ING has released a report analysing the performance of the greenium in European bonds. It notes that the jump in the supply of new green bonds this autumn comes as the greenium on sovereign and SSA curves is shrinking, which ING links to worsening liquidity conditions in sovereign bond markets.
ING warns that a greenium can no longer be taken for granted in the green bond market.
Greeniums are not correlated but liquidity and bid-ask spreads are the best proxies to understand pricing.
2022 has brought a reduction in the greenium, potentially affecting green bond market growth.
ING Senior Rates Strategists Antoine Bouvet and Benjamin Schroeder noted: “As is the case in many markets, 2022 has proved a bruising year for green bonds. There remains a frustrating heterogeneity in how the greenium trades across sovereign and SSA (Sub-sovereign, Supranational, and Agencies) curves.
“As we have highlighted in previous reports, we find a greenium, ie a tendency for green bonds to trade with lower yields than their peers, exists on most curves but this hides discrepancies between green bonds within the same curves, and there’s no uniform way of pricing greenium from one curve to the next. And yet, ironically, the 2022 market turmoil has, for the first time shown, the beginning of an analytical solution to this green bond pricing conundrum.”
Overall there have been worsening trading conditions in government bond markets this year, owing to both macroeconomic uncertainties and a change in market structure with central banks stopping their QE programmes and, in some cases, going into reverse. Various market liquidity indicators have worsened, with summer trading conditions also adding to existing problems. According to Bouvet and Schroeder, that worsening of liquidity conditions and shrinking of sovereign greeniums is more than a coincidence.
Despite lack of uniformity in greeniums, there are explanations in Sovereign and SSA curves
Bouvet and Schroeder added: “We find that bid-ask spreads and realised volatility, our two proxies for liquidity, have the greatest explanatory power when trying to model the greenium on sovereign and SSA curves. The contribution of each factor varies from issuer to the next but the signs and relevance are consistent. This is a remarkable result given the lack of uniformity in pricing greeniums. For instance, the correlation between each bond’s greenium on the same curve is very weak, and the greenium across curves is also insignificant.”
The tendency of the greenium to shrink when liquidity worsens is not a reflection of the liquidity of green bonds specifically, but rather an effect of trading conditions across all bonds on a curve, green or not. Bouvet and Schroeder said that green bonds are sometimes more and sometimes less liquid than their non-green peers depending on the curve.
However they say that none of this means liquidity conditions are to blame for the existence of a greenium in the first place. An imbalance between supply (possibly slowing this year, see below) and demand (with green reserve management a new potential driver for future growth) remains the prime suspect.
However it still doesn’t look like supply has caught up enough for demand for greeniums to disappear completely, although it is expected that a better balance between supply and demand would see secondary factors play a more significant role in pricing. For the moment, liquidity is a key driver of day-to-day greenium changes.
Slower growth in supply will affect the greenium
Lower, or at least slower, growth in supply is coming as greeniums shrink and display greater volatility. There is still a case to be made for demand exceeding supply in the long run but the past few months have proven that general market conditions matter.
Basically ING is arguing that In phases of low market liquidity, a steady greenium can no longer be taken for granted. The report says that while there is a chance that this year’s green sovereign and SSA issuance will outweigh that of previous years, it seems the phase of rapid acceleration in the market could be over.