A wave of green government bonds floods the markets


A WAVE OF green sovereign debt is flooding the markets. Britain issued its first such bond in September, alongside other new issuers, such as Colombia and Spain. They join at least 20 countries that are already issuing green debt, including Germany, which is on track to build a “green curve” of bonds with multiple maturities. Governments have collectively raised over $ 100 billion through the Green Lane so far this year. And later this month, the European Union is expected to join the club. Its 250 billion euros ($ 290 billion) green loan program is expected to make it the world’s largest sovereign issuer of instruments.

The main difference between a green bond and a regular bond is that the capital raised by it must be spent on certain environmentally friendly projects. So why not go into debt the old fashioned way instead, and simply focus the recipes on greenery? An advantage could be the possibility of borrowing at a lower cost. Investors may be willing to accept a lower yield for green bonds (i.e., pay a higher price for them), as they may either count their holdings against their environmental, social and governance goals, or because it gives them a good image in the public, says Dion Bongaerts of Erasmus University Rotterdam.

Indeed, investors demand a higher return on conventional debt than on green debt with almost identical characteristics. The yield spread (called “greenium”) may seem modest: for a ten-year bond in Germany, it is around 0.05 percentage point. But that starts to look more significant when you consider that the yield on a conventional ten-year German bond is -0.18%. The yield spread fell 0.02 points a year ago, suggesting that demand for green debt is exceeding supply. The UK bond, issued last month, had a yield spread of 0.025 percentage point, more than expected for an opening green issue. The sale was ten times oversubscribed, more than any Debt Management Office issue.

Yet the cost savings are unlikely to be significant for governments, says Antoine Bouvet of ING, a Dutch bank. For 1 billion euros of debt, a lower interest rate of 0.05 percentage point would mean a saving of about 500,000 euros per year, a drop in the bucket for a government.

This suggests that green bonds have another advantage: they serve as an engagement device for politicians. The UK show’s proceeds, for example, will be spent on a range of green policies, including a plan to develop low-carbon hydrogen technologies by 2030. The risk with such commitments is that they end up being watered down or reversed when a new government comes to power. But when a finance ministry creates a green bond program and builds a “green curve,” it can become more difficult to give up specific policies, Bouvet said. This would hurt liquidity and irritate investors.

However, the issuance of latest generation bonds could lead to other liquidity problems. The first is that investors may be reluctant to invest money in an emerging market. But as green bonds become more popular, the risk for governments is that they will divide the overall sovereign bond market in half, says Bongaerts. Normally, all bonds issued at the same time and of a given maturity are the same, which makes them easier to trade. But a greener green segment could have the effect of reducing the liquidity premium that investors place on conventional bonds and increasing the cost of fundraising.

Germany tried to guard against it. Last year, it started issuing green bonds that correspond to a conventional “twin” with the same maturity date and the same coupon. The Bundesbank maintains market liquidity through “switch trades”, allowing investors to swap green bonds for conventional bonds. As more governments go green, other workarounds may follow. ■

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This article appeared in the Finance & Economics section of the print edition under the title “Green Party”

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