EU cheer only partly masks green bond shortcomings

Europe’s debut issuance should be merely an hors d’oeuvre

  
European Union flags flutter outside the European Commission headquarters, where Brexit talks are taking place, in Brussels, Belgium, December 13, 2020.

European Union flags flutter outside the European Commission headquarters, where Brexit talks are taking place, in Brussels, Belgium, December 13, 2020.

REUTERS/Yves Herman

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

LONDON - Brussels is the nascent green bond market’s new big hitter. The European Union’s debut issuance of debt earmarked for environmental aims has been a huge success, garnering orders of 135 billion euros, over 10 times the amount of debt on offer. But such securities only incentivise planet-saving behaviour if issuers other than big public entities can borrow more cheaply.

Europe’s debut issuance should be merely an hors d’oeuvre. European Commission boss Ursula von der Leyen wants to fund around 30% of its Covid-19 NextGenerationEU recovery scheme through the securities. That implies up to 250 billion euros of total issuance, and some 35 billion euros to 45 billion euros a year, Bank of America analysts reckon. That’s equal to the total amount of green debt issued by euro area governments so far this year.

It’s also a good example of how green bonds are supposed to work. They allow sustainable investors to know their money is being well spent, while issuers get to promote their own green activities. Yet to go beyond being merely good marketing, companies need to be rewarded with lower funding costs.

In the government bond market, this lower cost, dubbed a greenium, is increasingly apparent. In September, the UK was able to borrow about 3 basis points more cheaply through its debut green bond than its ordinary debt. The EU’s bond also looks set to benefit from favourable funding costs, according to IFR. Assume a 3 basis point greenium on all 250 billion euros of the EU's green issuance, and the bloc could save 75 million euros in annual interest costs, according to Breakingviews calculations.

Yet greeniums are also a puzzle. There is little reason for investors to accept a lower return, as green bonds have exactly the same credit risk profile as ordinary debt sold by the same issuer. The spread difference may exist more because of temporary excess of demand for green debt, which might not last.

Meanwhile, the greenium for bonds issued by companies is shrinking. A flood of issuance means that the difference in yield spreads offered by environmental debt and ordinary securities has shrunk to just 1 basis point, down from a peak of 9 basis points in 2020, according to AFME data. If virtue is not rewarded, green bonds will start to look more like cumbersome advertising.

CONTEXT NEWS

- Investors placed over 135 billion euros of orders for the European Union’s debut green bond, over 10 times the 12 billion euros of bonds on offer.

- The EU’s debut green bonds have a 15-year maturity and are due to be priced to pay a spread of 8 basis points below swap rates, equal to a yield of about 0.44%, Reuters reported on Oct. 12.

- The EU’s bonds were issued under its NextGenerationEU Covid-19 recovery fund, which is targeting 800 billion euros of issuance, of which 30% could be in green bond format. That implies perhaps 35 billion euros to 45 billion euros of EU green debt each year, according to Bank of America analysts.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

(Editing by George Hay and Karen Kwok) ((For previous columns by the author, Reuters customers can click on UNMACK/ SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS http://bit.ly/BVsubscribe | neil.unmack@thomsonreuters.com; Reuters Messaging: neil.unmack.thomsonreuters.com@reuters.net))


More From Global