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New research finds the pricing of tax-exempt municipal “green bonds” is nearly identical to similar non-green securities.
Municipal bond investors don’t seem very interested in taking a hit on their returns to support environmentally friendly projects, new research about tax-exempt “green bonds” suggests.
The thinking with green bonds is that they might drive extra demand among investors, especially those concerned about environmental and social responsibility goals. That should advantage governments issuing the bonds when it comes to borrowing terms and costs.
But researchers at Stanford University in a working paper released last month found that when comparing green municipal bonds to nearly identical non-green municipal securities, investors “appear entirely unwilling” to sacrifice gains in wealth to invest in green projects.
The paper also says investment banks, on average, appear to charge slightly more to issue green bonds, and that getting the bonds certified as “green” can add other costs for borrowers.
Green bonds can be used for projects ranging from clean energy to transit. S&P Global Ratings found in an analysis released last year that the majority of green bond issues it examined were for projects involving water, green buildings and transportation.
Massachusetts issued the nation’s first municipal green bonds in 2013, $100 million for a water and energy savings program. Since then, the bonds have become more common in the U.S.
San Francisco’s Public Utilities Commission has spent green bond proceeds on projects like water treatment plant and water pipeline upgrades. While King County, Washington has used funding from the bonds for waste transfer station projects and landfill closures.
S&P said in its report that “self-labeled” municipal green bond issues grew by about 43 percent in 2017 to 65 issues worth $10.4 billion. From 2013 to 2017, New York, California and Massachusetts were the top issuers of green municipal debt, accounting for nearly half of the transactions during that time, the report adds.
The Stanford paper says that between 2013 and 2017 green municipal bond issues exceeded $23 billion, a significant sum, but still a relatively small share of the roughly $3.8 trillion muni bond market.
To examine pricing, the researchers looked at 640 matched pairs of green and non-green bond issues, issued on the same day, by the same municipality. The green and non-green bonds had the same ratings and the same timelines for repayment.
In about 85 percent of the matched cases, they found the difference in yield for investors on the green and non-green bonds was zero.
They used another type of matching method as well that produced results along the same lines.
The study differs from past research that has used survey and experimental data to look at similar issues.
Edward Watts, a PhD candidate at Stanford’s business school and one of the study’s co-authors, says for an investor comparing green and non-green bonds with the same risks, the question becomes: “why am I going to pay any more for this particular security?”
Watts says the higher transaction costs involved in some green bond deals should be considered in context.
He said on a $150 million deal, general issuance costs might be in the ballpark of $500,000 to $600,000, while the extra costs involved in a green deal might add another $60,000 to $70,000.
“In the grand scheme of things it might not be huge, but again, it’s just 70 K that’s just sort of out the door,” he said.
The paper notes that due to a lack of standardization for what qualifies as a “green” bond, third-party certification providers have emerged to verify that borrowing proceeds are being used for eco-friendly projects. The cost for these services can run into the $50,000 range.
“If you’re a state or local government,” Watts said, “and you’re really deciding whether to issue these green securities or not, if it increases cost of issuance, you should really consider whether, and actually ask: is it really going to decrease my cost of borrowing?”
For now, he added, “it seems like the market is not pricing it.”
Watts emphasized that the working paper only looks at the tax-exempt municipal market and that it's unclear whether examining other types of securities, like taxable, corporate green bonds would produce the same results. A full copy of the paper can be found here.
Bill Lucia is a Senior Reporter for Route Fifty and is based in Olympia, Washington.