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Investors have long paid a premium to get hold of scarce green bonds, but record issuance might be about to change that.

Bonds sold to fund environmentally-beneficial projects have tended to command higher prices and lower yields than conventional bonds. But that differential -- dubbed the greenium -- all but vanished in April in the euro corporate bond market.

Comparing option-adjusted credit spreads on an index of euro green bonds with a comparable index of conventional bonds, the Association for Financial Markets in Europe, an industry body, found investors in April paid virtually no premium for holding green corporate bonds. That compares with an average 9 bps premium in 2020.

Estimates vary, depending on methodology, as most green bonds don't have a directly comparable conventional peer. But market players generally agree greeniums are shrinking.

The driver, it seems, is a big increase in supply.

Companies in the euro investment-grade corporate bond market, a major source of green funding, have already raised nearly as much through green bonds this year as during the whole of 2020, according to Refinitiv.

It's good news for investment funds that are under pressure to invest under environmental, social and governance (ESG) tenets. But borrowers may need to re-evaluate the cost advantage of funding themselves via the green market.

(GRAPHIC: Greenium dwindles in 2021 - https://fingfx.thomsonreuters.com/gfx/mkt/ygdvzxybyvw/BjZVB-greenium-dwindles-for-euro-ig-corporate-bonds-in-2021%20(1).png)

In selling their bonds, green issuers still paid a smaller new issue premium this year than conventional issuers, but the pricing benefit relative to conventional issuance has halved compared to 2020, according to data from ABN AMRO.

The spike in issuance comes as borrowers globally have raised $193 billion from green bonds this year, Refinitiv data to May 25 shows, a record for this time of year and nearly three times the amount raised at this point in 2020.

"There is a kind of limit to how big the greenium could get. Investors still need to make returns," said Barnaby Martin, head of credit strategy at BofA.

"If there's a lot more supply of green debt, eventually that's going to hit technicals."

In another sign that green bonds are becoming less scarce, green issuance comprises 16% of this year's euro investment-grade corporate bond sales -- more than double its share last year, according to Refinitiv.

Much of the euro issuance is from utilities and real estate firms, ABN AMRO senior fixed income strategist Shanawaz Bhimji said, noting these sectors already have many green bonds outstanding.

"If there's not much issuance coming from sectors which offer diversification, the market is not going to pay up," he said.

(GRAPHIC: Green bond issuance - https://fingfx.thomsonreuters.com/gfx/mkt/oakvebzxmpr/mF9gw-green-bond-issuance-triples-on-this-time-last-year.png)

SCARCITY PREMIUM

In government bonds and in corporate sectors where green debt is rare, the greenium still lingers. For instance, Daimler's green bond offers a credit spread that's seven basis points tighter than a conventional bond due the same year.

And in the U.S. dollar investment-grade market, with fewer green bonds, green borrowers have commanded a pricing benefit of about 10 bps at issuance since 2020, according to Goldman Sachs, though that is down from 16 bps in 2016-2019.

But on both sides of the Atlantic, the scarcity premium is shifting to social and sustainability bonds, the bank argues.

Social bonds finance expenditures like healthcare or education while sustainability bonds can fund both social and green projects. They are scarcer as issuance really only kicked off after the pandemic erupted last year.

Since last year, such bonds have offered issuers a 20 bp premium on average at issuance in the euro investment-grade market and 36 bps in U.S. dollars, Goldman estimates.

The good news for those who believe in the power of green finance to improve corporate environmental credentials is that the declining greenium has not deterred issuers.

"We hear from corporates it's not purely about the concession. They really want to improve their standing within the investment community," said Bhimji at ABN AMRO.