Greenium's mercurial nature is inevitable, and a strength
Letting everyone believe what they want to makes the often elusive greenium an effective concept
The existence of the greenium — the pricing benefit that issuers gain by applying a sustainability label to a bond versus conventional issuance — has been a well established fact in some markets for as long as 10 years. So why does it still have its doubters?
The logic behind the pricing advantage is straightforward, especially in the primary market, where, due to the existence of dedicated green bond funds, a green or otherwise labelled bond has a larger audience.
Those dedicated funds tend to buy and hold, meaning the bonds become scarce and trade rich in secondary.
One argument against the greenium is that it undermines the fundamental financial rule that rewards should match risks. But there are other factors at play — supply and demand — that trump such concerns.
Occasionally, the greenium seems to shrink or even vanish. This caused some consternation in the SSA market last year, when the EU flooded the market with green paper. In corporate bonds, meanwhile, bankers were surprised in November when the greenium appeared to wither away entirely.
Greenium skeptics appear with greater force at such times. But new issue premiums have been known to perform the same disappearing act from time to time, and no one questions that they exist. Why would it not also be true of greeniums?
In fact, the greenium is just like all of the other explanations that bankers and investors give to justify the price of a bond — informed guesswork. Even when analysing a benchmark-sized bond from a frequent issuer, there is room for subjectivity when calculating fair value.
And furthermore, green bonds are not all as green as each other. A paper produced by scholars at the Goethe University Frankfurt suggested that the credibility of a green bond and its issuer was the most important determinant of whether it would trade at a lower yield than its conventional counterparts.
They found that a bond was more likely to enjoy a greenium if it was certified by a third party or listed on an exchange with a tightly regulated green bond segment. Of the bonds they examined, only those issued by sovereigns and supranationals, denominated in euros, or of very large size exhibited a greenium.
Green ratings themselves are an inexact science, but in this they do not differ from credit ratings. Moody's, S&P and Fitch quite often disagree on the creditworthiness of an issuer, and careful investors do their own credit work, coming to a variety of conclusions that suit their own needs and outlook. It would be unfair to expect greenness to be determined with greater unanimity.
The greenium, then, is a way to aggregate market feedback on the credibility of the environmental, social and governance attributes of a bond. But as with every other component of a spread, it cannot be taken in isolation. Maybe it was just a good or bad day in the market.
Feature or bug?
By now, it should be beyond question that greenium exists, though it will not necessarily be clearly discernible at all times or in all places for all issuers. In fact, its protean nature is part of its effect, since it allows everyone to believe what they want about it.
For issuers that believe that the greenium is significant, it is another incentive to go green and sell labeled securities. Corporate treasurers certainly still seem to think a green label helps with pricing, as last week several companies applied them to the longest tenors of multiple-tranche deals, apparently in an effort to counter the prevailing bias towards shorter dated bonds. Bank issuers too have recently found that ESG labels reduced price sensitivity, even if the precise pricing advantage was hard to calculate.
Investors, meanwhile, can reassure themselves that the greenium they are paying is not so large, and carry on buying labelled bonds with undiminished enthusiasm.
In any case, the mystique around the greenium means that the phenomenon is likely to remain a topic of discussion for some time to come. And if one of the main aims of green bonds is to get people talking about sustainable finance, then this is certainly a feature, not a bug.