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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