Liquidity risks in Green Bonds

8/13/2019 Liquidity risks in Green Bonds

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LIQUIDITY RISKS IN GREEN BONDS

Thomas Hägglund



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 developmentbanks, corporations, government qualified organizations

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

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

Securitization:Asset-backed, by the issuing institution, mortgages or publicsector 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 withwhich a bond can be sold at or near its value“ – Fabozzi 2011.

The primary measure of liquidity is the size of thespread between the bid price and the ask pricequoted by a dealer.

The wider the spread, the higher the liquidity risk

FrequencyPortfolio 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 definitionGreen 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 analysisComparison to benchmark bonds:

German government bonds with similarmaturities and coupons

Qualitative analysis:

Market information from market makers, clearinghouses, 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 periodSupporting features: Interviews with institutional investors of research

findings with focus on validity (insurance companies,pension funds, etc.)



Empirical Findings

0.000%

0.500%

1.000%

1.500%

2.000%

2.500%

3.000%

3.500%

4.000%

4.500%

104.000

105.000

106.000

107.000

108.000

109.000

110.000

111.000

112.000

1 2 3 4 5 6

W O R LD B A N K 1 0 - y ea r ( 3 , 5 %)

Spread

Ask

Bid

0.000%

0.002%

0.004%

0.006%

0.008%

0.010%

0.012%

0.014%

0.016%

0.018%

116.800

117.000

117.200

117.400

117.600

117.800

118.000

118.200

1 2 3 4 5 6

B U N D AN L . 1 0 - y ea r ( 3 , 5 %)

Spread

Bid

Ask



Empirical Findings

0.000%

0.200%

0.400%

0.600%

0.800%

1.000%

1.200%

103.500

104.000

104.500

105.000

105.500

106.000

1 2 3 4 5 6

W O R LD B A N K 6 - y e ar ( 3 , 5 %)

Spread (Frankfurt)

Sp re ad ( Be rlin )

Bid ( Fran k f u rt)

Bid ( Be rlin )

Ask ( Fran k f u rt)

A s k ( B e r l i n )

0. 222%

0. 223%

0. 224%

0. 225%

0. 226%

0. 227%

0. 228%

0. 229%

0. 230%

0. 231%

108. 200

108. 400

108. 600

108. 800

109. 000

109. 200

109. 400

1 2 3 4 5 6

BUNDOBL 7-year (0,77%)

Spr ead

Bid

Ask



Empirical Findings

0.295%

0.295%

0.295%

0.295%

0.295%

0.295%

0.295%

101.050

101.100

101.150

101.200

101.250

101.300

101.350

101.400

101.450

101.500

101.550

101.600

1 2 3 4 5 6

W O RL D B A NK 5 - ye a r ( 2 , 0% )

Sp re ad

Bid

Ask

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

0.009%

105.300

105.350

105.400

105.450

105.500

105.550

1 2 3 4 5 6

BU NDESOBL. 5-year (2,25 %)

Sp re ad

Bid

Ask



Empirical Findings

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5 7 1 0

Y I E L D

MATURITY

Y ie ld c ur ve

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/investorsBuy & 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

Liquidity risks in Green Bonds

Documents

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