EU's gold standard in green will command biggest debt premiums
Even in the world of green bonds that often command a premium over conventional debt, Europe’s securities are expected to be in a league of their own.
Debt issued under the European Union’s self-proclaimed “gold standard” rulebook unveiled this week is likely to command greater prices than others following different sustainable frameworks, according to NatWest Markets Plc and Nordea Asset Management.
The bloc’s rules require mandatory impact reporting and external reviews, extra efforts that will mean cheaper borrowing costs as investors pay up for ethical quality.
A rush of funds into environmental assets has led many ethical bonds to trade at a premium to normal debt, or a so-called greenium. That’s spurred a frenzy by borrowers, leading policy makers to create a plethora of rulebooks to try to regulate a market now worth over $3 trillion.
“New innovations in the market tend to enjoy a bigger greenium in the beginning, because there’s little supply and much demand,” said Sascha Stallberg, portfolio manager of a global green bond fund at Nordea Asset, which oversees €266 billion ($316 billion).
The EU’s rules will take effect next year and also require spending for environmentally-friendly projects to be in line with its extensive “taxonomy” for what counts as sustainable investment. Issuers can choose to call their bonds a European green bond, but if they do so they must meet the eligibility criteria laid out by the EU.
The upside to that “tough but fair” approach is that “guidance is provided and a strong, transparent European green bond market is created,” said Mallory Rutigliano, an analyst at BloombergNEF. “The downside to this is creating two separate labelled green bond markets in the region, one with a stronger label and one with a weaker.”
The existing greenium can be shown by Germany, which has two bonds maturing in 2030 that are identical except one has a green label, making it an ideal case study. Since its September sale, the yield on the green security has dropped further below that of its conventional twin to create a “greenium” of around six basis points.
This conceptual split between green and non-green is likely to remain a bigger driver of the greenium than different rulebooks, according to Dominic Kini, a green bond strategist at HSBC Holdings Plc.
In the sustainable bond market, borrowers have until now been issuing debt under various voluntary market rules, such as by the International Capital Market Association, where reporting requirements and reviews are only recommended. For its debut green bonds this year, the EU is also likely to rely on these, but ultimately should follow its own rules and become the biggest issuer of green debt globally.
Rhys Petheram, head of environmental solutions at Jupiter Asset Management, said that while he will still invest in non EU-aligned green bonds, the stringent nature of the EU’s standards aligns with Jupiter’s internal frameworks. “When it comes to scoring a green bond, these bonds will achieve a higher score than a bond that does not use the process,” assuming other things being equal, he said.
There will be pockets of the European market where it may not be worthwhile economically to go through the additional steps, even if they help achieve better pricing, according to Arthur Krebbers, head of sustainability, corporates at NatWest Markets. For those who do, the EU green label could potentially give greater security to investors in future, if non-compliance enables an option to exit or get a step up in coupon.
“Green bonds are moving from gentleman’s agreement to a more contractual undertaking,” he said. “There is now a meaningful label that can be embedded into the legal protection offered to green bond investors.”
Germany will lead sovereign issuance with auctions for €4 billion of 10-year debt and €5 billion of two-year notes. Portugal CPI data on Monday will kick off a week focused on inflation data, which will culminate with final June figures for the euro area. The UK will also publish inflation data for June. Central bank speakers include ECB's Guindos and Schnabel, and BOEs Ramsden and Saunders^
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