Green transformation with triple-A quality

There has been strong demand from investors for Germany’s first green government bond. The country’s plan is to create a green Bund yield curve. Going forward, this should provide investors with more opportunities to diversify their portfolios through the addition of investment-grade green bonds.

Germany is currently strengthening its green credentials in the capital market. The order book for its first green Bund came to a record-breaking volume of €33 billion. Ultimately, the bond issue was placed last Wednesday with a volume of €6.5 billion – much (at least €4 billion) more than originally planned. Investors were also willing to accept a small markdown in yield of one basis point relative to a comparable conventional Bund. One day later, car manufacturer Daimler also placed its first green bond, which was strongly oversubscribed as well. The ten-year bond issue with a volume of €1 billion attracted a total order volume of more than €6.5 billion.

Two things we can learn from this are that the market for green bonds, which had been flagging a little amid the coronavirus crisis, is recovering and that investors are ready and willing to support the transformation towards a greener European economy. Ahead of Germany’s green Bund issue, Sweden had placed its first green government bond with a volume of just under €2 billion. This transaction, too, was oversubscribed at least twofold. In the European corporate bond market, airport operator Schiphol and Spain’s Banco de Sabadell followed suit with placements this week. As a result, the issuance volume in the European green bond market should soon exceed the entire volume placed in the previous year.

The bond market is becoming increasingly green

The bond market is becoming increasingly green
Source: Climate Bonds Initiative, Uni Credit, Union Investment; as at September 2020.

High level of comparability

What benefits do green Bunds offer investors? Firstly, they support the German economy’s process of transformation towards greater climate protection. In addition, these securities are very useful for portfolio construction purposes. Green Bunds enable investors to benefit from Germany’s triple-A credit rating and the excellent security and liquidity characteristics of German government bonds while also adding an element of sustainability to their portfolio. The issuer, and thus the credit rating, and the maturity period are identical to that of a conventional Bund. This means that these twin securities differ in price only. The premium or discount that the capital market ascribes to the green twin is therefore immediately evident. Any positive price difference between the green Bund and the conventional Bund directly represents a ‘green premium’.

This high degree of comparability is currently unique in the capital market, because green bonds are usually placed as independent government bonds that compete with existing conventional government bonds. Green Bunds are different, however. For these, the German government creates a traditional, non-green sovereign bond and, when this is issued, announces that an equivalent green government bond will be brought to the market at a later date. It is planning to offer these ‘twin bonds’ with maturities of two, five, ten and 30 years and in doing so create a green yield curve. Reports from the Federal Ministry of Finance also suggest that Germany is aiming to become the benchmark in the European green bond market.

Borrowing in line with the federal budget

The plan is to issue up to €12 billion in green Bunds in 2020, which appears to need some explaining given the high level of interest from investors. According to the German government, the issuing volume planned for 2020 has been matched to €12.7 billion of money that has already been spent from the 2019 federal budget. This expenditure, spread across seven ministries, is said to cover the areas of transport, the environment, international collaboration, research, energy and industry as well as forestry, protected landscapes and biodiversity.

This illustrates the fact that borrowing via green Bunds is matched with government expenditure in the prior-year. The federal budget is, after all, subject to the ‘universality principle’. This means that any funds borrowed – whether they are now designated as green or conventional – must be used to cover all budgetary expenditure and thus cannot be allocated to specific projects. The rules for the German federal budget dictate that no differentiation can be made as to how funds from different sources are used. So to provide evidence that the invested funds are allocated to ‘green’ projects, the government has to match them to past expenditure when planning its issues. The record demand for the first green Bund has left legislators in no doubt that the capital market is willing to put up the money to fund the economy’s green transformation.

Other types of green bonds do allow targeted funding, however – provided they meet certain monitoring conditions. The development of electric cars is one area that Daimler, for example, is looking to fund through its green bond. And France – whose debut green bond in 2017 attracted an order book of €24 billion – is also using this form of borrowing for specific green projects. Indeed only last Thursday, Emmanuel Macron’s government announced that from a new economic stimulus package of around €100 billion, around €30 billion would be made available to fund green technologies.


As at 4 September 2020