Welcome mat out for Europe green bonds

The European Union's potential green bond issuance has caught the attention of investors, not only for the financial and sustainability opportunities it presents but also for its wider impact on the market.

Green finance will make up around 30% of the European Commission's €750 billion ($888 billion) plan to help Europe recover from the coronavirus pandemic. Market participants expect this financing to come in the form of about €225 billion of green bonds — making the European Union the largest issuer in the world of these instruments — with proceeds earmarked for climate or environment-related projects.

Institutional investors and money managers are discussing the potential issuance and will look to invest — depending on pricing and structure.

ATP, Hilleroed, Denmark, has close to 30 billion Danish kroner ($4.8 billion) invested in green bonds within its liability-hedging portfolio. Executives at the 918 billion kroner pension fund are focused on "high-rated supranationals and 'govies' within our green bond portfolio," said Lars Dreier Kristensen, director, portfolio manager. "If the EU green bonds are presumably coming with the same credit quality as current EU bonds, from that metric they would fit into the portfolio. But we also put a layer of ESG metrics on top — we have to measure that before we make a final decision on whether (the EU green bonds are) interesting or not."

A spokeswoman for the 293.3 billion kroner Sampension, Hellerup, Denmark, said the fund has more than 1 billion kroner in green bond investments. "We are likely participants in EU green bond issues," she said.

A number of money managers also said they would consider investing in the EU's issuance.

"I can't say if we will invest in it as it is still under development, but we will definitely have a close look at it and I would expect that, if this develops, then there is a very good chance we would ... invest in it, depending on pricing," said Michiel De Bruin, portfolio manager, global macro fixed income at Robeco Institutional Asset Management BV in Rotterdam, Netherlands. Robeco ran €1.7 billion in green bond assets as of April 30.

Green sovereign bonds outperformed conventional bonds so far this year. Through Sept. 24, the Bloomberg Barclays MSCI Euro Green Bond Treasury and Government-Related index gained 4.6%, vs. 3.64% for the Bloomberg Barclays Euro Aggregate Treasury Total Return Index Value Unhedged Euro index.

The global green bond market currently stands at around €650 billion, sources said. And the potential issuance by the EU will further encourage growth.

"Such green bond issuance by the EU should further help liquidity, diversification and an increase of green bond supply, especially among the sovereign segment, which remains small with just 17% of the total green bond issuance," said Rachida Mourahib, head of fixed-income ESG and green research at HSBC Global Asset Management in Paris. The firm runs "several billion" euros in green bonds.

Ms. Mourahib expects to see more sovereigns coming to market.

"Following the issuance of the first national green sovereign bond in Germany (in September), other states might be tempted to follow the suit. In Canada, both provinces and cities have started to issue green bonds, whilst in France, green bonds have been issued at the city, regional and state levels," she said.

And it's Germany's €6.5 billion issuance that investors are looking at to figure out whether a "green premium" exists, forcing them to pay more for bonds financing green projects than for conventional bunds.

Germany's 10-year green bonds were issued with the same maturity and coupon as conventional bunds, with proceeds earmarked for projects including those that support clean transport systems. "So for the first time we have an instrument that will be able to assess the pricing difference between a green and conventional bond," said Johann Ple, portfolio manager at AXA Investment Managers in Paris. "There is no reason why they would price differently, but we see larger demand for green bonds," he said. AXA ran €7.5 billion in green bonds as of Aug. 31.

Germany's green bond was issued at 1 basis point higher than the conventional equivalent. "A few weeks later it trades at 2 basis points tighter," Mr. Ple said.

And while the EU's issuance will enhance liquidity in the market "and establish an even more solid footing for others to issue into and price off of this reference set of securities … it could also trigger some widening of spreads (as) the market has trouble absorbing so much volume of issuance over a relatively short period of time," said Mitch Reznick, head of sustainable fixed income at the international business of Federated Hermes Inc. The £507.5 billion ($625.4 billion) firm does not run dedicated green bond funds.

Shawn Keegan, a senior vice president and a member of the credit portfolio management team focusing on U.S. and global portfolios at AllianceBernstein LP in New York, said there is a green premium, and "if you think about sovereigns, where they are today 1 or 2 basis points makes a big difference." However, he thinks pricing will improve as the market grows. The firm ran $1.1 billion in green bonds and sustainable bonds across all fixed-income funds as of June 30.

But that seems to be a premium that investors are willing to pay. Issuers of green bonds commit to providing impact reports on the projects the bonds are financing. "You get additional transparencies at almost no cost," he added.

Bram Bos, lead portfolio manager green bonds at NN Investment Partners in Amsterdam, agreed that the "green bond premium" is normally a couple of basis points. But in his view, it is "not significant if you consider you can greenify your portfolio in exchange for that." NN IP runs €2.9 billion in dedicated green bond strategies.

Other investors, however, are a little less forgiving. "For the same issuer and credit quality, we would expect the same return on a green and non-green bond. If we compare apples to apples, then I expect the same return," ATP's Mr. Dreier Kristensen said.

Before pricing can become clear and the EU can start issuing the bonds — which sources said is expected to be by the end of next year — the EU needs to finalize its own green bond framework.

"The European Commission is determined to establish market standards that promote a uniform understanding of 'green,'" said Lukas Herrmann, assistant vice president-fixed income-portfolio manager and buyside analyst at DWS Group in Frankfurt. "The two most prominent examples are the EU Green Bond Standard and an EU classification system that defines environmentally sustainable economic activity" — the EU taxonomy. DWS ran €2.3 billion in green bonds as of March.

However, even though the taxonomy has not yet been finalized, "it is becoming market practice," said Felipe Gordillo, senior ESG analyst at BNP Paribas Asset Management in Paris. Two green bonds issued last month by banks "used the taxonomy as a reference to determine eligibility. That is a key development in the market — we don't need the taxonomy to be fully adopted by the institutions to use it."

Mr. Gordillo thinks use of the taxonomy prior to formal adoption also will put pressure on other European institutions "to adopt the taxonomy so they can issue green debt."

BNP Paribas AM invests in more than €3.6 billion in green bonds across its fixed-income strategies.

However, HSBC GAM's Ms. Mourahib added that challenges remain. "Identifying eligible projects may prove challenging at a European level, since EU state members are likely to use eligible green expenditures as eligible assets for their own green sovereign bond issuance. In addition, we don't have full visibility on what the process of fund allocation per member state will look like," she said.