Green Bond juggernaut starts rolling for EU, what next?

Synopsis: Under its plan NextGenerationEU, the European Union plans to raise €800 billion over the next five years to support Europe’s recovery from the coronavirus pandemic and help build a greener, more digital, and more resilient European Union. Of this, almost 30% or €250 billion will be in green bonds between now and the end of 2026. This huge green bond issuance will make the EU one of the largest green bond issuers in the world, as one single economic entity or economic bloc. The juggernaut has started to roll and last week, the EU sold its first-ever green bond, a 15-year instrument of 12 billion euros ($13.9 billion). It was a massive success from a demand-supply point of view as it received more than 135 billion euros of demand, enough to make it the largest green bond launch and the highest level of demand for any green bond, to date. This green bond and the subsequent green offerings will finance the EU member states’ environmentally beneficial projects, aligned with the green finance definition. While the start, no doubt, could not have been better, two issues will be important in making this program a success in the final evaluation. The first is how to make sure that the green bonds are used for green objectives as the investor community must know how the funds will be used. Under the extant rules, the EU member states will report to the European Commission about the green expenditures they incur. So, a lot depends on the member states and how the green investment is defined by the EU. Based on this information, investors will be in the know-how of how the proceeds of the green bonds have been allocated to investment categories and the different EU member states. The other is pricing. The last week’s bond was priced for a yield of 0.453%, the EU Commission has said, implying the EU is paying a marginally lower new issue premium than it usually pays for its bond issues, which suggests a pricing advantage. The EU estimated that the bond is priced with a “greenium” of 2.5 basis points. Greenium refers to the slightly lower yield these bonds pay relative to conventional bonds. However, the greenium may shrink in the future as supply is expanding rapidly. This could make the green bonds even more attractive to those investors that are interested in green bonds but are not willing to compromise on returns. Already, some investors have started questioning the rationale and are not willing to pay a higher price, purely because of a ‘green’ tag. This category of investors will be more interested in investing in green bonds, if the premium is smaller, making the demand even higher for these green bonds offered by the EU. The next twelve months will be interesting on how this will play out.