Green, social and sustainability bonds – debt that finances environmental or social projects – have yet to become as popular in America as in Europe. They make up 7.4 per cent of the key euro-denominated corporate bond index but just 1.6 per cent for its dollar-based equivalent. To catch up with the euro-index, an additional USD430 billion of dollar bonds would have to be issued.
But despite a shortage of qualifying dollar bonds, there is evidence of strong demand and US sustainable bond funds have been growing quickly. However, we expect the dollar market may grow differently to Europe’s.
Euro-issues account for 48 per cent of all outstanding green bonds and 51 per cent of sustainability bonds while the dollar proportions are just 29 per cent and 33 per cent. In the year to June, Europe issued 48 per cent of all green bonds, with just 19 per cent from North America. And while European issues were 132 per cent higher than in the same period of 2020, US growth was just 97 per cent.
But the strength of demand for dollar bonds shows in the ‘greenium’ – how much more investors will pay for green, social and sustainability bonds. For dollar-based corporate bonds investors will accept a yield 5.4 basis points lower than for comparable non-green bonds from the same issuer; for their euro equivalents the difference is just 2 points.
This indicates a shortage of dollar-denominated green bonds relative to demand and a desire by investors to diversify.
Investment in sustainable funds holding dollar-based corporate bonds has grown quickly from a low base over the past two years. However, variation in sector weights between the dollar and euro corporates indices means the markets may develop differently.
To issue green bonds, issuers need projects to fund and a clear transition story. So now that car companies are rolling out electric vehicles, they can issue green bonds. But the US index has a lower weight in auto firms than the European index. The US index also has lower weights for banks and utility companies, which in Europe have been large issuers of green bonds.
However, the dollar index is overweight oil and gas – a hard to abate, high carbon-intensity sector that could struggle to issue green bonds.
Sustainability-linked bonds could provide an alternative. These don’t fund projects; instead the coupon, or principal, steps up if the issuer fails to meet pre-agreed environmental targets. This focus on outcomes rather than inputs makes them well-suited to sectors unable to issue green bonds. Indeed, USD24 billion has been issued in dollar-bonds since September 2020 compared with USD18 billion of euro bonds. May’s dollar total was more than double the euro issuance.
Meanwhile, the US municipal-bond market could prove a spur for issuance, given that municipalities typically fund public projects. Only about 1.6 per cent of the USD4.4 trillion market is in green bonds. The green muni market could also benefit from a possible return of Build America Bonds under the Biden administration’s stimulus plan.
The direction of travel is clear: environmental, social and governance issues will rise in importance in US bond mandates with the potential for more bond issuance in dollars – even if the regulatory environment adopts a lighter touch than in the EU.
First published 4 June 2021.
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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Dominic Kini
Fixed income: Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to four months, relating to specific instruments, which are predominantly derived from relative value considerations or driven by events and which, in the case of credit research, may differ from our long-term opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; HSBC has assigned a fundamental recommendation structure, as described below, only for its longer-term investment opportunities.
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Definitions for fundamental credit and covered bond recommendations
Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve within the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.
Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable for up to six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.
Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate within the next six months.
For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.
Definitions for trades (Rates & Credit)
Buy and Sell refer to a trade call to buy or sell a bond, option on an interest rate swap ("swaption"), interest rate cap or floor, inflation cap or floor, or Total Return Swap ("TRS"). The buyer/seller of a TRS receives/pays the total return of the underlying instrument or index at the end of the period and pays/receives the funding leg.
Buy protection and Sell protection refer to a credit default swap (CDS): the protection buyer/seller is effectively selling/buying the reference entity's credit risk.
Pay and receive refer to a trade call to pay or receive the fixed leg of an interest rate swap (IRS), a non-deliverable IRS, the firstnamed leg of a basis swap, the realised inflation leg of an inflation swap, or a forward rate agreement (FRA). An investor that executes a pay or receive trade is said to be "paid" or "received."
Payer and receiver refer to inflation caps or floors and to swaptions: a payer is an option giving the right but not the obligation to enter a paid position in an interest rate or inflation swap, and a receiver is an option giving the right but not the obligation to enter a received position in an interest rate or inflation swap.
ASW (also asset-swap, Buy on asset swap, Buy on an asset-swapped basis): Buy a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
RASW (also reverse asset-swap, Sell on asset swap, Sell on an asset swapped basis): Sell a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.
Distribution of fundamental credit and covered bond recommendations
As of 02 June 2021, the distribution of all independent fundamental credit recommendations published by HSBC is as follows:
All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Overweight 119 26 64 54
Neutral 219 49 92 42
Underweight 112 25 36 32
For the purposes of the distribution above the following mapping structure is used: Overweight = Buy, Neutral = Hold and Underweight = Sell. For rating definitions under both models, please see "Definitions for fundamental credit and covered bond recommendations" above.
Distribution of trades
As of 31 March 2021, the distribution of all trades published by HSBC is as follows:
All Covered instruments Issuers to whom HSBC has provided Investment Banking in the past 12 months
Recommendation Count Percentage Count Percentage
Buy 133 76 84 63
Sell 41 24 22 54
For the purposes of the distribution above the following mapping structure is used: Buy/Sell protection/Receive/Buy Receiver/Sell
Payer = Buy; and Sell/Buy protection/Pay/Buy Payer/Sell Receiver = Sell. ASW is counted as a buy of the bond and a paid swap, and RASW as a sell of the bond and a received swap. For rating definitions under both models, please see "Definitions for trades (Rates and Credit)" above.
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Recommendation changes for long-term investment opportunities
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