Denmark is Considering a Novel Approach to Sovereign Green Bonds


NordSIP (Stockholm) – On May 27th, the central bank of Denmark announced that together with the Ministry of Finance it is considering the issuance of a Danish green sovereign bond. Due to liquidity concerns, policymakers are considering a new model of sovereign green bonds that separates financial commitments from green commitments.

Liquidity Concerns

Danmarks Nationalbanken expressed a particular concern for liquidity conditions in any upcoming sovereign green bonds. Referring to the liquidity premium, the central bank noted that “a liquid government bond market is essential, as a high degree of tradability means that investors are willing to pay a higher price for the bonds, implying reduced funding costs for the Kingdom of Denmark.”

- Promotion -

However, for small issuers such as Denmark, which has the fifth-lowest government debt-to-GDP in the EU, this can be a problem. Reviewing the existing approaches, the central bank notes that in all instances, the issuance of green bond drains liquidity from pre-established bond series already trading in the market. Given the small size of Denmark’s public debt, this is a particularly relevant issue for this sovereign. “We are working on a model for sovereign green bonds that will enable small sovereign issuers like Denmark, with limited funding needs, to access the green bond market without compromising liquidity.”

A Novel Approach

The new model separates the financial commitment to provide coupon payments and the principal at the time of redemption from the commitment that the expenditures will go to green projects. As a result, the “green” bonds issued by the Danish sovereign would in effect be regular vanilla bonds complemented by a separate “green certificates”. According to the Danish central bank, “owning both the conventional government bond and the green certificate is equivalent to owning a sovereign green bond.”

Source: Danmarks Natinoalbanken

While the two parts of the Danish green bond would be available for purchase in primary markets concomitantly, the main innovation is that the “green certificates” can be traded separately. Technically speaking, “the green certificate is a zero-coupon bond with zero redemption at maturity,” according to the central bank. “The certificates will have their own ISIN codes and can be traded separately in the secondary market.”

The Path Ahead

In a related announcement, Danmarks Natinoalbanken also disclosed it has appointed BNP Paribas, Danske Bank and Nordea as advisors to investigate the potential green issuance in the format of green certificates. The mandate to the three advisors also requests that they investigate the potential for establishing a Danish Green Bond Framework, in preparation for a final political decision on green issuance.

Image Courtesy of Danmarks Nationalbanken

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The coronavirus epidemic has further accelerated the rise of ESG into the investment mainstream. As deficits skyrocket, bond investors have an opportunity to engage with governments on climate change, argues Thomas Dillon, Senior Macro ESG Analyst at Aviva Investors.

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