still represent a smaller portion of the overall bond market. Unintended consequences could be crowding out of specialized investors in a similar way than what happened with QE and the covered bond segment in the past. On the other hand, despite the fact that there are other ECB members that have been supporting the step forward to decarbonize ECB’s corporate-bond holdings, some of these measures could also have a negative impact on the effectiveness of the monetary policy as a whole, and some will challenge what falls within ECB remit and what should be left to governments.
We will soon see in which direction the balance will lean, but without any doubt supportive policies will eventually be reflected in bond prices and will be crucial for the evolution of greenium going forward.
Neli Toseva, CFA - Director of International Fixed Income Sales, Beka Finance