The Growing Green Bond Market Could Plateau. How Can It Grow Further?

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(The RAND Blog)

Watering a topiary depicting growth, photos by robert and Naypong Studio/Adobe Stock

Robert and Naypong Studio/Adobe Stock

by David Catt, Nihar Chhatiawala, Mark Stalczynski

November 23, 2021

This is one in a series of commentaries on environmental finance and green bonds.

Investors have a growing appetite for environmental, social, and governance (ESG) products like green bonds, which have positive societal impacts in addition to risk-adjusted financial returns.

Sales of green bonds have grown rapidly over the past decade, from roughly $4.2 billion in 2012 to nearly $300 billion in 2020. The Climate Bond Initiative (CBI), a non-profit that certifies and tracks green bonds, estimates total issuances at over $1 trillion. While encouraging, this is still a small and novel share of the $100 trillion global bond market.

If green bonds are a viable tool to reduce emissions and adapt infrastructure to the effects of climate change, how can governments encourage the issuance, sales, and growth in the share of green bonds in the total bond market?

Promoting a "Greenium"

One strategy may be to emphasize and promote a premium for green bonds. This so-called "greenium" refers to a yield discount that investors may be willing to pay because of the higher demand for ESG products or a perceived reduction in risk for green investments.

For example, there may have been a 5 basis-point premium for green bonds in the secondary municipal bond market versus an equivalent S&P Index between 2014 and 2018. Additionally, studies in the Journal of Banking and Finance and the Proceedings of the European Financial Data Institute have suggested that green bonds issued by governments and supranational entities may have a premium that exceeds corporate-issued green bonds. The existence of a greenium could incentivize further issuances of green bonds in the primary market; if that greenium persists after issuance, investors might benefit from sales of green bonds in the secondary market.

Some research on the existence of a greenium, however, posits that the iterative nature of pricing discussions may be a result of both pricing methodologies and market growth dynamics.

The sustained existence of a greenium may hinge upon a consistent and objective measure of "greenness."

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If a greenium is not present, the market could plateau. To that end, the sustained existence of a greenium may hinge upon a consistent and objective measure of "greenness." Ensuring that green bonds are in fact sufficiently green remains a challenge and is not without costs, as our colleagues have discussed. That could hold back newcomers to the market and reduce the supply of issuances.

Unfortunately, green bonds are currently self-labeled by issuers that can choose from a variety of external reviewers and standards. The lack of consistency and objectivity in green labels threatens market integrity and growth. Companies that have low overall ESG ratings and that typically do not have green projects have had trouble convincing investors to accept green ratings on transition projects.

Additionally, smaller firms must shoulder high monitoring costs to prove their compliance to investors. Adopting consistent standards could lower these costs and offer governments the opportunity to promote a green transition by stimulating green bond demand through fiscal, monetary, and regulatory policies.

The Role of Governments and Central Banks

According to data from CBI, the largest issuers of green bonds from 2014 to 2020 were in the United States, China, and the European Union. Corporate institutions accounted for roughly 56% of issuances; government entities (national, local, and government-backed) almost 30%; and development banks almost 20%.

Policymakers might consider offering tax exemptions for investors in certified green corporate bonds similar to those that exist for municipal bonds. Such a mechanism might attract capital to green assets and reduce debt burdens on green asset owners.

There may be a limit to the share of the overall bond market that green bonds can reach without external policies to boost supply and demand.

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Globally, central banks could also play a role. They hold vast amounts of government and corporate bonds as a result of quantitative easing and could begin to tilt purchases toward green bonds and buy fewer brown assets. Central banks also impose capital requirements on commercial banks and insurance companies to reduce systemic financial risk. They could begin to require these institutions to prioritize holding and disclosure of green bonds with equivalent financial risk to the typical requirements.

If these actions can be accomplished without compromising monetary policy goals, the outcome could be a win-win in promoting the greening of the financial system.

Planning for Growth

To date, the green bond market appears to have grown organically as a result of private and non-profit entities like the CBI certifying green bonds to satisfy a growing appetite for ESG investments. But there may be a limit to the share of the overall bond market that green bonds can reach without external policies to boost supply and demand.

The long-term growth of the green bond market could hinge on confidence in the existence of a greenium and wide adoption of high-quality certification standards. If governments view green bonds as an additional tool to offset climate change, they might develop more fiscal, monetary or regulatory policies to encourage the issuance and purchase of these securities.


David Catt and Nihar Chhatiawala are doctoral students at Pardee RAND Graduate School and assistant policy researchers at the nonprofit, nonpartisan RAND Corporation. Mark Stalczynski is a quantitative analyst at RAND. This commentary was supported by the John and Carol Cazier Initiative for Energy and Environmental Sustainability.

Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.