Not all green bonds are the same. Here's how to tell.
To check whether yours is more than just marketing, examine the coupon.
(Mark Hulbert, an author and longtime investment columnist, is the founder of the Hulbert Financial Digest; his Hulbert Ratings audits investment newsletter returns.)
CHAPEL HILL, N.C. (Callaway Climate Insights) — Here’s how to know whether the green bond that a company is issuing will actually have an impact on its behavior:
Check to see if it’s being issued with a lower coupon than the company’s non-green debt of similar maturities. (That means it would be trading at a higher price, of course, since bond prices go up when interest rates decline.) If it is, then the green bond has the potential to impact the company’s environmental friendliness.
Otherwise it’s being issued largely for marketing purposes.
Those are the implications of recent research by Martin Oehmke, a finance professor at the London School of Economics, and Marcus Opp, a professor of banking and finance at the Stockholm School of Economics. Their research couldn’t be more timely, as the market for green bonds is mushrooming. Refinitiv reports that “green bond issuance accelerated during the third quarter, reaching an all-time record of $76.5 billion from 171 issues.” UBS Global Wealth Management is projecting that the “size of the green bond market will likely hit $1 trillion during the first half of 2021.”
Secondary market yields tell us nothing
Notice that the professors are urging us to focus our attention on green bonds’ coupons at issuance. Most other analysts focus instead on secondary market yields, finding generally that green bonds’ yields are similar to those of comparable non-green bonds.
That means nothing, the professors argue. Of course green bonds have similar yields in the secondary market as non-green bonds from the same issuer with similar maturities, since in most cases they both represent the same legal obligation of the issuing company and therefore carry the same default risk.
It’s at issuance that the green bond can have a different yield, and that is the key to whether it has the potential to make a difference. Provided the green bond’s yield is lower than what the issuing company would have to pay on a comparable non-green bond, it will enable the company to pursue green projects that otherwise would have been passed over because of their lower return.
That’s why the professors argue that, if the green bond doesn’t have a lower coupon at issuance (a higher price, in other words), it will have no impact on the issuing company’s behavior. In that case, the company would have been able to secure just as favorable financing without using the green bond structure. To put that another way, this means the green projects the company was envisioning would have been pursued anyway.
There’s nothing wrong with that, of course. Our longer-term hope is that green technologies will become so compelling from a purely financial perspective that companies pursue them without any special nudging from climate-focused investors.
But we’re not there yet. And until then investors interested in actually changing corporate behavior should seek out a company’s green bonds with a lower yield at issuance.
This puts in a wholly different light the mental gymnastics that ESG’s champions undergo to show that investors need not forfeit any return in order to invest in green bonds. From the professors’ perspective, a green bond with no lower yield at issuance is a green bond that has no impact.
That’s just another way of saying that green bonds with no lower yield at issuance are more a marketing tool than anything else. In essence, they enable both corporate managers and investors to feel good while continuing to do what they were doing before.
The case of German green bonds
It’s worthwhile going off on a slight tangent at this point to discuss the green bonds that the German government recently started issuing. The government has inaugurated a novel structure in which each green bond will be paired up with a non-green German government bond with the same maturity. This potentially sets up a real-world experiment that can show the extent to which greenness leads to the lowering of a bond’s yield.
The first German green bond with this structure was issued in early September at a coupon rate just one basis point less than the yield on its twin non-green German government bond — essentially no difference, in other words.
It’s difficult to draw any meaningful conclusions from this, however, since the German government is not using its green bonds to finance new climate-friendly projects. Instead, to quote the German Finance Office’s press release, “Green German Federal Securities will have eco- and climate-friendly federal spending from the preceding budget year assigned to them.”
As Professor Opp put it to me in an email: The German government’s green bond program “doesn’t seem to finance green activities that otherwise would not be financed. It seems to be mostly a marketing tool.”
Impact of buying green bonds in the secondary market
Putting the professors’ research into practice will be difficult for most of us individually. That’s because we typically invest in bond funds rather than individual bonds, and so we’re not directly offering favorable financing to companies that pursue green projects. The biggest effect of investing in green bond funds will be to add liquidity to the secondary market.
That’s not a worthless endeavor, I hasten to add. Greater liquidity in the secondary market for green bonds can have indirect effects on corporate behavior, encouraging management to at least entertain the possibility that financing is available at favorable terms to pursue green projects that they might not otherwise consider.
But we could have far more impact if we pooled our money in a fund that focused on buying green bonds with lower yields at issuance than the issuing companies’ non-green bonds. Rather than bragging about its return, this fund’s marketing would highlight its lower return — bragging, in other words, about the opportunities it afforded companies to actually pursue climate-friendly projects that they wouldn’t have otherwise considered.
Such a fund undoubtedly would be a hard sell to investors who focus only on return, as well as to fair-weather climate-friendly investors who have been taught to believe they don’t need to forfeit any investment performance in order to change the world.
But I for one would be interested in such a fund. Any other takers?