My Name Is Bond, Green Bond

INVESTORS ARE INCREASINGLY ATTRACTED TO THIS NEW CLASS OF BONDS WHOSE SUPPLY, WHILE RAPIDLY INCREASING, IS STILL LOW RELATIVE TO DEMAND. A STUDY HIGHLIGHTS THE YIELD SPREAD BETWEEN TRADITIONAL BONDS AND GREEN BONDS, CONCLUDING THAT THE POSSIBILITY OF COLLECTING RESOURCES AT A DISCOUNT DOES A DOUBLE SERVICE TO THE ENTIRE SYSTEM

by Maurizio Dallocchio and Emanuele Teti, Full Professor at Department of Finance and Affiliate Professor of Corporate Finance at SDA Bocconi
Translated by Alex Foti

The first green bond was issued in 2007 by the European Investment Bank and since then their market has grown dramatically, carving out its own space among debt instruments. Suffices it to say that total green bond issues reached $900 billion in 2021, a buoyant growth considering thatin 2018 the market was worth little more than $300 billion. There are numerous reasons for the success of the green bonds. First of all, they signal the attention of a business institution towards sustainability, the environment and the quality of life of future generations. Consequently, their issuance has a positive impact on the assessment of the ESG profile, improving the company's risk profile and its cost of capital. And their cost is lower than traditional financing tools. In support of these considerations, a recent study by the European Central Bank shows that the cost of capital is lower for green bond issuers (and the related enterprise value higher) than non-issuers of green debt, other things being equal. Overall performance indicators such as ROE or the ratio between price and book value of shareholders' equity (P/BV) are also positively impacted. Furthermore, one cannot fail to acknowledge the fact that investors from all over the world are attracted by green securities and their issuers, but their supply is still very limited compared to potential demand. Hence the real risk of running into issuances resulting from "greenwashing”, or securities artfully referred to as green bonds.

But is there a real difference, in terms of the risk-return ratio, between green bonds and traditional bonds? Two differences are evident. The first consists in the fact that investors in green bonds have a marked sensitivity towards issues relating to the environment and sustainability, both due to the specific orientation of ownership and management, and due to the increasingly tangible pressures in this direction coming from stakeholders in the broadest sense of the expression. This means that they are not only interested in returns as such, but in the dual performance of the green security subscribed: the environmental element and the economic one, which may be lower with respect to a traditional financial product, due to the return offered on the first front. The second difference is based on the theory of asset pricing and links the possibly lower yields of green bonds to some of their characteristics which delay the attainment of truly satisfactory profits over time by virtue of the type of investment selected. Furthermore, green bonds are subject to continuous monitoring, both with respect to the environmental objectives they aim to achieve, and in relation to the actual destination of the financial proceeds after issuance, elements which could further limit the probability of default.

Concretely, is there actually a yield spread between traditional and green bonds? Our research has highlighted differences, depending on the market considered. In the primary market we demonstrate that the issuance of green bonds entails, other things being equal, a yield 35-40 basis points lower than standard bonds. Furthermore, although the yield spread at time of issuance is confirmed for each type of green bond, the discount is more robust for corporate issuers, with an average of minus 40 basis points compared to financial issuers, for which the discount was estimated to be lower than or equal to 22 basis points.

On the secondary market, however, we found that at the end of 2020 the yield on green bonds was around 12 basis points below their traditional counterparts. The "premium" in favor of green bonds (called Green Bond Premium or Greenium) widened in early 2021 to minus 28 basis points, and then reached minus 35 basis points at the end of the first semester of 2021. Our results would seem to demonstrate that the discount on yields between the two types of bonds is growing. This could be explained by a growing demand/supply imbalance leading to a higher appreciation of green bonds compared to traditional bonds.

Ultimately, the possibility of collecting resources at a discount renders the system a twofold service: on the one hand, it facilitates issuers who can finance green projects at a lower cost; on the other, it attracts the attention of investors who can actively support the transition towards a more sustainable economy.



Valeria Sandei, CEO of Almawave

What impact and what future can forms of financing such as green bonds have for companies?

Despite their being a relative novelty, green bonds have quickly become the financial instrument of choice for many companies and institutions. And if we think about the EU climate and energy targets for 2030, it is plausible, if not certain, that their use could increase exponentially in the near future.
On the other hand, attention to sustainability is no longer considered a passing fad but rather the precondition for doing business, inventing new products and planning investment. Also at my company, Almawave, we have developed a strong sensibility on the issue for some time and this can be seen from the commitment put in place by our people every day and from the tangible results achieved and collected in our annual sustainability report. In fact, our impact has not only internal relevance for corporate operations, but also on the whole ecosystem since digitization and machine learning have a decisive impact on the path towards the Agenda 2030 objectives.
And since we were listed in 2021, sustainability has been discussed in every meeting with the financial community. From this point of view, it should be emphasized that finance acts as a stimulus and an accelerator towards greater implementation of ESG issues in companies.
As specialists in Artificial Intelligence, particularly in the comprehension of written and spoken human language, we are privileged to work with both the public and private sectors and, beyond green bonds, it is now evident how the financial management of a company or entity can no longer disregard the impact of its own activities in terms of sustainability. Not only that, but ESG ratings now concretely affect access to credit, relationships with stakeholders and the ability to attract the best talent. AI can become an essential lever for interpreting "alternative data" and building new models for assessing creditworthiness that take ESG issues into account.


Carlotta de Franceschi, Managing Director HPS Investment Partners

Green bonds are becoming a more and more common financial instrument. Where are we in terms of this instrument growth stage?

As a premise, the opinions that I discuss are my own and are not the views of HPS Investment Partners - the various European Institutions are coming together to make it easier for sustainable economic activities to attract private investments through green bonds. The premise, as Mario Draghi pointed out during the UN meeting prior to COP26, is that government resources won’t be enough to support the energy transition and therefore policy makers are focused on enabling private investments in the space. The European Commission, for example, created a solid regulatory architecture that defines a taxonomy of green activities, based on six objectives (two of which, regarding climate, have already been defined in detail, with the activities that would qualify as such). The EC also issued a directive that requires funds to disclose their activities as green, not green and light green, in their portfolios. Furthermore, the EC has also proposed to modify Solvency II to facilitate insurances’ investments towards sustainable ones. Finally, last October, the ECB has launched a purchase program for green bonds at a lower haircut compared to other banking assets.

What future do you foresee for greenbonds between geopolitical turmoil and inflation?
European policy making is focused on facilitating green bond investments by strengthening their standardisation (including a common definition of “green activity”, prescribing an external audit of the activities etc) and promoting further transparency in the system through disclosure. The global attention to the environment, that Europe set at the center of its political agenda with the Green Deal, isn’t a new phenomenon. For sure the Ukrainian conflict is making the political debate over both diversifying energy sources and the energy transition in Europe pressing. In this respect, there is room for EU policies on greenbonds to further evolve. For example, the EC proposal over Solvency II is under discussion at the European Parliament and the EBC could potentially expand its “green purchase program” to include “green covered bonds” or “green abs”. The true elephant in the room is “greenwashing” where the attention of the Regulators across the globe is extremely high.