Green Bond – Beyond ‘greenium’

Green bond, an innovative financial instrument developed to support environmentally friendly projects, crossed a cumulative issuance of $3.5 trillion by the end of 3Q FY2025 – a number that was previously unthinkable when it was first issued. In 2007, the bond was issued specifically to support a class of investors interested in funding only environmentally friendly projects, particularly those related to climate change. Over time, green bonds have become increasingly mainstream in the financial markets as issuers have begun using this financial instrument to secure debt financing, possibly at a more favourable rate, and send a signal to the financial market and stakeholders on their commitment to the environment.

Financial intermediaries have purchased them to mitigate climate-related financial risks or meet the demands of their investors looking to allocate more capital in sustainable financial assets. Investors, seeking financial assets that offer more than just financial returns or risk management, also allocate a significant amount of capital to green bonds, aiming to create a positive environmental impact.

While ‘greenium’, the ability of the issuer to issue green bonds at a lower rate than conventional bonds, is widely discussed, the perspective of shareholders of green bond issuers is rarely discussed in the mainstream media, but is covered reasonably well in the academic field. In this blog, I discuss how green bonds can create value for the issuer’s shareholders, including reducing the cost of financing, improving market liquidity, garnering investor attention, and enhancing the firm’s fundamentals.

Lower-cost capital pushes up valuation.

Although the green premium has shrunk, even to negative levels, companies have been able to reduce the cost of financing at the firm level. Academic literature suggests that companies may not be able to mitigate the issue of green bonds at a lower rate, but have been able to raise capital at a lower rate in subsequent issuances. Additionally, green bond issuers can also enhance their ESG scores, thereby mitigating climate-related transition risks associated with the company. All these positive value drivers push up stock prices as the bond issuer benefits from a lower cost of debt capital.

Improving reputation and media coverage amplified the demand for stocks.

After the issuance of green bonds, issuers have been able to attract large-scale institutional investors seeking to hedge climate-related risks or add green stocks to their sustainable investment/ESG portfolios. Additionally, at the time of green bond issuance, higher visibility of the company in the media leads to increased curiosity among investors to learn more about the issuer. The interest of institutional investors and media visibility leads to higher demand, which in turn pushes up the company’s stock price. Investors pay more attention, and the company enjoys a reputation boost, rather than immediate financial advantages. This became a significant advantage for large companies like Apple, Tesla, Adani Green, and the State Bank of India, which are willing to be open and transparent by utilising their bonds to enhance their reputation through media coverage, thereby building trust in the minds of their investors and boosting their overall brand value.

Positive signalling impact

Issuers also send a signal to the market that they are decarbonising their business and moving towards low-carbon business models. This signalling force demonstrates the firm’s dedication to reducing carbon emissions and improving its green profile, and investing in such projects can be valuable to firms in the long run, including helping them survive adverse situations. The issuance of green bonds is also an indicator that investors believe these bonds increase the company’s long-term value, as it suggests better governance, reduced risk exposure, and a more trustworthy reputation for the issuers. Green bond issuance also offers marketing benefits for the company, resulting in increased top-line growth by attracting new customers. All these promising elements enhance the company’s fundamental value.

Cautions

While all these uplifting aspects of the green bond issuer enhance its stock price, there are also downside risks associated with the issuer. Greenwashing is one of them. There are instances where firms issue green bonds to appear sustainable and environmentally friendly without making any real changes. The correlation between green bond issuance and GHG emission reduction post the issuance is not significant enough within any timeframe of up to three years from the date of issuance. While energy companies have been able to reduce GHG emissions by utilising the proceeds from capital investments in renewable energy, the reduction has not been substantial enough for non-energy companies. All these downsides can lead to climate-related transition risk, previously considered to be lower for the issuer.

Empirical evidence suggests green bond issuers gain a material gain and a higher stock price only when green bonds are issued for the first time. The subsequent issuance of green bonds has not increased in the stock price. There could be two arguments for the lack of response from investors at the second time issuance. The impact of the company’s positive signal and commitment to the environment on investors has already been reflected in the stock price. Over time, investors may react negatively to issuers if the latter is engaged in the practice of making unsubstantiated or misleading claims about the company’s environmental commitment.

Although there is no fundamental difference between a green and a conventional bond in the financial market, there is inherent business value associated with the issuance of green bonds for investors. Companies that issue green bonds while decarbonising their business models can enhance their value in the era of the green transition, while reducing climate-related financial risks. Green bond issuance is a powerful signal to investors, enabling them to identify the right companies while mitigating the risks associated with greenwashing.

Views are personal and do not represent that of the authors’ employers.

Disclaimer: “Any views or opinions represented in this blog are personal and belong solely to the author and do not represent views of CFA Society India or those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated.”