By Amélie CLEMENT-LAMIRAULT
Amélie is a talented consultant, part of the CSR Community, at ADNEOM Luxembourg. She graduated last year with a master degree in Management with a specialization in Finance. Amélie has always been fascinated by sustainable finance and dedicated her final thesis to Green Bonds. She believes that Green Finance is the path leading to a better and greener world. Through this article, she explains the ins and outs of Green Finance.
Labelled Green, Social and Sustainable bonds have skyrocketed by 42,4% in the first semester of 2019 showing that green finance is becoming a key driver in investment decision. New instruments are launched reflecting social, ethical and environmental interests for sustainable finance. Green Bonds are one of the most traded green financial products and constitute engaging financial instruments fulfilling low carbon, responsible and social objectives (OECD, 2011).
Green bonds are fixed-income securities financing exclusively “green” projects, assets or business activities. Are Green Bonds equivalent, ceteris paribus, to Conventional Bonds in terms of performance and attractiveness? Investors willing to invest in securities labelled ESG (Environmental Social and Governance) will have to answer that question. If a difference exists between regular and green bonds it will be defined as the Green Bond Premium.
To demonstrate the existence of this difference and to describe its components this thesis proposes a framework and a method to calculate the Green Bond Premium.
The analysis focuses on the Eurobond Market from January 2014 until October 2018 as research shown that Europe represented 37% of the overall green bond market in 2017 with 21 global markets and 144 issuers for a total amount of 141 billion dollars of transactions (Bloomberg, 2018).
Several methodologies have been used to calculate the Green Bond Premium but no consensus has been reached upon the most appropriate method to prove that we need to match two “twins” (Green Bonds and Conventional Bonds) to analyze their differences (yield, maturity, rating, volatility…). Thus, the paper proposes a review of the current literature and an econometric analysis through two regressions (the first to prove the existence of the Green Bond Premium and the second to define its variables).
The first regression is performed to validate the statistical and economical significance of the Green Bond Premium. The regression shows a difference of 0,04 in the yield of Green Bonds compared to Conventional Bonds. The existence of the Green Bond Premium therefore proves that Common Bond yield is higher than the yield of its equivalent Green Bond. This distortion is the result of a pressure in the demand of Green Bonds compared to the offer provided by the market.
The surplus in the demand of Green Bonds has two origins. On the one hand, public actors are creating incentives to foster investments in Green Bonds in the form of tax incentives and credit enhancements (Climate Bonds Initiative, 2018). On the other hand, environmental performance leads to decrease the cost of capital (Stakeholder Theory) which can have a negative impact on the yield of Green Bonds compared to their equivalents Conventional Bonds.
While, the offer of Green Bonds is kept low by an unattractive environment: low-carbon pricing or lack of corporate tax incentives. Which add up specific “green costs”: labelling of Green Bonds (monitoring, legal cost, notoriety cost) and to extra costs due to shortage of information.
Once the framework defined, the thesis breaks down the variables representing the Green Bond Premium. The regression shows that 10 variables are explaining 84.35% (R-squared) of the Green Bond Premium. Those 10 variables are all related to bond characteristics except for the credit rating which is related to the issuing company (currencies of the green bonds, the credit rating of the issuer, the amount at issuance of the green bond, the bid/ask spread of the bond and the modified duration).
But, the graph presented below provides solid evidence that, from 2014 to 2018, the Green Bond Premium tends to zero. If the variable become null in the coming years, investors will be encouraged to make their arbitrage between Conventional and Green Bonds according to their appeal for specific green/social projects or Green Bond Premium ratings, looking for the lowest.
Considering the small or null difference in yield between Green Bonds and Common Bonds, it would be interesting for investor to use the Green Bond Premium as a variable when building portfolio, in order to couple higher chances of good performance and social and/or green impacts.
This study stands for an original methodology using peers analysis (Conventional and Green Bonds) to compute the Green Bond Premium for a specific market (the Eurobond Market) and for a defined period of time (2014-2018). It also proposes a definition of majors Green Bond Premium determinants including issuer characteristics which is not analyzed in previous researches.
The methodology proposed in this research could be transposed to Social Bonds in order to identify if there is a Social Bond Premium. Moreover, the Green Bond Premium could be used as a leverage to build portfolios and even industrialized through automated tools such as roboadvisory to benefit asset managers as well as private investors.