Source: Bloomberg Fixed Income Indices. Data as of 29th December 2023 for historical constituents of the Bloomberg Euro-Aggregate Corporates index. JP Morgan Asset Management application of the Nelson and Siegel yield curve function. Histogram of the calculated issuer-level greenium as at two historical dates.
The European corporate GSS bond market has grown rapidly over the last five years, thus attracting much attention as a potential vehicle to help finance the transition to a sustainable economy. The benefits of ‘use-of-proceeds’ bonds are clear: full transparency is available on the use of capital, with various international frameworks in place to guide reporting and disclosure by GSS issuers.10
Whilst a premium may have existed in the past for entering such investments – thereby discouraging some environmentally and socially conscious investors – this no longer seems to be the case, at least in the secondary European investment grade corporate bond market. As demonstrated in this study, the observed greenium seems to have diminished quite significantly since its peak in November 2022. Moreover, whatever greenium does currently exist in this market is no longer statistically significant. The good news for investors is that they don’t necessarily need to give up returns to make GSS investments, whilst at the same time being conducive to obtaining sustainable outcomes via targeted environmental and social projects.
1 Globally, the cumulative amount of GSS bonds issued reached USD 3.8 trillion at the end of 2022, with green and emerging market bond issuance representing 64% and 16% of the total amount, respectively – see ‘Green, social and sustainability (GSS) bonds.’ World Bank Market Update, January 2023.
2 Green bonds are bonds with proceeds earmarked for projects aimed at generating positive environmental impact, in particular across activities in renewable energy, green buildings, sustainable water or clean transport. Social bonds, on the other hand, are bonds whose proceeds are used to fund activities that achieve positive social outcomes or address a particular social issue, such as investment that targets poverty or provides access to essential services, affordable housing or healthcare. Sustainability bonds are bonds with proceeds earmarked for activities aimed at generating positive environmental and social impact, as described above.
3 On the face of it, there is no rational reason for the GSS label to influence the yield of a GSS bond. GSS bonds rank pari-passu with the conventional bonds of the same rank and issuer. The GSS bond holder does not own any additional rights on the underlying projects and is subject to the same market dynamics. So, in one sense, the existence of a greenium can be seen as somewhat of a market anomaly.
4 While the cost of funding for companies is defined by bids in the primary markets, secondary markets nevertheless have a pronounced effect on primary markets via the price and liquidity of bonds – see Bond, P., A. Edmans, and I. Goldstein (2012), ‘The real effects of financial markets.’ Annual Review of Financial Economics 4, 339-360.
5 To put these European figures into context, USD GSS investment grade corporate bond new issuance during 2023 was much lower at USD 33.9 billion, representing only 2.7% of new issuance in the US investment grade corporate bond market during the year.
6 Empirically, in order to get well-behaved issuer spread curves, we only apply the curve fitting process to bonds that have the following characteristics: (i) senior conventional EUR investment grade corporate bonds in the Bloomberg Barclays Global Aggregate Bond index, (ii) issued in the last five years, and (iii) have a maturity of under ten years. Furthermore, we only utilise issuers with at least four conventional bonds, and that have both conventional and GSS bonds in issuance.
7 The Nelson and Siegel (NS) yield curve factor model is frequently used by researchers for modelling bond yield curves. The model essentially uses three smoothing parameters to describe the shape of the yield curve. The parameters respectively describe the long-term level of interest rates, the slope and the curvature of the yield curve – see Nelson, C.R., and A.F. Siegel (1987), ‘Parsimonious modelling of yield curves.’ Journal of Business 60, 473–89.
8 The standard error of a regression measures the precision of the model’s fit – about 95% of the data points are within a range that extends from +/-2 standard errors of the regression from the fitted line. The observations outside of the +/-2 standard error band are deemed to be statistically significant at the 5% significance level.
9 This means that the greenium is no longer significant at the 5% significance level.
10 For example, refer to the GSS bond principles set out by the International Capital Markets Association (ICMA), which are designed to encourage clear alignment to sustainable projects and a full commitment to regular impact reporting by issuers.