Phoebe Stone, Partner and Head of Sustainable Investing
This week, the UK government issued its inaugural sovereign green bond, the green gilt. It is the largest sovereign bond on record and will aim to help fund green infrastructure projects, wind power, carbon capture and storage. It is positive to see the UK Government join what is an important and fast-growing market. According to the Climate Bond Initiative, the cumulative green bond issuance to date is more than $1.35 trillion, with over $259 billion issued so far this year, to August.
Issued by both corporate and governmental entities, green bonds are what is known as ‘use-of-proceeds’ bonds. The ‘green’ activities that the bond will fund are specified and the funds raised are ringfenced for these purposes. They can be used to finance investment in areas including renewable energy, clean transportation, pollution prevention and green buildings. Where green bonds are issued, the issuer reports on the progress of the financing activities relating to the bond - providing greater transparency to the investor, something which is not often available for more standard, vanilla bonds.
Total annual green bond issuance globally
This week’s first ever green gilt was priced higher than the comparable conventional bond, representing what has been described as the largest greenium seen for a sovereign green bond. The term ‘greenium’ refers to any premium that exists whereby an investor would have to pay more to invest in a green bond than the equivalent vanilla bond. As the green bond market has developed in recent years, a greenium is certainly visible in certain pockets, but is not systematic across the whole market. As the green bond market continues to grow, and there are more issued by governments such as the UK, we expect to see greeniums to become less prevalent.
According to the CBI, in Europe, the average oversubscription for green bonds is 4.2 times versus 2.9 times for their vanilla equivalents, implying that green bonds should trade (higher), at a lower spread. During the COVID-19 pandemic, the green bond market proved more resilient than the wider conventional bond market. Green bonds sold off by a lesser extent, but this also meant that they underperformed in the subsequent period. This was likely due to investors without a dedicated sustainable/green bond mandate moving into larger and more liquid bond issuances. Broadly speaking, we have seen the greenium at its widest points during the height of uncertain periods and during periods of low volatility, this premium looks less evident.
However, regardless of whether the bond is green or not, the issuer default and business risk is the same, and therefore the inherent risk to the bond does not change. Due to these important factors, it is reasonable to suggest that any long-term premiums that exist for certain issuers or sectors will be down to the fact that investors are willing to pay more for the higher level of transparency and the environmental performance of the bond itself.
Data from Columbia Threadneedle suggests that the greenium across most sectors is low to non-existent, however, one sector that exhibits a notable premium is the automobile and parts sectors. An example of a company within this sector with a visible greenium is Volkswagen (VW). Given the controversies linked to VW resulting from the company’s emissions scandal, it is not unreasonable to propose that investors in the company now require a higher level of transparency around environmental issues to mitigate the risk of holding VW debt. It is therefore fair to conclude that investors will continue to pay a premium for certain bonds where they desire a higher level of transparency, something that is likely to be influenced by both company and sector specific risks.
We continue to favour active management when investing in the green bond market to ensure that both valuation discipline is factored into investment selection, and that the green bond is financing demonstrably environmentally positive activities.
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