Is paying a ‘greenium’ worth it when it comes to the bond market?

Green bonds are a mighty tool with which to drive environmentally friendly activities. But there are challenges too.

The term refers to any type of bond instrument where the proceeds are used to finance or refinance new and existing projects with environmental benefits.

“If a company issues a green bond the proceeds must be invested in environmentally beneficial projects. So, for example, they could use the proceeds to invest in wind farms, or solar,” explains Shane O’Neill, head of debt advisory at Davy Corporate Finance.

Green bonds constitute just 5 per cent of the global bond market. While that proportion is expected to grow significantly, in a small country such as Ireland, where most green bonds are issued by banks, a constant stream of green projects is needed – but that is not always available, despite the strength of demand from investors.

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“For investors, there is often a double bottom line objective‚” says O’Neill. “They get almost exactly the same return as an equivalent bond and are willing to give up a very small bit in return, in order to encourage environmental benefit outcomes.”

For the issuer there is a slight benefit, or ‘greenium’, which is just enough to cover the cost of the green wrapper, in terms of certification, tracking and reporting.

Germany has been offering twin bonds since 2020, issuing both a conventional bond and a green bond that share the same maturity date and coupon. This provides a way of benchmarking the greenium, which IMF analysis puts at around three to four basis points.

At the end of last year the EU agreed a European green bond standard, laying down uniform requirements for issuers that wish to use the designation. The idea is to foster consistency and comparability in the green bond market, benefiting issuers and investors alike.

As such, the stage is set for expansion. But the fact that the use of green bond proceeds is tied to specific environmentally friendly activities, and as such does not constitute general financing, will remain a disincentive for some, according to Fabiola Schneider, assistant professor in accountancy at University College Dublin.

In such cases a sustainability-linked bond, such as a social bond, might look a lot less prescriptive and restrictive.

“Sustainability-linked bonds are not tied to specific activity, so you can spend the money in whatever way you wish, like a general-purpose finance bond. And you have a forward-looking target, such as, ‘in five years I will have reduced my energy usage by x per cent, or improved my gender balance by x per cent’,” she explains.

“It is linked to a key performance indicator that has to be reached but you can spend the money as you wish, with a financial incentive to do so because there is a penalty or reward for reaching the target.”

Green bonds are usually oversubscribed, with demand from institutional investors greater than supply. A huge part of the benefit such investors get from them is greater transparency. If you issue a green bond you have to offer more disclosures, which, from an investor’s perspective, reduces risk, Schneider points out.

Simply doing good, as part of your corporate and social responsibility activities, is also a key driver, she adds.

But despite the work on standardisation, the market still has some concerns around greenwashing.

“The problem is that anyone can issue a green bond if they have green activities. So, say you have a big fossil-fuel company, such as an oil or gas company that now does a little bit of solar, they can now issue a green bond for those solar activities,” says Schneider.

“That means they can use all the other money they have from their revenues, their cash, to finance their fossil-fuel activities. So if you ask me, you’re still financing a fossil fuel company, and freeing up all the other cash they have, by issuing a green bond for the small amount of renewable activities they do. So again, for me, greenwashing and green bonds can be a problem.”