How Large is the Sovereign Greenium? (2024)

1 Introduction

Financial markets will play a catalytic role in financing the adaptation and mitigation to climate change. Maltais and Nykvist (2020) show that green bonds in the private sector have become the most prominent innovations in the field of sustainable finance in the last fifteen years.¹ The literature often cites the bond issued by the European Investment Bank in 2007 as the first green bond (Cortellini and Panetta, 2021, OECD, 2021). Since then, international organizations, municipalities, and private sectors have increased the issuance. Yet, the issuances at the sovereign level have been relatively recent and not well documented in the literature. Until 2015, although the annual total issuance of green bonds had reached $40 billion, no issuance by central governments was recorded. In 2016, building on the momentum of the Paris Agreement adopted in 2015, Poland became the first issuer of sovereign green bonds. The issuance of these instruments could provide an additional source of stable financing with more favorable market access conditions, mitigate the stress of climate risks on public finances and facilitate the transition to greener low-carbon economies.

A central benefit associated with green bonds has been labeled as the green premium (greenium).² When a green bond exhibits a lower yield compared to a similar conventional bond without the green label, the green bond is said to exhibit positive greenium. Theoretically, the greenium can take either positive or negative signs. On one hand, the issuance amount and liquidity are smaller than conventional bonds, which could lead to a negative greenium. On the other hand, environmental, social, and governance investors’ demand for green bonds and more information on the use of proceeds can justify a positive greenium. Thus, whether sovereign green bonds are issued and traded at a positive greenium is an empirical question.

Given that the issuance of green bonds at the sovereign level is a recent phenomenon, the literature analyzing their pricing is scarce and, to our knowledge, there are no comprehensive empirical studies of the sovereign greenium. This paper fills this gap and estimates the sovereign greenium using a comprehensive sovereign green bond database. First, we focus on the twin bonds issued by Denmark and Germany with the explicit purpose of measuring the greenium. The twin-bond analysis reveals that the greenium has been on average positive but small (around 3 bps), and even negative for some periods. Second, we compile a dataset of conventional and green bonds for the rest of the countries that did not issue twin bonds, and use it to estimate the greenium through panel regression analysis. In line with the results from the twin bonds, we find that the average greenium is small and positive (around 4 bps). However, we find significant variation in the estimated greenium depending on the country’s stage of development and the currency of the bond: the estimated greenium is larger in developing economies and in foreign currency-denominated bonds. Finally, our analysis suggests that the greenium has been increasing over time. These results are consistent with those in Baker et al. (2022), who analyze the pricing of U.S. corporate and municipal green bond markets.

The rest of the article proceeds as follows. Section 2 presents the greenium for twin bonds. Section 3 presents the regression analysis and greenium estimates. Section 4 concludes.

2 Twin Bonds

Germany has issued twin bonds since 2020 to provide a benchmark of greenium. Twin bonds consist of a conventional bond and a green bond that share the same maturity date and coupon. The main difference is that the use of proceeds from the green bond is limited to green projects. They are, however, also different in that the green bond’s issuance volume is smaller, and the issuance date is later. For example, in the twin bonds with maturity in 2030, the conventional bond was issued in August 2019 with a size of €30 billion, while the green bond was issued in May 2021 with a size of €6 billion. Through the issuance of twin bonds, Germany aims to establish the yields of green Federal securities as the reference for the Euro green finance market (German Finance Agency, 2022).

Table 1 presents the distribution of the sovereign greenium for all the twin bonds that have been issued so far. It shows that Germany’s greenium is on average between 2 to 4 bps. As of October 2022, four German twin bonds are on the market with a maturity date in 2025, 2030, 2031, and 2050. Coupons are zero for all bonds. Figure 1 shows that, although the greenium is mostly positive, it can turn negative when the yield dives, as can be seen in the twin bonds with maturity in 2030. Interestingly, the negative greenium does not happen in all maturities, although the time series of yield to maturity shares a similar pattern.

Following Germany’s model, Denmark issued twin green bonds in January 2022.³ Figure 1 shows that the first month recorded nearly 5 basis points of greenium, but it has been in a downward trend afterwards, and the sign sometimes turns negative in 2022Q3. Table 1 shows that the average sovereign greenium for the case of Denmark is 3 bps.

3 Panel Data Analysis

Since twin bonds are not available in other countries, greenium needs to be estimated with a different approach. In this exercise we estimate greenium using panel regression analysis, comparing the differences in the yield of green and conventional bonds. This section presents data sources, summary statistics of green versus conventional bonds, regression specification, and empirical results.

4 Conclusions

The growing popularity of green bonds may allow governments to issue bonds with longer maturities (given the longer horizon of green projects) and at a lower borrowing cost relative to conventional bonds: the greenium. However, the issuances at the sovereign level have been relatively recent and not well documented in the literature. This paper is the first empirical study to estimate the sovereign greenium using both the twin bonds issued by Denmark and Germany, and panel regression analysis. While the estimated greenium in this paper is not large, it has been increasing over time alongside the level of sovereign green bond issuances. Whether the administrative costs associated with green bond issuance exceed the benefit is a country-specific question, but strengthening peer learning and climate information architecture could help reduce the costs and increase the benefits over time (Ferreira et al., 2021, Gao and Schmittmann, 2022). It remains an open question whether the purpose of the project associated with the green bond is a key determinant of the greenium, and whether green bonds have resulted in the climate outcomes they intended to achieve.