Greenium: is it still fit for purpose?

The way green bond issuers and bankers conceive of the greenium is in flux, after the green bond market has developed rapidly in recent years.

The greenium — the tighter pricing of green or other sustainable bonds, compared with the same issuer's ordinary debt — has become less visible and reliable, many market participants say.

The shrinking of the green premium in the secondary market has been less obvious for some public sector than corporate issuers, but it is nevertheless worrying some issuers and their dealers.

In the primary market, too, the greenium has been slowly evaporating. For most issuers, it has become all but impossible to define.

Investors, of course, have never liked the idea, and often deny that they are willing to accept tighter spreads on green bonds. To admit this could be seen as revealing to their clients that they are sacrificing some return to invest in a green way.

But after an early phase in the market's life, in which bankers and issuers pretended there was no greenium, for fear of putting investors off, the sell side all admitted the obvious: the particular demand for these instruments did mean they were regularly priced more tightly.

This could be visible at new issue, or in the secondary market, or both.

And it helped the market attract new deals.

Few green bond issuers are willing to say they use the structure because they hope to achieve a greenium. Such a base thought would never enter their heads, of course.

But origination bankers know from experience that conversations with prospective issuers flow a lot more easily when they can point to a pricing advantage, even a small one.

In recent years, however, many have observed the greenium being squeezed.

A variety of reasons are suggested. Some put it down to the product becoming more mainstream, and hence less special.

Others say the end of quantitative easing has removed a distortion of fair value on bonds in general and made investors refocus on the fundamentals of credit and interest rate risk. An airy fairy green premium might get crushed between those hard rocks.

Issuers and banks still often hunt for and try to capture the elusive greenium.

Sometimes the number crunchers dig up a quarter of a basis point and call it a "greenium", after playing in an arty rather than scientific way with new issue premiums, liquidity premiums, scarcity premiums and all the other market technicals during execution, even as a deal is buffetted by underlying interest rate moves and the level of demand on the day.

The picture can be baffling. Sovereigns are the largest, most liquid and sometimes the highest quality public sector issuers. But the greenium varies significantly between them, and sometimes between different green lines of the same issuer.

Germany, for example, currently has greeniums ranging from 0.5bp to 4.3bp on seven of its pairs of green and conventional bonds.

Two short-dated lines — with 1.5 and 3.6 year residual maturities — yield significantly less than their grey twins.

But the upper end of this greenium range was 12bp in May 2023 and over 18bp at the end of 2023.

Germany and Denmark are the only two issuers whose greeniums can be studied with scientific accuracy, because they issue twin green and non-green bonds.

But even for Germany, analysing greeniums can require trying to account for nuances and coming up with justifications.

And what rhyme or reason does this picture present? The size of greenium does not correlate with the credentials of any given issuer.

A small French agency may trade with a much larger greenium than Germany, or achieve a much bigger theoretical one in primary, due to technical factors. It does not make Germany any less ‘green’ or investment-worthy.

This confusion, and some of the intellectually unconvincing attempts to specify a greenium on certain deals, are raising anxiety.

What concerns market participants is not so much the shrinking of the greenium. It is that the greenium no longer seems relevant to much of the market, especially when it comes to primary issuance.

What purpose does a greenium that is all but impossible to analyse still serve? Rather than issuers and banks tying themselves in knots trying to specify it, why not just forget the whole thing?

Such concerns are understandable. But sustainable finance specialists need to clear the air, and restate what the greenium is and is not.

It is clear that in some markets, such as Japan, the greenium has become very regular and predictable. But in European and north American markets it appears and disappears almost mysteriously.

That is entirely to be expected, since the greenium is purely a by-product of supply and demand.

Green bonds have an extra virtue, which appeals to some investors: they can buy them and feel they are investing in a green way, and justify this to their end clients.

This advantage is inherent in the bonds and will never go away, unless green investing goes out of fashion.

Market participants generally agree that this attraction means green bonds attract a different mix of investors: in other words, they garner extra demand in some quarters. They also trade more stably during market sell-offs, because green investors do not want to part with them.

What can be harder to define is whether this advantage shaves any basis points off the yield. Sometimes it does, sometimes it doesn't.

A useful analogy is the differences in appetite for other aspects of bonds, such as maturity.

Some investors, in given market conditions, prefer five year bonds over seven year ones. To those investors, a bond's five year maturity makes it inherently superior. But it is only sometimes that this excess demand is strong enough to visibly change the shape of the yield curve.

The difference from maturity is that a bond's greenness as a characteristic can have no downside for an investor: its attitude can only be enthusiastic or indifferent. Of course, individual green bonds can have disadvantages of other kinds: being small, illiquid, having the wrong coupon or maturity.

The greenium is caused by excess demand, relative to supply. When supply of green bonds more fully satisfies demand, it will tend to shrink.

No one should expect this to be uniform across green bonds, either.

Green investors, for example, now have much more triple-A rated and sovereign paper to choose from than they used to. They may feel they have plenty of it when deciding how to build their portfolios for optimal risk and return.

On the other hand, a new corporate green issuer from an unusual sector, offering a tasty yield, might excite them and make them willing to pay up.

Issuers and bankers may feel the greenium is an unreliable friend. Fair comment. But they should not stress about it.

The greenium's theoretical underpinning is sound, and its visible appearances and disappearances are consistent with how markets work.

Casting doubt on the greenium's validity or existence is dangerous. It undermines people's understanding of green finance and its purpose.

This is that a subset of investors want to finance green activities, and will prefer instruments that enable them to do that.

In debt markets, extra demand logically leads to finer pricing. Even if the effect may sometimes be too small to discern amid the market hubbub, that fundamental logic remains in operation.

Many issuers say they are happy to forget about the greenium and issue green debt for other reasons. Good for them.

But that does not mean other present and potential issuers' enthusiasm cannot be weakened by denying the greenium's reality.

Issuers know they cannot bank on a greenium, and that it may be small. But don't take away their hope of it existing at all.