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How issuers can maintain the ‘greenium’ associated with green bonds

Green-labeled bonds’ pricing advantage will be harder to maintain as the U.S. debt markets become more ESG-oriented and as supply grows.

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Which green bond issuers will get to ride the green premium, or "greenium," wave for longer will come down to the robustness of an issuer’s "whole of business" approach to decarbonization.

This is because the pricing benefit that green bonds are enjoying is largely linked to a supply and demand imbalance, said Anne van Riel, co-head sustainable finance capital markets at BNP Paribas.

"Our bond was nine times oversubscribed," observed Katie McGinty, vice president and chief sustainability, government and regulatory affairs officer at Johnson Controls, describing interest in the company’s 10-year $625 billion use-of-proceeds green bond issued last fall. 

McGinty's and van Riel's comments, as well as those of the other subject matter experts in this article, came during sessions at last week’s inaugural GreenFin event, hosted by GreenBiz.

Broad agreement that climate change is a long-term risk that needs to be managed because it is rife with potential financial consequences has been one of the primary forces driving investors’ appetite for ESG-linked investments, including green bonds.

The bar needs to be raised on what constitutes ‘green’. Issuers, investors and regulators really have to have confidence that an investment in a green financial product is genuinely going to move the needle on decarbonization.

"What we are seeing is that 80 percent of the investors that we talk to — and we talk to a lot of investors everyday at S&P Global — are saying that they are taking ESG into account in their decision making," said Susan Gray, global head of sustainable finance business and innovation at S&P Global.

The ESG fixed-income assets market has been broadening out to social, sustainable and sustainability-linked bonds, but use-of-proceeds green bonds still represent the ESG bond market’s largest segment. The expectation that the market could grow to $700 billion in issuance next year is the reason why it is so important for companies to articulate their commitment to sustainability and decarbonization to the financial market, Gray said.

A price to pay

Green-labeled bonds’ pricing advantage will be harder to maintain as the U.S. debt markets become more ESG-oriented and as the supply of green bond issuers and green bond issuance grows, van Riel said.

Still even as the greenium fades, non-green — or gray — bond issuers likely will face a pricing penalty, she added.

In terms of green bond formats, use-of-proceeds green bonds finance new and/or existing projects or activities that have positive sustainability impacts. Sustainability-linked bonds, for which operating principles were published in June, can be used for general corporate purposes.

Unlike use-of-proceeds green bonds, sustainability-linked bonds also include a coupon step-up — effectively increasing the cost of financing — if the key performance indicator or specific target that the bond is committed to achieving is not met. "It’s not for the faint of heart," van Riel said.

Use-of-proceeds green bond issuers, on the other hand, face no immediate penalties for failing to meet the contractual terms of their bonds.

But if an issuer does not meet the contractual terms of its use-of-proceeds green bond, that issuer would face consequences the next time it came to market because "no one would trust" its voice, McGinty said. In addition to reputational damage, the company potentially could be exposed to legal claims, she added

It is not just an issuer’s reduced future financing costs that would be derailed. When it came to Johnson Control’s bond, 55 percent of its fixed-income investors were green investors and a significant number of them were new investors to the company. That means that an issuer can lose an entire audience by failing to meet its bond’s commitments.

Regulatory guardrails and the credibility factor

According to van Riel, BNP Paribas tells corporations interested in issuing green bonds that entering the market requires total organizational buy-in. Essentially, the message that the sustainability team wants to get out and the results that the finance team want to achieve need to be aligned, she explained.

The bank also recommends that a prospective issuer uses a third-party assurance company, such as Sustainalytics, Vigeo Eiris or ISS ESG, to evaluate its own internal green finance framework and the goals that it wants to accomplish. This is important because matching an issuers’ internal framework with International Capital Market Association (ICMA) standards means that a company can issue a bond that meets investor requirements while achieving the company’s own internal ESG goals.

To date, the U.S. ESG market has been shaped by investors, issuers and ICMA’s voluntary guidelines. However, because issuers are already out there with robust commitments that they want to be able to finance and objectives that they want to achieve, there is a growing willingness and openness to regulation around ESG disclosures in the U.S., McGinty said.

"The bar needs to be raised on what constitutes ‘green’. Issuers, investors and regulators really have to have confidence that an investment in a green financial product is genuinely going to move the needle on decarbonization," she said. “We’d like to see some standardization."

The U.S. Securities and Exchange Commission in March opened up a discussion about facilitating the disclosure of consistent, comparable and reliable information on climate change.

Trying is learning

For prospective ESG bond issuers, simply getting started requires wading through the various GHG emission scopes and the alphabet soup of standard-setting institutions’ ESG frameworks. It’s a formidable learning curve but a worthwhile one, McGinty said.  

"When we went jointly on a roadshow [with the finance team], we were able to hear firsthand, as a sustainability team, what 150-plus investors had on their minds and what they needed to see," she said.

"[Our] financing team and [our] sustainability team totally wound up with a shared view in that mutual learning," McGinty said. Both teams came away with an aligned perspective about how the greening of the capital market is key to addressing the climate challenge, she said.

For an issuer, incorporating a comprehensive "whole of business" ESG approach that ties strategic corporate goals with investors’ needs and goals also can help a company attract and retain talent, added Olivier Leonetti, executive vice president and chief financial officer at Johnson Controls. Employees are proud to be part of an organization that is actively pursuing strategies that reduce carbon emissions and fight climate change, he said.

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