It better be good, it better be green

Greenium and the pricing of green bonds

Given the growing awareness about climate change and the role of financial markets in supporting the transition to a low-carbon economy, it is not surprising that the pricing of green assets has received significant attention. In particular, one of the most recurrent goals of the literature is to verify whether green bonds are placed (and traded) at a lower return than traditional bonds. The existence of this spread, also known as greenium, would suggest an advantage for the funding of green projects. It is worth mentioning that the use-of-proceeds approach allows any company to issue green bonds, regardless of their main business activity.

The role of issuer frameworks in green bond pricing

While the bulk of the literature has focused on the yield spread between bonds with the green label and traditional bonds, we argue that investors do not price all green bonds in the same way. We show that, in addition to the green label, there are other characteristics about the issuer’s sustainability framework that matter. When the latter are taken into account, premia attached to green bonds turn out to be very different, not only across bonds but also across issuers.

ESG scores and certifications: key information for investors

There are (at least) two sources of additional information regarding a company’s environmental performance that must be considered when comparing bond returns: the ESG score and the readiness of a second-party certification. The ESG score evaluates not only the environmental performance of a company (E-score) but also the social performance (S-score) and the soundness of the governance framework (G-score). The second-party certifications introduce an additional guarantee that green bonds to be placed are consistent with an international sustainability taxonomy. The two most used taxonomies are the Green Bond Principles and the Climate Bond Standard. Since both issues are part of the information set of the investors, they will likely have a bearing on the price of the bond.

Quantifying greenium and the role of disclosures

In the paper “It better be good, it better be green” we show that indeed investors price both additional sources of information. After matching a large sample of traditional and green bonds placed over the period 2014–2023, we end up with a working sample of around 15,000 bonds, 2,600 of which are green bonds. By employing a traditional regression approach, we first show that the green label of a bond is worth around 16 basis points. At the same time, having an E-score available at the time of the bond placement is worth 20 basis points, regardless of the “colour” of the bond. This shows that the green label is not the only disclosure about the green involvement of the company that is valued by investors.

Interaction between green labels and ESG scores

As a natural successive step, we take into consideration the interaction of the two sources of disclosure. Regression results suggest that green bonds that are issued by companies with an E-score are awarded an additional premium of 11 basis points, making the overall greenium reach 27 basis points. From an economic point of view, given that the unconditional mean of the cross-sections of yields at issuance stands at 2.44%, the greenium amounts to a non-trivial 11% discount on the company financing costs.

Non-linear effects of ESG scores on bond pricing

A further investigation concerns the possibility of a non-linear effect of the environmental performance of the issuing company on the bond yield. Disclosing a high score might be more favourably received by investors than disclosing a low score, affecting both ordinary and green bonds. In addition, there might be a threshold below which the additional discount is not applied by market participants, or it even turns negative.

Thresholds and the significance of high E-scores

We show that when the E-score is in the top tercile, the interaction of the green bond and the disclosure is rewarded by investors by an additional 17 basis points with respect to green bonds issued by non-disclosing companies. Thus, the overall greenium on bonds in the top tercile of the distribution amounts to 33 basis points. No additional premium at issuance is attributed to the green bonds issued by companies in the other two terciles, indicating that disclosing a poor or an average environmental performance is neither rewarded nor penalized by investors. In summary, only a very good environmental performance matters for the greenium.

The impact of certification on greenium

We then focus on the subset of green bonds having a second-party opinion certifying the consistency with the Green Bond Principles or the Climate Bond Standard. We observe an increase in the greenium to 25 basis points for non-disclosing companies and a slight reduction in the spread from the top tercile of disclosing companies, which however maintain an overall premium of 30 basis points. This suggests that certification enhances trust in the authenticity of the green credentials of the bond, especially for non-disclosing companies.

Climate stress and fluctuations in greenium

Looking at external factors that might have a bearing on the green bonds’ pricing mechanism, we consider a theoretical framework to model the impact of changes in sustainability preferences on asset prices. For bonds, in particular, greenium tends to spike around the occurrence of catastrophic climate-related events, as seen during extreme weather events in recent years. Such events may influence investor behaviour, increasing the perceived value of investments in sustainable projects and, consequently, the pricing of green bonds.

Testing the impact of climate stress on greenium

To test the saliency of the two-tiered mechanism at work on green bonds, we construct dummy variables tracking the periods of climate stress based on indexes measuring climate policy uncertainty and media-driven climate concerns. We find that, when the value of the index is above the median, the greenium is larger. Specifically, the market discount granted to green issuance made by companies in the top tercile of the cross-sectional disclosure distribution is the largest across all regressions (30 basis points) and leads the overall greenium to reach 44 basis points. Additionally, in periods of climate stress, the discount in yield at issuance extends to firms in the middle tercile of the E-score. This indicates that investors not only finance green projects at a higher cost but also reward companies with moderate environmental performance, suggesting a “dash for green” during challenging environmental times.

Policy implications of a two-tiered greenium

The existence of a two-tiered greenium as a function of the environmental performance of issuers has significant policy implications. ESG rating agencies play a crucial role in signalling and assessing corporate environmental performance, as market participants invest according to these scores. This dynamic awards further discounts to green projects from highly rated firms, making access to finance easier for green companies while creating challenges for brown firms. Such a strategy contributes to mitigating transition risks and supporting an orderly climate transition.

Facilitating decarbonization for high emitters through green bonds

However, completely orienting portfolio composition away from high emitters and toward low emitters may not lead to an effective transition. A fully-fledged decarbonization strategy must support high-emission firms in their shift toward less polluting technologies. Our findings suggest that, by financing climate-friendly projects via green bonds, this is still possible. Companies with poor or average environmental performance (i.e., with an E-score in the lower and middle terciles) can still secure a positive greenium. Placing green bonds by high emitters with genuine and ambitious carbon footprint reduction efforts allows these companies to access a portion of the overall greenium, specifically, the part directly associated with the green label.

Full paper

Read the full paper: It Better be Good, it Better be Green

Full paper reference: Fornari, Fabio and Pianeselli, Daniele and Zaghini, Andrea. It Better be Good, it Better be Green (September 25, 2024). FDIC Center for Financial Research Paper No.723.

Authors

• Fabio Fornari, European Central Bank
• Daniele Pianeselli, Bank of Italy
• Andrea Zaghini, Visiting Fellow at the Centre for Business, Climate Change and Sustainability and researcher at the Bank of Italy