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Green Bond ETFs

Why are Investors so Excited?

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by Carl-Christian Höeg, Head of Nordic, Lyxor ETF

In January 2019, Lyxor launched its green bond ETF in Stockholm – the world’s first Green Bond ETF was the first on the NASDAQ OMX Nordic exchange. Carl-Christian Höeg, Head of Nordic for Lyxor ETF, explains why investors are excited about green bonds.

- Promotion -

Tackling climate change is expensive, and green bonds are raising the finance necessary to bring the fight home. They are also rapidly being snapped up by investors, who are cottoning on to the fact that the environmental benefits do not come at a premium. Environmental concerns aside, green bonds can be an attractive investment in their own right.

Lyxor’s Green Bond ETF (code LYXGREEN SS)

From niche to normalised

Because green bonds are a reasonably new investment, they suffer from a lingering perception that they are a niche investment. But in reality, they are now hitting the mainstream. In 2018, new issuance of green bonds hit $168 billion, skyrocketing from $87 billion in 2016.1 This rapid market growth can be traced back to the Paris Agreement in 2015. That’s when 195 leaders agreed to “stabilize greenhouse gas concentrations in the atmosphere at a level that will prevent dangerous human interference with the climate system” (UNFCCC, 2017).

The Paris Agreement is based on nationally defined contributions: each country quantifies and states greenhouse gas reduction targets. The goal is to limit global warming to 2 degrees Celsius above pre-industrial levels. But change on this scale costs money. According to the OECD, $6.3 trillion is needed annually until 2030 to meet global climate goals. That puts finance at the heart of the drive for change.

Figures from the Climate Bonds Initiative put the market for green bonds at $389 billion in September 2018. This could be as high as $1 trillion per year in the early 2020s if the green financing goals set by international agreements are to be met. Green bonds are truly a growth market.

Find out more about the Green Bond market

How ‘green’ is your bond?

Thanks to the rise in ‘greenwashing’, investors are increasingly switched on when it comes to ascertaining how ‘green’ any given product is. Because issuers self-label their green bonds, there is a risk of ‘greenwashing’ whereby bonds do not actually live up to the rigorous standards expected of such products. Because of this, investors are paying much closer attention to how ‘green’ a bond really is.

Green bonds are easier than most to quantify, because of the ‘use-of-proceeds’ principle. A company cannot simply slap a ‘green’ label onto a new issue. First and foremost, the issuer needs to earmark the proceeds raised for eligible environmental projects. The issuer also needs to meet other criteria, and to comply with the Green Bonds Principles. This is a framework put in place by the International Capital Markets Association (ICMA). And although the Principles are voluntary, an issuer needs to adhere to them to have a realistic chance of ‘green’ accreditation.

As well as ensuring the funds raised are allocated solely to eligible green projects, the issuer must also carefully track the proceeds of the issuance. Later on, the issuer reports back to the subscribers on metrics of impact measurement – in other words, how the proceeds were used and how the green projects benefited.
As we mentioned, the Green Bond Principles reflect the criteria that should be met if an issuer is to be considered ‘green’. But meeting them does not guarantee accreditation. First, a second opinion is often sought, from agencies such as Vigeo Eiris, among others. Then certification and accreditation are often the remit of the Climate Bonds Initiative (CBI). This gives the investor the reassurance that their prospective investment truly is ‘green’.

For investors, it is important not to confuse green bonds with generic, climate-change bonds. The latter derive most of their revenues from climate-aligned activities, but they do not adhere to the use-of-proceeds principle just described.

More on how the CBI reviews bonds

The elusive ‘greenium’

Investments that promote environmental sustainability often attract criticism from those who believe that ethical concerns come at the cost of financial performance. Or, to put it more plainly, that ‘you get what you pay for’. Surely the environmental benefits ramp up the price, making green bonds more expensive than their ‘vanilla’ counterparts?

But in reality, it is still hard to quantify, let along prove the existence of any ‘greenium’. In the primary market, green bonds are, on average, sold at tighter spreads than were indicated in the book-building guidance, but not so much more than comparable vanilla issues. According to the Climate Bond Initiative market study January-June 2018, bonds denominated in Euro tend to be around 8 basis points (bps) tighter then suggested by the Initial Price Talk (IPT), whereas regular issues are 7 bps tighter than IPT. US dollar issues are around 17 bps tighter than IPT, only slightly higher than the 14 bps observed with regular issues. While green bond issues tend to be eagerly sought after, and are sometimes three times oversubscribed, there is still no evidence that this strong demand has pushed primary market green bond prices significantly above vanilla issues.

Spreads of green bonds generally tighten in the immediate secondary market, which could further indicate that primary market prices are not entirely reflecting the strong demand for green bond issues. Therefore, primary market investors are not giving up any meaningful ‘greenium’ or excess yield to companies for issuing green. According to the CBI, “spreads tightened materially [for many green bonds] in the first seven and twenty-eight days after the announcement date, both on an absolute basis, and when measured against a corresponding index.” The CBI suggests that, seven days after the issue announcement, 70% of green bond spreads have tightened more than spreads in their corresponding bond market segment.(2)

You can do well by doing good

Taken together, the evidence above suggests that it does not really matter if your primary concern is environmental sustainability or financial returns. Green bonds stand up to scrutiny in both respects, and are a worthwhile option for those looking for an attractive addition to their portfolio.

Full information including factsheets for the Lyxor Green Bond ETF

This article is part of the Handbook NordSIP Inights – Sustainable Indices and ETFs, which you can download here:

(1)Source: Climate Bonds Initiative, reports January and September 2018.
(2)Source: Climate Bonds Initiative, Green bond pricing in the primary market, reports 2017 and 2018

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