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A wave of green government bonds is flooding markets

The benefit may be more political than economic A WAVE OF green sovereign debt is flooding markets. Britain issued its first such bond in September, alongside other new issuers, such as Colombia and Spain. They join at least 20 countries that already issue green debt, notably Germany, which is well on its way to building a “green curve” of bonds across several maturities. Governments have together raised more than $100bn through the green route so far this year. And later this month the European Union is due to join the club. Its €250bn ($290bn) green-borrowing programme stands to make it the world’s largest sovereign issuer of the instruments. The main difference between a green bond and the regular sort is that the capital raised by it must be spent on certain environment-friendly projects. So why not raise debt the old-fashioned way instead, and simply direct the proceeds towards greenery? One advantage could be the opportunity to borrow at a lower cost. Investors may be willing to accept a lower yield for green bonds (that is, to pay a higher price for them), because they can either count their holdings towards their environmental, social and governance targets, or because it makes them look good in the public eye, says Dion Bongaerts of Erasmus University in Rotterdam. Indeed, investors do demand a higher yield on conventional debts than they do on green ones with near-identical characteristics. The yield difference (called the “greenium”) may seem modest: for a ten-year bond in Germany it is about 0.05 percentage points. But that starts to look more significant when you consider that the yield on a conventional German ten-year bond is -0.18%. The yield gap has risen from 0.02 points a year ago, suggesting that the demand for green debts exceeds their supply. Britain’s bond, issued last month, had a yield gap of 0.025 percentage points, more than had been expected for an opening green issuance. The sale was oversubscribed by ten times—larger than any issuance by the Debt Management Office. Still, the cost savings are unlikely to be meaningful for governments, says Antoine Bouvet of ING, a Dutch bank. For €1bn of debt, an interest rate that is 0.05 percentage points lower would mean savings of about €500,000 a year, a drop in the bucket for a government. That suggests that green bonds carry another benefit: they serve as a commitment device for politicians. The proceeds of Britain’s issuance, for instance, will be spent on a range of green policies, including a plan to develop low-carbon hydrogen technologies by 2030. The risk with such commitments is that they end up being either watered down or reversed when a new government comes into power. But when a finance ministry creates a green-bond programme and builds out a “green curve”, backing out of specific policies may become harder, says Mr Bouvet. Doing so would hurt liquidity and anger investors. Issuing newfangled bonds could carry other liquidity problems, though. One is that investors may be unwilling to plough cash into a still-nascent market. But as green bonds become more popular, the risk for governments is that they split the overall sovereign-bond market in two, says Mr Bongaerts. Normally, all bonds issued at the same time and of a given maturity are identical, which makes them easier to trade. But a more verdant green segment could have the effect of lowering the liquidity premium that investors place on conventional bonds, and increasing the cost of raising funds. Germany has tried to guard against this. Last year it began issuing green bonds that are matched to a conventional “twin” with the same maturity date and coupon. The Bundesbank maintains liquidity in the market through “switch trades”, allowing investors to swap green bonds for conventional ones. As more governments go green, other workarounds may follow. ■

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