Green German government securities: a twin with future potential?
Munsbach, the 14th of October — In September, the German government embraced the trend for sustainable bonds with the issue of its first 10-year green sovereign bond. The funds from the issue of these bonds will be used to reach the climate protection targets to which the Federal Republic of Germany has committed itself. Further details are set out in a framework, which is regularly reviewed by an independent body. With these specifications, the German state meets the requirements of sustainably-oriented investors who can use these minimum standards to check that their investments are really being used to protect the environment. Dr. Volker Schmidt, Senior Portfolio Manager and bond expert at ETHENEA Independent Investors S.A., explains how the conventional sovereign bonds differ from its newly issued green twin and what future potential the latter has.
The twin concept
With the introduction of a green sovereign bond, Germany is pursuing a so-called twin concept for German government securities. The 10-year green bond has exactly the same maturity and coupon as the ordinary 10-year sovereign bond. Both mature on 15 August 2030 and have a coupon of 0%. This is intended to make it clear to both investors and the issuer what costs or returns are involved when issuing or investing in a green bond. Thus far, the two securities appear to be identical. However, on closer inspection, there are differences between the twins, as when it was issued the green bond offered a negative yield of -0.46 %, slightly less than the -0.45 % of the conventional bond.
The advantages of green bonds
The advantages of green bonds can be summarised as follows: sustainability and flexibility for investors and interest rate savings for the issuer. A win-win situation for all parties. Based on the initial issue volume of EUR 6.5 billion and with a current yield difference of one basis points between conventional and green bonds, the German government will save EUR 650,000 per year in interest costs with the green bond - and that for the next 10 years! If we assume that the German government issues a total of EUR 50 billion in green bonds and the interest rate discount rises to five basis points, then the annual interest savings of the German government amounts to EUR 25 million. In other words, this is precisely the amount that investors are prepared to forego in order to support Germany's climate protection goals. By the end of 2020, the German government plans to have placed a total of EUR 11 billion in green bonds with investors and will therefore issue a five-year green sovereign bond in the last quarter of this year.
An exciting future
The twin concept also includes the right for the buyer to exchange his green bond for the conventional twin at any time. However, we believe that very few people will exercise this right, as it can be assumed that the green twin will always have a higher value. While the conventional twin should always be slightly more liquid due to its higher issue volume, this minor drawback of the green bond is balanced out by the exchange option. We also believe that the one to two basis point yield discount we have seen so far is certainly only the beginning, given the demand for green investments. The German government has attracted EUR 33 billion in demand for its first green bond, so we would not be surprised if the discount widened rapidly towards five basis points. It will now be exciting to see what discount investors are prepared to accept in the long term when investing in green sovereign bonds.
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