Seeking ‘greenium’

While sustainable investing is growing rapidly, it is unclear who is benefitting from this and how. Based on analysis of data on green bonds and loans, this article finds that the gainers are mainly financial institutions, as they earn premium in the bond market but do not pass this on to the loan market. Further, there is lack of due diligence by banks, with borrowers of green loans being unable to reduce emissions.

Growth in sustainable investing can be expected due to the fact that, to attain net-zero goals by 2050, US$9.4 trillion investment per year would be needed (Haegeli and Garbers 2022). A survey by Morgan Stanley of 900 institutional investors across North America, Europe, and Asia Pacific, including 295 asset owners and 606 asset managers, reveals that four out of five asset managers and owners expect to see increases in their sustainable assets under management (AUM) and allocations over the next two years (Segal 2024). Yet, it is not clear who is benefitting from the growth in this asset class, and how. In new research (Aswani and Rajgopal 2024), we shed light on these questions.

‘Sustainability gatekeeper’ hypothesis

We propose a relatively novel ‘sustainability gatekeeper’ hypothesis. We suggest that the bond market potentially trusts the financial sector to screen out ‘brown’ issuers (entities traditionally associated with high carbon emissions or environmentally harmful activities) while deploying the funds that banks raise via green bonds. Moreover, financial firms do not directly emit pollutants, unlike the oil and gas industry. Hence, ‘green bonds’ issued by financial sector firms are likely to be associated with (i) a positive response from stock market; and (ii) ‘greenium’ (green premium) in secondary bond markets. However, the banks issuing green bonds do not pass through this greenium in the loan market.

To test this hypothesis, we use information on 5,179 green bonds obtained from the Bloomberg Fixed Income database as of 31 December 2022. Of the 5,179 bonds, 4,324 were endorsed by a third party (for example, Climate Bond Initiative, an ESG (environmental, social and governance) assurance provider). Our data suggests that corporate green bond issuances began in 2013. However, most of these are issued in the last four years of the sample and headquartered in the US, China, Sweden, France, or Germany. These bonds mainly belong to the financial, energy, utility, and industrial sectors.

The 16-day cumulative abnormal return (used in Flammer (2021))¹ concurrent with the announcement of green bond issue during 2013-2022 is 0.274%. However, this result is primarily attributable to financial sector firms. The 16-day market reaction for financial sector green bonds is 0.33%. Surprisingly, the analogous stock price reaction for green bonds issued by sectors known to pollute the environment is statistically insignificant. These findings are consistent with the role of financial firms as sustainability gatekeepers that channel capital to sustainable projects. We also conduct a comparative analysis of the market's response to announcements of green bond issuances against those of conventional bonds by the same issuers. This comparison reveals that announcements of green bonds do indeed yield a higher market reaction compared to conventional bonds. However, this distinction is notably more pronounced among financial sector firms.

Previous research has studied the primary market of green bond issuance and found no apparent premium when compared with conventional bonds (Larcker and Watts 2019). However, we also emphasise the critical importance of analysing the secondary debt market. This is based on the recognition that various post-issuance reports, such as impact reports, second opinion reports, capital allocation reports, and use of proceeds reports, become available to the market subsequent to bond issuances. As a result, the pricing of debt securities can evolve over time, often differentiating them from primary market pricing.

Compared with a conventional bond of same issuer in the same year, the 3,689 green bonds in our sample traded at 5.7 basis points (bps)² of greenium accumulated over one month. The average greenium is mostly explained by the 8.3 bps greenium for green bonds issued by the financial sector. This fact pattern is consistent with our proposed sustainability gate keeper hypothesis. We find higher yields for green bonds issued by the polluting sectors of the economy (that is, the utility, energy, material, and industrial segments) suggesting that such bonds are perceived as riskier by investors, and therefore, trade at a discount. This is somewhat surprising because one would expect higher greenium in the polluting sectors, given investors’ presumed desire to provide financing to these sectors to lessen their environmental impact.

Next, we examine whether green bond-issuing banks share the greenium in the loan market. For that, we gather the ‘green loans’ data from Dealscan database and merge it with banks’ green bonds information from Bloomberg. This linkage to green loans reflects that majority of these loans are allocated in renewable energy and green building projects. On comparing green loans to traditional loans by the green bond-issuing banks, we find that although green loans tend to have lower spreads than traditional loans, this difference is statistically insignificant. This suggests that while green bond-issuing banks benefit from a premium in the bond market, this advantage is not transferred to the loan market.

Lastly, we evaluate the environmental performance of green bond issuers and loan borrowers. We find that green bonds are more likely to be issued by firms with high environment risk exposure, measured as high carbon emissions risk, water stress risk, biodiversity risk, and toxic emissions risk, as per MSCI’s ESG rating database. Despite an implicit motivation to improve their environmental record, we found no change in the environmental performance of the issuers of the green bonds compared with their counterparts, even after three years. Exploring the environmental performance of green loan borrowers, we find no change with time – this shows the lack of due diligence by the banks in monitoring the environmental parameters of borrowers.

Conclusion

Our study has important policy implications, demonstrating that despite the growth of sustainable investing, the main beneficiaries are financial institutions like banks, which get the premium in the green bond market but do not pass this gain through to the green loan market. Investors are not supporting sustainable investments by polluting firms, even with their efforts. We also demonstrate that polluting firms are unable to mitigate environmental externalities in the short term, with borrowers’ ability to effectively reduce emissions remains unchanged, indicating a lack of due diligence by banks.

Notes:

Cumulative abnormal returns (CARs) are the sum of abnormal returns in the event window. For instance, for a 3-day event window, the CARs would be the sum of abnormal returns from one day before the event to the day after, including the event day (that is, (t-1, t+1) if t=0 is the event day). The abnormal return is the stock return minus the market return on the same day.
One basis point is 1/100th of a percent and is commonly used to measure movements in interest rates.