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November 7, 2023updated 08 Nov 2023 11:06am

A vanishing greenium

Incredible growth in the ESG bond market has presented the bond market with a new systemic risk due to the presence – or not – of a greenium.

By Nick Herbert

Incredible growth in the ESG bond market has presented the bond market with a new systemic risk due to the presence – or not – of a greenium.
(Photo by Monthira via Shutterstock)
  • New research from the European Securities and Markets Authority (ESMA) finds no systematic greenium in the secondary market for ESG bonds.
  • There is more suggestion of a greenium persisting in the primary market, but the magnitude appears to be diminishing.
  • The market is heading towards a point where there will be more focus on the overall ESG credibility of a company and less focus on green bonds themselves.

Investor interest in sustainability has resulted in the supply of labelled ESG bonds increasing dramatically in recent years. Issuer groups have expanded to include corporates, financials and sovereigns, as have varieties of ESG debt instruments.

Accompanying the development of an ESG market has been widespread discussion of the existence of a greenium – and of greenwashing. A significant sub-sector of the bond market trading at a premium to conventional bonds based on the sustainability factor raises concerns should ESG credibility come into question. These are concerns that are of interest to investors and market regulators alike.

New research from Sara Balitzky and Paul Reiche of the economic financial stability and risks department in the European Securities and Markets Authority (ESMA) takes an analytical approach to determine the presence of a greenium and assess the implications for the bond market.

“ESMA’s objectives include inter alia financial stability and investor protection,” says a spokesperson. “Whenever we see market developments that could potentially impact these objectives, we carry out research or analyses to assess if they present real risks.”

The underlying risk factor in this context stems from issues arising from diverging bond prices that do not correspond to fundamental bond characteristics and subsequent investor expectations.

“If the underlying sustainability aspect supporting a greenium would prove to be inaccurate, this could trigger a very rapid market unravelling,” says ESMA. “That could lead to volatility and a potential risk to financial stability.”

The greenium is of interest to regulators elsewhere. Spain’s National Securities Market Commission (CNMV) has noted that one of the most important focuses of regulators and supervisors is on avoiding greenwashing, which could have a negative impact on the credibility of markets and companies.

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Nothing to see here

Research conducted in the past on the greenium has been inconclusive. ESMA has sought to expand on existing analysis that focused mainly on green bonds to look at all environmental, social and governance bond types and identify the key factors potentially causing ESG bonds to price at a premium to conventional notes.

Results could “not confirm the existence of a systematic and consistent pricing advantage for any ESG bond category” in the secondary market. It neither found a premium on the comparable analysis made for 2022 and 2021.

A lack of a persistent greenium in the euro-denominated corporate sector has also been identified by ABN AMRO.

“You can’t really pinpoint a greenium like you could a few years ago,” says Larissa Fritz, fixed income strategist (credit) at the bank. “Recent volatility in the market since the energy crisis goes some way to explain it. When markets are in a risk-on mode, you tend to see the greenium decrease, just because bond spreads on green bonds tend to be more stable over time.”

That points to green bonds being less volatile than conventional bonds, which has some logic given the buy-and-hold nature of green bond funds.

The significance of any research depends on the quality and size of the data set. And in identifying a greenium, an issuer’s ESG bond needs to be gauged against conventional bonds of a similar size and maturity.

ESMA’s raw dataset consisted of 330,000 bonds from issuers in the European Economic Area and the UK with prices quoted on Refinitiv Eikon. These were cleaned to reach a final dataset of 8,696 bonds corresponding to a combined outstanding face value of €3.7trn ($4trn).

The research covers bonds denominated in euros and only those trading in the secondary market.

“The reason we decided to look at the secondary market only was to assess if a pricing difference persists after issuance because when we look at it from a financial stability perspective, this would be more linked to the secondary market than to the primary market," says ESMA. “Looking at the secondary market seemed to more accurately capture the movements and the questions we were trying to assess.”

There is more suggestion of a greenium persisting in the primary market.

In September, Climate Bonds showed that within a sample of 50 green bonds, 16 priced inside their own secondary market yield curves (32%). In this case, the sample reviewed bonds denominated in euros or US dollars, across countries and issuer types.

But even in primary, the magnitude of any greenium enjoyed by issuers appears to be diminishing.

“There used to be a clear greenium in place,” says Antti Kontio, head of funding and sustainability at MuniFin, one of Finland’s largest credit institutions. “The greenium has basically disappeared, or if it hasn't disappeared, it's diminished from the five basis points we experienced in the back in the best days of 2016/2017.”

But he puts that down to the supply-demand imbalance for ESG products normalising as green bonds become more mainstream.

“In the past, books on our green deals were heavily oversubscribed, which helped push pricing through our conventional yield curve. But recently, I think investor interest has been similar for our green and conventional bonds,” says Kontio.

“That may also be due to the current interest rate volatility – especially in euros,” he says. “Investors are more cautious in general.”

First mover advantage

While ESMA found no systematic greenium in its research it observed that “ESG bond issuers benefitted from yield discounts in the past due to their issuer characteristics.”

“We can’t say that ESG bonds, by just being labelled ESG have a greenium,” says ESMA. “But what we did find is that in 2021 and 2022 issuers which had previously issued ESG bonds, those issuers in general had lower yields on all their bonds – ESG and conventional.”

It suggests borrowers which moved into the market early, that have a track record of issuing ESG debt instruments untarnished by the stain of greenwashing and with all the systems and data in place to satisfy investors, are being rewarded for their efforts.

“It’s a valid point,” says Kontio. “If you have sustainable products in place, it has a positive impact on the company brand as a whole."

“It’s a sign that the market is heading towards a point where there will be more focus on the overall ESG credibility of a company and less focus on green bonds themselves,” he says.

The development is reflected in ABN AMRO’s investor surveys.

“Over the years, investors have moved from a bond level analysis to a more issuer level analysis,” says Fritz. “Issuers that are very green tend to outperform peers across the curve, irrespective of whether bonds are green or not.”

[Read more: Explainer: What is a green bond and how does it work?]

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