Differences Between Green Bonds Versus Conventional Bonds
This chapter empirically investigates how the green bond markets price greenness. Using the liquidity-adjusted yield premium of green bonds over their synthetic conventional bonds, this study explores the possible determinants that drive green bond premiums. Evidence shows that, on average, there is no significant yield premium or discount on green bonds compared with their paired conventional bonds. Interestingly, in the case of a subsample, such as the euro and the US dollar, to control for the currency effect, most explanatory variables are not statistically significant, which suggests that a green bond premium does not exist in dollar-denominated and euro-denominated bonds, while a green bond premium does exist in other currency-denominated bonds. However, green bonds are also not standardized instruments. Certain factors, like “greenness,” are necessary to match the needs of issuers and investors. These factors might have an impact on the price, liquidity, and volatility of green bonds.
KeywordsGreen bond Green premium Market development
JEL ClassificationG12 G14 G19
The green bond market has grown rapidly over the past decade. It started with the “climate awareness bond” issued by the European Investment Bank in 2007 as the first green bond. A key catalyst for the subsequent market development was the International Capital Market Association’s (ICMA) introduction of the Green Bond Principles (GBPs) in January 2014. Although the green bond market has expanded substantially since then, Ehlers and Packer (2017) showed that it is nevertheless still very small compared to the wider global bond market, with a share of less than 1.6% of the global debt issuance in 2016.
While the green bond market began to form in 2007, due to the lack of a globally accepted definition and standards for green bonds, the nascent market faced two issues. First, as Ehlers and Packer (2017) pointed out, while the GBPs and the Climate Bonds Standard (CBS) serve as the general guidelines to distinguish between green bonds and conventional bonds, due to the lack of enforcement mechanisms, some countries have produced their own standards for regulating green bonds. The European Union (2016) stated that the central bank of the People’s Republic of China (PBoC) suggested its own version of what constitutes green bonds in 2015 in lieu of the Green Bond Principles and Climate Bonds Standard. This has led to the issue of heterogeneous data sets on green bonds and the problem of the generation of green bonds that do not necessarily improve the environment. Second, the green bond premium, which Zerbib (2017) defined as the difference in yield between a green bond and an equivalent conventional bond, is not associated with the impact that green bonds exert on the environment but the sizeable excess demand. As VanEck (2017) asserted, whether projects are successful or not does not affect the principal and the interest payment of green bonds.
Therefore, this chapter addresses the above issues as follows. Section “Green Bonds” is devoted to understanding issuers and investors and the other players involved in green bonds, since a thorough understanding of them could facilitate further development of green bond markets and improve policy measurements. Section “Differences Between Green Bonds and Conventional Bonds” uncovers the differences between green bonds and conventional bonds and addresses the determinants of a green bond premium. Section “Empirical Analysis” focuses on the measures and building blocks to develop further green bond markets.
Green bonds, in short, are fixed-income securities that fund exclusively green projects with environmental or climate-related benefits. In most countries, any issuer can label its bonds “green,” because only the People’s Republic of China (PRC) and India have defined the term legally. In practice, issuers can label bonds “green” only if they comply with the GBPs, the CBS, or the national guidelines and regulations governing green bond issuance. Each national standard incorporates many or most elements of the GBPs; however, there are some differences between them. Therefore, more coordination is necessary to facilitate further development of green bond markets. ICMA’s GBPs, which are a voluntary process and guidelines, best describe the specific criteria and requirements underpinning the concept of green bonds. Major private financial institutions compiled these under the aegis of ICMA (2017). The GBPs guide prospective issuers on the four key components of green bond issuance: (a) the use of proceeds, (b) the process for project evaluation and selection, (c) the management of proceeds, and (d) reporting. Though external review is not one of the main four GBPs, the 2015 edition of the GBPs recommended that green bond issuers “use external assurance to confirm alignment with the key features of green bonds”. This can include second opinions and verifications. From 2016, the Principles referred to “external reviews” rather than “external assurance,” while the list of recommended external reviews expanded to include those that rating agencies provide (ICMA 2017).
Once issuers have issued green bonds in accordance with the GBPs, certification and scheduled reporting are necessary. If the proceeds from the green bonds do not fund green projects, as the pre-issuance reports suggest, within 24 months of issuance, then the issued bonds will lose their green status, according to Petrova (2016). As investors do not have reliable data and analyses of the impact of green bonds on the environment, all that investors may use as a yardstick with which to discern what is green from what is not green is the green bond label.
According to the Asian Development Bank (2018), issuers in 38 jurisdictions had brought green bonds to the market by the end of June 2017. In many countries, the green bond issues are very limited in unlocking private investments, except for those in the most established markets, such as the PRC, the US, and Europe. Although the green bond markets have rapidly grown over the last 10 years since the European Investment Bank’s first green bond in 2007, the Climate Bonds Initiative estimated that $895 billion of climate-aligned bonds were outstanding in 2017, comprising both labeled and unlabeled green bonds and amounting to $221 billion and $674 billion, respectively, in 2017. The labeled green bonds account for only 24.7% of the climate-aligned bond universe, while the remaining 75.3% are unlabeled and generally non-investable, although they also contribute to a low-carbon economy.
Therefore, the lack of a common practice and definition might deter the further development of green bonds enough to unlock the private sector’s issuance and investment in green projects. For the green bond market to channel a significant amount of funds into environment-friendly projects, green bonds should also meet the needs of both issuers and investors at the same time.
Green bonds are no different from conventional bonds, except that their proceeds are earmarked for investment solely in certain green projects with environmental benefits. Green bonds are also in general less liquid than conventional bonds, since many investors in green bonds are long-term investors who seek incentives to protect themselves against inflation risk, default risk, and market volatility. Therefore, most green bonds offer tax privileges, guarantees, and letters of comfort to attract more investors (Veys 2010). Although maintaining the green label helps reduce the environmental risks for the issuer, the costs of providing scheduled reports and recurring research and development (R&D) expenditure to become green may be burdensome to small-sized green bond issuers. As the concerns in addressing environmental risks associated with corporate finance increase, global reporting on greenhouse gas emissions has become a requirement rather than an option. Standard & Poor’s Ratings Services (2016) introduced the Carbon Disclosure Project on behalf of 827 institutional investors, managing $100 trillion in assets, and the United Kingdom (UK) government’s 2013 requirement for all UK-listed companies for reporting greenhouse gas emissions.
Considering the same issuer, the risk characteristics of a green bond are essentially identical to those of a conventional bond: while the proceeds from the issuance of a green bond are earmarked for environment-friendly projects, the cash flows of the entire operations of the issuer—not just the green project—service the green bonds.
Investors in green bonds do not purchase them only because they can hedge against environmental risks for their portfolios. Investors check the indexes and reports that the issuers provide to make their investment decision regarding green bonds. Investors in green bonds are usually institutional investors, such as pension funds, insurance companies, and so on. Treasurers like to offer green bonds since doing so diversifies their investor base. When the market is volatile, a diverse portfolio deals better with the volatility of the market. In many cases, fans of green bonds have no alternative investment, since green bonds are insufficient to meet the increasing demand. Thanks to oversubscription in the green bond market along with solid supporters of green bonds, the pricing of green bonds is tighter than that of conventional bonds.
Furthermore, because there is no widely recognized mechanism to monetize the environmental impact of green bonds, green bond investors currently take advantage of the same yields as conventional bonds, with the bonus of the reputation of investing in green projects that resolve environmental issues. In other words, if investors are not in need to withdraw cash from green bonds, in the current market with imperfect information, green bonds compensate investors for their patience.
Investigations into whether a green bond premium exists have produced mixed empirical results. Investors who purchase green bonds clearly do not do so because they have a special preference for green bonds over conventional bonds. However, Östlund (2015) found no evidence of green bond preference. An empirical analysis with 28 matching pairs would not be highly random, but it is hard to be confident about the existence of a green bond premium. Zerbib (2017) reported evidence of the existence of a green bond premium, but the amount of data is limited for green bonds. In addition, depending on the framing of the data, the results lead to different conclusions. If investors have green preferences, it would mean that they would accept a lower return on their investment at the identical risk level as the alternative to conventional bond if and only if the bond they are investing in is green.
The distinction between conventional investors and responsible investors is an important factor for green bond markets. In the case of conventional investors, their investment decision making depends mainly on financial factors, such as profitability and cash flows. The financial statements of securities issuers provide this information. On the other hand, the decision-making processes of responsible investors include both financial and nonfinancial factors, such as ESG (environmental, social, and governance) factors. Both conventional and responsible investors hold green bonds. However, green bonds are especially attractive to responsible investors because their proceeds are limited to environmentally beneficial projects, although the division between conventional investors and responsible investors is not clear-cut. Given the absence of institutional investors with responsible investment mandates to guide issuers and underwriters in structuring green bonds, a comprehensive policy framework for green bonds is necessary to support the further development of green bond markets.
Other Players Involved in Green Bonds
For green bond issuance, there are four players who play different roles in the market in addition to issuers and investors. They are the underwriters, the external reviewers, the index providers, and other market intermediaries. Underwriters are the financial institutions that set up the public issuance and distribution of the bonds. Underwriters specify the terms, definitions, and obligations of the bonds. External reviewers verify the greenness of the underlying projects. Index providers are not directly involved in the issuance and distribution of the bond; however, they create green bond indexes according to their own standards. In practice, a widely recognized index provider’s inclusion of a green bond may add an extra inch of reliability for investors. Lastly, other market intermediaries are optional in a way, since most green bonds are traded over the counter (Östlund 2015).
Rating agencies and third-party auditors generally check the financial soundness of bond issuers or projects. However, when it comes to green bonds, their main objective is to check whether green bonds are environmentally responsible and observe the eligibility criteria that they pledged to abide by at the time of issuance (ADB 2018). Rating agencies, such as Moody’s, investigate green bonds and climate-related bonds and assign quantitative scores to them based on their greenness. Both Moody’s and S&P Global Ratings use a transparent scoreboard approach to provide forward-looking opinions about the issuer’s effectiveness in meeting the green criteria. In both cases, green bonds receive a grade, which assesses their greenness. The green bond ratings are not credit ratings, which the agencies issue separately. In the PRC, the China Chengxin International Credit Rating Company has also developed a green bond methodology, which follows the GBP approach and assigns one of five ratings to green bonds. While only a handful of issuers have sought green ratings, both Moody’s and S&P Global Ratings have made efforts to develop their green bond assessment capabilities expecting that all issuers will look for both a credit and a green rating soon.
The following section will analyze the differences between green bonds and conventional bonds more thoroughly. These characteristics have implications for the pricing of green bonds and their attractiveness to investors. A premium at issuance over comparable bonds without a green label would indicate that a significant number of investors value the label, enough to give issuers an extra incentive to issue bonds that have it. At the same time, these investors will still be interested in an acceptable financial performance of green bonds over time.
Differences Between Green Bonds and Conventional Bonds
Apart from the fact that green bonds require scrutiny by observing the GBPs and strive to meet the requirements that the Climate Bonds Initiative suggested, VanEck (2017) and Östlund (2015) insisted that they are not particularly different from conventional bonds, especially in primary markets, where brokers must sell green bonds to a large pool of investors buying both green bonds and conventional bonds. Standard & Poor’s Ratings Services (2016) showed that green bonds’ trading occurs near the yield spreads of conventional bonds. However, in secondary markets, investors also consider the green bond label as a criterion for selecting bonds.
Therefore, the only way to assure investors that the bonds they are buying are truly green bonds is for them to check the binding guidelines regulating green bonds’ issuance and maintenance. The PRC, for example, strongly limits the use of the proceeds of green bonds to the environmental projects of the issuers only. In fact, the country has two guidelines for overseeing green bonds: China’s Green Bond Guidelines and the PBoC’s Green Bond Endorsed Project Catalogue, according to the European Union (2016). In Norway, on the other hand, for green bonds to maintain their label, their issuers need to list them on Oslo’s Stock Exchange. The European Union (2016) introduced Norway’s example of how to run green bonds. Norway also requires green bonds to seek a second opinion for listing on the stock exchange. The issuer must make the result of the second opinion available to the public. Lastly, the only certified green bond in Mexico underwent a second review in accordance with the CBS. Whether a green bond premium exists or not has been a topic of fierce discussion among economists. The chapter introduces the existing analyses of the green bond premium to scrutinize the issue further.
A Green Bond Premium Does Exist
To investigate the existence of a green bond premium, Zerbib (2017) used a matching method, comparing each eligible green bond with two similar conventional bonds with identical conditions, such as currency, rating, bond structure, seniority, collateral, and coupon type. He started out with 681 green bonds complying with the GBPs on 30 December 2016; however, after filtering out the outliers and incomplete data, he selected only 135 investment grade senior bullet fixed-coupon bonds for analysis. Zerbib (2017) aimed to estimate the green bond premium and to identify its determinants. He found that the average green bond premium was –8bps against conventional bonds within the whole sample of investment grade bonds, –5bs in US dollar bonds and –2bps in euro bonds. He drew attention to the presence of an excess demand for green bonds in the market.
Ehlers and Packer (2017) compared the credit spreads at issuance of a cross-section of 21 green bonds issued between 2014 and 2017 with the credit spreads at issuance of conventional bonds of the same issuers with the closest possible issue date. They showed that green bond issuers on average have borrowed at lower spreads than they have through conventional bonds. Their findings confirmed the results from other recent studies, such as Barclays (2015) and Zerbib (2017).
Wulandari et al. (2018) investigated the relationship between the liquidity risk and the yield spread for both green and conventional bonds. The evidence showed a positive relationship between the liquidity risk and the yield spread. However, for green bonds, the impact of liquidity risk on the yield spread has become negligible over time. Barclays (2015) indicated in across-sectional analysis a–17 bps premium as of mid-2015. However, the historical returns of green bonds are like those of conventional bonds.
A Green Bond Premium Does Not Exist
Östlund (2015) used a data set of 28 matching pairs of bonds from Bloomberg on 17 March 2015, focusing on the essence of a green bond premium defined as the spread differentials between green bonds and conventional bonds of the same issuer. The analysis tests the null hypothesis that there are no differences between green bonds and conventional bonds. The results showed that indeed there is no evidence of a green bond discount in the overall dataset. However, using the data for the year 2015, the mean difference was statistically significant at the level of 10%, and the yield spread was 0.0758, indicating that conventional bonds have lower yields than green bonds. The only case in which a green bond premium was apparent involved the six green bonds related to the real estate industry.
Petrova (2016) conducted both panel regression analysis and timeseries analysis to evaluate and compare the performance of green bonds and conventional bonds during a sample period covering 2008–2016. After controlling for various possible factors, such as default risk and term premium, and different time-series parameters, no statistically significant difference between green bond and conventional bond yields was documented.
Sample Construction Using the Matching Method
The matching method is a useful and simple technique as a model-free approach to analyzing the specificity of a financial instrument by matching a pair of instruments with the same characteristics except for the one characteristic of interest from the point of view of its effects. In line with Zerbib (2017), the authors construct a database to evaluate the yield spread between a green bond and an equivalent conventional bond of the same issuer. For this purpose, for each pair, we match a green bond to a conventional bond with identical characteristics except for its liquidity. We, therefore, define the difference between the green bond yield and the equivalent conventional bond yield as the so-called “green bond premium.”
We collect conventional bonds with a maturity that is neither 2 years shorter nor 2 years longer than the green bond’s maturity, because the maturities cannot be exactly equal. The difference between the two categories of bonds is their liquidity, which is possible to measure from either the issued amount or the issuance date of the benchmark. A substantial difference in liquidity can considerably affect the yield level; therefore, we must control for it. We restrict the eligible conventional bonds to those with an issued amount of less than four times the issued amount of green bonds and greater than one-quarter of this amount to ensure a fair approximation. We also restrict the range of conventional bonds to those with an issue date that is 6 years earlier or 6 years later than the green bond’s issue date.
We examine the entire sample of 990 green bonds complying with the GBPs on 10 November 2017. This set includes bonds of various kinds: supranational, sub-sovereign, and agency, municipal, corporate, financial, and utilities. In the first step in building the equivalent conventional bond, for each green bond, we search for the conventional bond with the closest maturity from the same issuer, with the same characteristics: they all have the same currency, rating, bond structure, seniority, collateral, and coupon type. Among the 158 green bonds stemming from the selection process following Zerbib (2017), we focus on 123 remaining green bonds with an investment grade senior bullet fixed coupon, while we select the 123 equivalent conventional bonds from the same issuers among 121,777 observations. The 123 green bonds of the sample are the ones for which we managed to find an equivalent conventional bond. The issuers are mainly among the most active bond issuers in the market.
In the second step, we eliminate the maturity bias by building a data set consisting of pairs of bonds: we assign one conventional bond with the closest characteristics to each green bond. We retrieve the bid and ask yields of the green bonds and the corresponding conventional bonds from Bloomberg on 10 November 2017. Since this study focuses on the investors’ demand and the issuers’ supply of green bonds, we focus on the ask yields of each bond to ensure a more precise analysis.
Mean difference (P-value)
Average Issue Amount by Currency
Average issue amounts
(in $ million)
Rating and Yield by Currency
Average ask yield to conventional (%)
Results of the Step 1 Regression (OLS)
Dependent variable: Difference_AskYLD
Results of the Step 2 Regression (OLS): Whole Sample
Dependent variable: green bond premium (residual terms of the step 1 regression)
AmtIssued ($ billion)
Results of the Step 2 Regression (OLS): US Dollar Sample
Dependent variable: green bond premium (residual terms of the step 1 regression)
AmtIssued ($ billion)
Results of the Step 2 Regression (OLS): Euro Sample
Dependent variable: green bond premium (residual terms of the step 1 regression)
Time To Maturity (years)
Time To Maturity_Square (years)
AmtIssued ($ billion)
The negative green bond premium highlights the fact that the buying pressure relative to the supply capacity is greater in the case of green bonds than in the case of conventional bonds. These market phenomena result from an excessive investment demand due to the characteristic of green bonds and an insufficient volume of bond issuances. The negative green bond premium leads to a favorable situation for green bond issuers, which prioritizes a green project instead of a conventional project, due to a lower cost of capital. Nevertheless, this situation poses two problems. First, it reveals the structural lack of green projects. Second, a negative green bond premium subdues the appetite of institutional investors that have not set up a binding floor for green assets in their strategic asset allocation.
Summary and Policy Implications
Green bonds significantly contribute to enhancing green investments, which aim to mitigate and adapt to climate change (CICERO 2015). The green bond markets have substantially grown over the past decade, although the market size is still insignificant compared with that of conventional bonds. This paper attempts to analyze the green bond premium, which is defined as the yield difference between a green bond and an equivalent conventional bond after controlling for the difference in liquidity by using a matching method in line with Zerbib (2017). The main objective of the article is to determine the value of the green bond premium and to identify its major determinants.
Our empirical results indicate that on average there is no significant premium for green bonds relative to conventional bonds. The empirical results that we obtain for the whole sample show that the yield is not statistically significant while the issued amount is statistically significant in all the specifications. The issued amount negatively impacts the green bond premium, in contrast to the results of Zerbib (2017). The larger the issued amount is, the lower the green bond premium becomes. Financial bonds show a 6.9–15.5 bps premium below the reference level (government group). Interestingly, in the case of a subsample, such as the euro and US dollar, to control for the currency effect, most explanatory variables are not statistically significant, which suggests that a green bond premium does not exist in US dollar-denominated and euro-denominated bonds while a green bond premium does exist in other currency-denominated bonds.
Like conventional bonds, green bonds are not standardized instruments, and certain factors, like “greenness,” are necessary to match issuers’ and investors’ needs. These factors might impact the price, liquidity, and volatility of green bonds. Therefore, for further research to construe the pricing mechanism of green bonds, it should incorporate the definition and measurement of “greenness” into the empirical analysis with a larger data sample. One limitation of this study is also due to the quality of the data; since green bonds are not frequently traded, a bond yield sometimes does not accurately reflect its fair value.
Going green does not mean sacrificing the yield because some institutional investors are not willing to pay a green bond discount. The excessive demand, rather than the environmental impacts, has driven the current premium. Essentially, to make green bonds more attractive and desirable than conventional bonds, issuers should monetize externalities like the environmental benefits generated from green projects for investors in green bonds. Yoshino and Abidhadjaev (2016) insist that it is possible to measure the spillover effects from the tax increment that infrastructure projects generate through the difference-in-difference method, which the issuer can internalize as an additional return for investors and not by increasing the issuer’s burden.
On the demand side, a sufficiently large, committed demand from institutional investors would lower the cost of capital for green projects. There is a good opportunity for issuers to expand their funding capacity for green projects, thanks to ethical investors who are willing to sacrifice some of the yield to participate in environment-friendly projects. The urgent need to finance the change to a low-carbon economy makes green bonds more attractive and essential investments based on ESG (environmental, social, and governance) criteria. More green bonds would help economies meet the huge green investment needs to cope with climate change and mitigation.
The supply of green bonds should increase to provide the huge amount of green investments required for climate change. The European Union (2016) pointed out five main bottlenecks in the supply of green bonds that issuers need to address to remove the hindrances to green bond market development: (a) the lack of green bonds and green project pipelines, (b) the lack of aggregation mechanisms for green projects, (c) the lack of green bond definitions and framework, (d) the lack of information and market knowledge, and (e) the lack of a clear risk profile for green investments.
The lack of commonly recognized standards in the green bond market especially has limited the universe of institutional investors, who are ethically mandated to invest in green bonds since the standardization of green bonds’ definition and framework is ongoing. However, external reviewers and issuers are cooperating to establish more up-to-date methods to track the proceeds from the green bonds and their impact on the environment. The ASEAN Capital Market Forum (2017) has recently developed the ASEAN Green Bond Standards based on ICMA’s GBPs, which are internationally accepted and widely used for the development of national green bond guidelines or standards issued globally. The expectation is that this regional standardization and harmonization will facilitate the further development of the green bond market.
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