Embracing new green bond guidelines: The market for “green lemons”

It’s understandable that some corporate green bond issuers have felt in the past like a “Green Santa Claus” desperately trying to meet the wish lists of a multitude of ESG stakeholders, while not always feeling duly compensated for their work.

26 May 2020 . 2 min read

This is starting to change. With the mainstreaming of this market the financial and reputational benefits of a “well structured” green bond are rising. Recent research shows that green bonds with an external review trade on average 6 basis points tighter than those without such verification, which tend to trade in line with conventional bonds.

Better pricing through external verifications

In addition, green bonds with verification from the Climate Bonds Initiative typically achieved, on average, a price improvement of 15 basis points (Hyun et al, 2020).

Guiding principles help to spot the lemons and pick the peaches

Such intra-market distinctions are likely to become more pronounced. Rather like the economist Akerlof’s “market for lemons”, new and trusted guidelines help investors distinguish between high quality green bonds (“peaches”) and less impactful ones (“lemons”).

Such guiding principles could come from various sources:

Institutions: such as the EU Green Bond Standards, or regulatory authorities setting green bond prospectus requirements
Listing authorities: designated sustainable / green bond listing requirements
Leading investors: publishing their own guidelines for green bonds
Digital innovations: such as the blockchain-powered Green Asset Wallet platform for green bond impact reporting
Index providers: dedicated green bond indices with clear inclusion criteria

While it may sometimes seem like a cacophony, these market agents all have a key role to play in further improving the credibility (and hence attractiveness) of the asset class.

References:

Hyun, S.; Park, D. and Tian, S., 2020. “The price of going green: the role of greenness in green bond markets.” Accounting and Finance 60, 73-95
Akerlof, G.A., 1970. “The Market for "Lemons": Quality Uncertainty and the Market Mechanism”. The Quarterly Journal of Economics 83, 488-500