Municipality Finance (MuniFin), a Finnish funding agency, announced on August 30 that it would make its debut in the green bond market at the end of September.
Antti Kontio, MuniFin’s funding manager, was keen to make it clear that green bonds would not provide a price advantage relative to its conventional bonds.“There’s no difference in price,” he said emphatically.
Nevertheless, MuniFin has chosen to brave the extra reporting costs and time-consuming compliance activities required to access the market.
Many thought, and some still hope, that the green bond market would provide borrowers with a source of cheap capital, at least compared to conventional finance, with which to fund projects that benefit the environment, and that the availability of cheaper funding would encourage them to launch more green initiatives.
As the market develops, it has become clear that this has not happened, but the green bond market is certainly here to stay. Every year the market grows, spreading across the world and through the credit spectrum, but what is driving the asset class’s success, given that there is no perceptible advantage in pricing, and is that success having a material impact on the financing of environmental projects?
Investors will not pay over the odds for green bonds. Why would they, asks Stephanie Sfakianos, head of sustainable capital markets at BNP Paribas in London. “The big question for investors is: given that the credit quality of a green bond is exactly the same, why should we pay through their curve for green bonds?”
Issuers, of course, see things differently. “Although the risk is the same,” says Sfakianos, “they have to put in extra work, which they feel merits a funding advantage.”
But the consensus is that dealers cannot guarantee that issuing a green bond will provide a saving relative to a conventional bond.
Ralph Ockert, head of syndicate at DZ bank, says: “We use the same approach for green bonds as when pricing a senior bond, so we pitch at pretty much the same level.”
However, the green bond market is still developing and some believe that, in its final form, issuers will receive a better cost of funds from green bonds than conventional bonds.
Demand growth is outpacing supply growth. Investors are under increasing pressure to decarbonise portfolios and invest in more sustainable bonds.
“If the demand continues to increase ahead of supply, then we could see significantly oversubscribed books, which could lead to tighter new issue premia,” says Kontio of MuniFin. “We hope to get some benefit going forward.”
But not everyone shares the belief that the growth of the green investor base will lead to a pricing advantage for green bond issuers. Ockert says: “While the investor base is growing, the new investors tend to be smaller, local banks and are unlikely to be moving the market. I can’t see any reason why green bonds would change and not continue to price in line with conventional bonds. No one can tighten much more than the market standard, because investors will avoid them next time and they’ll be shut out of the market.”
However, if the market does change to allow borrowers to source cheaper funding, participants believe that those issuers who have an established presence will benefit the most.
“In a few years, perhaps there will be a pricing advantage and, if you are an established name in the green bond market, then that will help your funding,” says Jens Hellerup, head of investor relations at Nordic Investment Bank (NIB) in Helsinki.
Kontio of MuniFin agrees: “We were keen to debut soon as nobody wants to be the last to the table.”
In the secondary market, the rarity value of green bonds means they trade at a premium. Green bonds tend to be purchased by buy and hold investors so, should a green bond be offered in secondary, the response is usually vociferous, which can lead to an improvement in price.
Sfakianos believes that this secondary pricing spread over conventional bonds will “lead to a pricing advantage for issuers [in the primary market] in future”.
Exactly how improved pricing in the secondary market could impact primary pricing is becoming clear, according to Cefas van den Tol, global head of DCM at ING in Amsterdam. Last year, a series of market shocks, including the Volkswagen emissions scandal, caused the senior bonds of utilities to widen.
TenneT, a high voltage grid company, had recently issued green bonds so, while the plain vanilla bonds of its peers traded in line with the credit market widening, TenneT’s green assets held their value. Since green investors are more inclined to hold assets, these bonds experienced much less of a sell-off.
According to Cefas, “If TenneT had issued a bond at that point, it would have been able to get a better price versus better rated peers.”
However, because of the ECB’s bond purchase programme, the secondary market, particularly for public sector issuers, is heavily distorted. Ockert says that the secondary market for green bonds is so sparsely populated that “it does not reflect fair value and doesn’t give a true picture of the credit against which to price a new issue”.
Indeed, NIB’s green bonds sometimes trade wide of its conventional bonds. The scarcity of data points appears to confound any claims about green secondary performance.
Green bonds: a must-have
Nevertheless, for many frequent issuers, a green bond programme is becoming a must-have. Borrowers seem undeterred by the prospect of having to comply with the rigorous certification and reporting standards that the green bond market demands. “It involves extra cost and extra work but it is becoming, if not exactly mainstream, widespread and accepted practice, increasingly so among corporates,” says Crispijn Kooijmans, head of public sector origination at Rabobank in Utrecht.
Establishing a green bond infrastructure is less costly for those borrowers with sustainability goals already in place.
“The question of reporting is tricky but some issuers are doing it already,” says Sfakianos. “For those companies that are already strongly committed to sustainability, for example by being carbon neutral, meeting the requirements of the green bond framework may not be too onerous.”
For investors, there is a certain cachet associated with ethical investment which makes the green bond market attractive.
“Investors,” says Hellerup, “want to have the green footprint, to show that they’re investing with a sustainable view.”
Borrowers also benefit from the good repute that comes with green issuance, but there are also tangible funding advantages, even if that does not necessarily translate into a difference in the cost for borrowers. Hellerup says: “The benefits of the investor diversification and the positive publicity appear to outweigh the costs involved in setting up the reporting framework.”
Some of these benefits may not be immediately obvious. While the ECB is supporting capital markets through its bond purchase programme, borrowers are flush with liquidity. The benefit of diversifying one’s investor base with the green bonds will, according to van den Tol, “not become obvious until liquidity conditions are stretched. If and when that happens, green bond borrowers will be at an advantage”.
It should also be noted that in a world of more stretched liquidity, the higher yields might, according to Sfakianos, allow borrowers to obtain a green bond pricing advantage in primary markets. “Socially responsible investors are very sensitive to price and I can’t see that changing with interest rates where they are. Every basis point counts just now.”
But the question remains, if it’s no cheaper (and, when factoring in reporting costs, often more expensive) for borrowers to access green capital, is the market having its intended effect: drawing money into financing ethical and sustainable projects that would otherwise not have been financed? Have environmental or social projects been financed that would not have been financed using conventional bonds?
Sfakianos says no: “I don’t think we’re yet at the stage where borrowers are launching green projects just because the market is there.”
Improving investor reach
But that’s not to say that the green bond market is useless from a funding perspective or an environmental one. The origination process has received a huge boost from the green bond market. Institutions are reporting that the green bond market improves their reach to find and finance green loans.
“While green bonds don’t price differently, we find some clients are prepared to take green loans that would not take conventional loans, so the green bond framework is helpful on the origination side,” says Hellerup. “So although one could claim we would need to finance these projects anyway, it is having a positive effect on green financing.”
Sfakianos believes that the green bond market is proving effective simply by bringing environmental concerns to the centre of borrowers’ attentions. “What I hear from borrowers is that it gets people internally discussing sustainability and that sustainability teams are more centralised. Many borrowers are in the early stages of amalgamating their assets into something appropriate for a green bond issue.”
For the market to be a success, borrowers need to have a distinct and lasting commitment to environmental concerns. Indeed, according to van den Tol, “green investors are increasingly discriminating. They are far keener to buy the green bonds of a regular issuer who is prepared to commit to a high standard of detailed reporting of their projects and are more critical of one-off green bond issuers.” This is a policy which banks are keen to encourage — van den Tol says ING over-allocates green bonds in favour of dark green investors.