LIQUIDITY RISKS IN GREEN BONDS

Thomas Hgglund

Contents

Definition Aim of study Theory & Literature Method Research strategy Empirical findings Conclusions Research implications

Definition of Green Bond

Issuer:
Governments or municipalities, commercial or development banks, corporations, government qualified organizations

General criteria:
Raise capital for a project with specific environmental benefits, Investments in climate change mitigation or adaptation, such as clean energy, energy efficiency, mass transit and water technology

Coupon rate:
Zero coupon, fixed-rate, floating rate, index-linked, coupon linked to environmental performance

Securitization:
Asset-backed, by the issuing institution, mortgages or public sector loans (covered bonds) or guaranteed by a third party.

Aim of study
Liquidity risks in Green Bonds Definition:
Liquidity risk or marketability risk depends on the ease with which a bond can be sold at or near its value Fabozzi 2011.

The primary measure of liquidity is the size of the spread between the bid price and the ask price quoted by a dealer. The wider the spread, the higher the liquidity risk
Frequency
Portfolio Managers marking a position to market (mark to market)

Market makers: distributing information of buyers and sellers

Theory & Literature

Fixed-Income Securities:
Bond characteristics, Bond pricing, Bond yields
Factors affecting bond yields Bond yield analysis

Risks related with bonds

Previous research
Green Bond definition Green Bond market (OECD, SP Policy Brief) Current Green Bonds (IBRD, IFC, EIB, NIB)

Method
Quantitative analysis:
Market data of bid-ask prices for Green Bonds Spread analysis, yield analysis

Comparison to benchmark bonds:

German government bonds with similar maturities and coupons

Qualitative analysis:
Market information from market makers, clearing houses, institutional investors, etc.

Research strategy
Data collection:
World Bank (IBRD), the most visible issuer Market makers, SEB, JP Morgan, Merrill Lynch Exchanges (Luxemburg, Frankfurt, Berlin, Stuttgart)

Constrictions
Three different maturity Green Bonds and similar benchmark bonds Specific research period

Supporting features:
Interviews with institutional investors of research findings with focus on validity (insurance companies, pension funds, etc.)

Empirical Findings

WORLD BANK 10-year (3,5%)

112.000 111.000 110.000 109.000 108.000 2.000% 107.000 106.000 105.000 104.000 1 2 3 4 5 6 1.500% 1.000% 0.500% 0.000% 4.500% 4.000% 3.500%

BUNDANL. 10-year (3,5%)

118.200 118.000 117.800
3.000% 2.500% Spread Ask Bid

0.018% 0.016% 0.014% 0.012%

117.600 117.400 117.200

0.010% 0.008% 0.006% 0.004%

Spread Bid Ask

117.000 116.800 1 2 3 4 5 6

0.002% 0.000%

Empirical Findings

WORLD BANK 6-year (3,5%)

106.000 1.200%

BUNDOBL 7-year (0,77%)

109.400 0.231% 0.230%

105.500

1.000% Spread (Frankfurt) Spread (Berlin) 0.600% Bid (Frankfurt) Bid (Berlin) 0.400% Ask (Frankfurt) Ask (Berlin)

109.200 0.229%

0.800% 105.000

109.000

0.228% 0.227% Spread Bid Ask

108.800 0.226% 108.600 0.225% 0.224% 108.400 0.223%

104.500

104.000

0.200%

103.500 1 2 3 4 5 6

0.000%

108.200 1 2 3 4 5 6

0.222%

Empirical Findings

WORLD BANK 5-year (2,0%)

101.600 101.550 101.500 101.450 101.400 101.350 101.300 101.250 101.200 101.150 101.100 101.050 1 2 3 4 5 6 0.295%
105.300 1 2

BUNDESOBL. 5-year (2,25 %)

0.295%
105.550 0.009% 0.009%

0.295%

105.500

0.009% 0.009%

0.295% Spread 0.295% Bid Ask

105.400 105.450

0.009% 0.009% 0.009% 0.009%

Spread Bid Ask

0.295%

0.295%

105.350

0.009% 0.009% 0.009% 3 4 5 6

Empirical Findings
Yield curve
4.5 4 3.5 3
YIELD

2.5 2 1.5 1 0.5 0 5 7 MATURITY 10 Green Bond Gov.Bond

Conclusions
Liquidity risks are present in Green Bonds Bid-ask spreads are exceptionally high Pricing of risk? The level of uncertainty is high Trading frequency low Mark to market activity non-existent in long maturity Green Bonds Unattractive for active managers/investors Buy & Hold strategy Liquidity risk irrelevant

Research Implications
Active market makers:
Marketing Competition

More Green Bond issuers:

Green Investment Bank Other financial institutions Governments

Increased interest and awareness amongst institutional investors