What exactly are green bonds - and how do they differ from their traditional counterparts?
Green bonds are basically normal bonds where the bond issuer borrows capital and pays a fixed interest rate for the term. The main difference to non-green bonds lies in the utilisation of the issue proceeds. They are used exclusively for the full or partial financing of suitable green projects that create a positive environmental benefit.
What kind of projects are typically involved?
The most common topics are energy transition and energy saving, for example wind turbines or solar parks. However, building renovations or energy-efficient new buildings are also frequently financed. Green bonds can also be used for electric car production, an area in which a lot is currently being invested in research and development. Factories in which electric cars are produced, for example, are financed in this way.
Who usually issues green bonds?
Issuers can be companies, governments or banks, for example. Among companies, utilities in particular are very active. These are grid operators on the one hand and energy producers from the solar energy, wind energy and water energy sectors on the other. Banks, which act as intermediaries here, are also strongly represented. As are real estate companies, which usually finance energy-efficient buildings with green bonds.
Green bond share of new bond issues at 1/3
The green bond share of new bond issues is now around 30 per cent. It can hardly be called a niche market anymore...
Today, 11 per cent of corporate bonds are already green, compared to just three per cent in 2019. The figures clearly show that the green bond market has transformed from a niche market to an absolute core financing market in just a few years. Today, if a company is in a position to issue green bonds, then it usually issues green bonds.
Why are so many companies now favouring green bonds over traditional bonds? Do costs play a role here alongside sustainability considerations?
Companies don't save much money with the coupons.[1] The so-called greenium - the premium that an issuer can save if it issues a green bond - is minimal to statistically undetectable and therefore negligible for corporate financing.[2]
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Then what is the reason?
Birkhäuser: Investors now often favour the green variant with the same valuation, usually for regulatory reasons. We have observed that green bonds are comparatively easier to place, particularly in weaker market phases.
Do you have an example of this?
Last summer, at the same time as a traditional bond from an established German energy supplier active in the coal sector, a green bond from a much less well-known Spanish solar park operator came onto the market. However, the less well-known and less large company was able to place its bond more easily, which is probably due to its status as a green bond.
Why is now a good time for investors to look at green corporate bonds?
Overall, we are currently in a good market environment for fixed income investments. Euro corporate bonds with good credit ratings, known as investment-grade bonds,[3] are currently among our favourites in the global universe of government and corporate bonds - including green corporate bonds.
What makes you optimistic about corporate green bonds in particular?
The yield in the overall universe for European corporate green bonds with good credit ratings is currently 3.6 per cent. This is no guarantee for the future, but it is currently an attractive yield that can certainly keep up with dividend yields on equities. We assume that the political tailwind from the EU Green Deal in particular should continue to support the broad market.
Speaking of the EU Green Deal: are green bonds a European topic?
First and foremost, yes. As the regulatory framework is already established, it is likely to remain an issue in Europe in the long term. In contrast, we hardly see any green bonds from US companies. There is currently no regulatory support for green bonds in the USA.
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In addition to investment-grade bonds, are high-yield securities[4]Â also worth a look?
As an addition, yes. However, due to the higher risk, they are not suitable as the basis for a balanced portfolio of green bonds.
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How else do they differ?
High-yield bonds are still considered a niche in the green bond market. In 2023, for example, there were 77 billion euros in new investment-grade issues and only 13 billion in high-yield issues. The mostly smaller issuers in the high-yield segment often still find it difficult to sufficiently delineate green projects and bring their reporting up to standards that are mandatory for the issuance of green bonds.Â
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Are there market phases in which green bonds can offer yield advantages over traditional corporate bonds?
As I said, green bonds are very close to the overall market in terms of yield and, just like traditional bonds, are therefore caught between interest rates, inflation and macroeconomic and regulatory developments. However, a yield differential can arise due to secondary effects.
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What is meant by this?
That the performance depends less on the status of the green bond itself and more on the composition of the sectors. A sector strength of banks, for example, should have a positive effect on green bonds due to the higher proportion of bank bonds compared to the overall market. Even in times of falling interest rates, the green bond market is likely to perform comparatively better, as the proportion of interest sensitive sectors is higher overall and the property sector in particular is more strongly represented.
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When could things get comparatively worse for green bonds?
For example, when the oil price rises massively, as no green bonds are issued in the oil sector.
What is the situation in terms of risk? Are there differences between green and non-green bonds?
Differences can arise due to different maturities, which are somewhat shorter on average for green bonds, but also due to the different sector focus mentioned above. However, when it comes to the repayment of the bond at maturity, the risks are basically identical, as the financing is provided at company level and not at project level. The pari passu principle applies[5], according to which green bonds rank pari passu with non-green bonds.
Broad diversification recommended
Let's move on to the practical side: How do you go about selecting green corporate bonds?
Step one is the fundamental analysis. We want to make sure that the companies in question are in a position to service their debt until the end of the term. After all, corporate green bonds[6] are nothing more than corporate debt. In step two, we then look at the factors specific to green bonds - in other words, whether the company in question fulfils recognised criteria such as those of the International Capital Market Association, or ICMA for short,[7] for green bonds, whether the projects are actually suitable green projects, whether the issuer selects and delineates them properly and whether there is meaningful reporting on the green bonds.
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What advice do you have for investors who want to invest in corporate green bonds? Many bonds have a minimum denomination of 100,000 euros...
As with other asset classes, it is essential to diversify the risk of green bonds. It is important to have enough issuers in the portfolio so that you are not suddenly faced with a major financial problem due to a default within the portfolio or a rating downgrade[8]. A broad-based product such as an actively managed bond fund, which is broadly diversified across various green corporate bonds and which can be started with smaller investment amounts, could therefore be a good option. Â
Learn more about bond funds
Risks
- Price losses when yields rise on the bond market: If interest rates or yields rise on the bond market, newly issued bonds have a higher interest rate than bonds in circulation. As a result, the price of bonds in circulation falls. Selling such bonds before they mature can therefore result in price losses.
- Price losses in the event of an increase in yield premiums on higher-yielding securities: Due to the perceived higher risk of default, bonds such as corporate bonds and government bonds from emerging markets generally have a higher yield than German government bonds, for example, which are considered safe. The higher the (estimated) risk, the higher the interest rate or yield premium. If the risk is assessed as higher by market participants, the interest rate or yield premium on newly issued bonds rises. As a result, price losses may be incurred on outstanding bonds if they are sold before maturity.
- Issuer credit and default risk. This generally refers to the risk of over-indebtedness or insolvency, i.e. a possible temporary or permanent inability to fulfil interest and/or repayment obligations on time.
Opportunities
- Steady interest income
- Price gains when yields fall on the bond market: If interest rates or yields fall on the bond market, newly issued bonds have a lower interest rate than bonds in circulation. As a result, the price of bonds in circulation rises. If such bonds are sold before they mature, price gains can be realised.
- Price gains when yield premiums on higher-yielding securities fall: Due to the perceived higher risk of default, bonds such as corporate bonds and government bonds from emerging markets generally have a higher yield than German government bonds, for example, which are considered safe. The higher the (estimated) risk, the higher the interest rate or yield premium. If the risk is assessed as lower by market participants, the interest rate or yield premium on newly issued bonds falls. As a result, price gains can be realised on outstanding bonds if they are sold before maturity.