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Three things you need to know about green bonds

The green bond market is expected to hit the USD 1tr mark soon. This year, over USD 400bn worth of environmental

As green bonds have turned more mainstream and a first official standard defining the asset class is due to be enacted soon by the European Union, here we discuss some of the most frequently asked questions regarding this nascent industry that is gaining increasing traction.

Is there a 'greenium'?

The green bonds of some prominent issuers are trading at a small 'greenium,' i.e. a slightly lower yield than for comparable non-green ones, but these are exceptions right now. Most green bonds trade fair on the issuer’s yield curve, and we think such scarcity premiums will remain small at just a few basis points. The 'greenium' would also fade as issuance rises.

What are the signs of greenwashing?

To identify greenwashing we look to see: 1) whether the green bond issuer is only refinancing existing activities or projects they must implement anyway, 2) whether the issuer is investing mostly in non-green business or aims to maintain existing polluting activities for as long as possible, 3) whether it fails to set any ambitious environmental targets on a corporate level, and 4) whether it offers only minimal reporting and transparency on the use of proceeds from its green bonds.

We think such cases only form a small portion of the market, and as regulation and external reviews become more prevalent, incentives for issuers to attempt greenwashing should diminish.

What are the advantages of buying green bonds vs. non-green bonds?

From a financial point of view, green and non-green bonds represent the same creditor claim on the issuing entity and should theoretically offer the same yield. Due to strong demand and a more diverse and longer-term-oriented investor base, green bonds have shown relatively good resilience during volatile market periods. But over time we think investors should expect similar financial returns.

From a sustainability point of view, however, green bonds provide greater transparency for investors with a focus on environmental issues, while also enabling them to build a specific portfolio exposure. Buying green bonds also sends a strong signal to the issuer and market participants that specific environmental topics matter.

Overall, we think green and ESG-labeled bonds are among several sustainable strategies that will play an even bigger role in the coming decade. As governments and businesses alike place an increased emphasis on sustainability over the coming years, we think systemic consideration of all relevant ESG factors can help investors navigate uncertainty and position for the long term.

Main contributors - Mark Haefele, Vincent Heaney, Thomas Wacker, Michaela Seimen Howat, Daisy Tseng, Alison Parums

Content is a product of the Chief Investment Office (CIO).