Germany set for first green bond with innovative structure but little scope for higher issuance

The German debt agency (Finanzagentur) is planning to issue green bonds as so-called twin bonds. The agency will designate a portion of bonds sold in conventional debt auctions as green bonds with the same maturity and coupon as their conventional bond twin, though as separate securities with their own ISINs. The green security will comply with the Green Bond Principles as defined by the International Capital Market Association (ICMA) so will be comparable to green bond issues by France (EUR 7bn in January 2017), Belgium (EUR 4.5bn in February 2018), and the Netherlands (EUR 5.98bn in May 2019).

“As a sovereign issuer, Germany is entering the green bond market later than some peers, but with a new strategy. Tying green bonds to conventional bonds could help to enhance market liquidity compared to issuing green bonds independently,” says Bernhard Bartels, lead analyst for Germany’s sovereign rating.

It is worth noting that KfW (AAA/Stable), the German government development bank that is seen as a sovereign proxy by capital markets by virtue of a Federal Republic guarantee, has been a regular issuer of green bonds since 2014. By the end of 2019, KfW had a total of EUR 22.6bn in green bonds outstanding.

The Federal debt agency has communicated to market participants that the expected size of its first green bond will be in the high single-digit to low double-digit billion range and mentioned the government’s intention to offer green securities along the entire yield curve out to 30 years.

“The government’s intention to offer green bonds on a broad scale could help ensure its position as a benchmark issuer, especially at the longer end of the yield curve,” says Bartels. “However, as long as the government sticks to its “black-zero” commitment, we see little scope for large-scale green bond issuance. Moreover, the replacement of some conventional bonds by green bonds does not necessarily generate a higher volume of green projects if already-existing projects are simply re-labelled in accordance with the green bond principles,” Bartels adds.

The scope for German green bonds is limited since the federal government’s debt burden has declined by around EUR 64bn from end-2012 to 2018, specifically, from EUR 1.39trn to EUR 1.32trn in 2018. The central government debt-to-GDP ratio has declined by 10pp to 40% of GDP over the same period, driven by steady growth and balanced budgets, reducing the need for debt issuance. In the absence of a debt-increasing investment programme to finance plans to become carbon-neutral by 2050, the ability to issue sovereign green bonds could remain restricted. Current programmes focus on budget neutrality, for instance by refinancing investments with environmental tax revenues.

The Green Bond Principles leave ample room for policymakers to define the use of proceeds. While the ICMA lists a number of possible uses, this list is not exhaustive and allows issuers to provide their own definition of environmental sustainability. In addition, the ICMA recommends a second-party opinion or certification of green bond programmes. Typically, governments finance infrastructure projects, energy-efficient housing or renewable-energy projects.

“As of now, the established ICMA framework does not guarantee the use of proceeds from green bonds for green projects given that they only provide guidelines, which allow the use of many instruments to serve a general purpose,” Bartels says. The upcoming green bonds will refinance existing green projects as well as new ones. For instance, the government could use green issuance to finance projects via the public energy and climate fund (EKF), part of which is currently used to reimburse energy companies for premature closure of coal plants.

Investors in sovereign green bonds rely on the selection of projects by respective governments and ministries for green ends. At the same time, many highly-rated issuers can expect low if not negative interest rates on green bonds given heightened market demand for these products. This may incentivise issuers to invest mainly in the reporting of projects as being green rather than programming new green projects.