Danmarks Nationalbank and the Ministry of Finance are looking into the possibility of adding a green element to the Danish issuance programme in a way that ensures a continued well-functioning and liquid market for Danish government bonds. This work will continue until a final political decision on green issuance is made. A liquid government bond market is essential, as a high degree of tradability means that investors are willing to pay a higher price for the bonds, implying reduced funding costs for the Kingdom of Denmark. All else equal, the larger the bond size, the more tradable it is. That is why it is important to ensure a sufficiently large outstanding volume in the individual bond lines. Following this, we are working on a model for sovereign green bonds that will enable small sovereign issuers like Denmark, with limited funding needs, to access the green bond market without compromising liquidity.
CONVENTIONAL SOVEREIGN GREEN BONDS IMPLY A LOSS OF LIQUIDITY
Countries with larger funding needs than Denmark have already issued sovereign green bonds, but in ways that may challenge liquidity for small sovereign issuers such as Denmark:
In one model, the existing issuance programme is maintained, but supplemented with a new sovereign green bond. As the number of bond lines increases, the volume in the existing bond lines decreases. This entails a fragmentation of the issuance programme. Such a model may imply a loss of liquidity, which will increase the funding costs for the Kingdom of Denmark.
In another model, the existing issuance programme is maintained, but one of the existing bond lines, i.e. the 10-year maturity segment, is dedicated to issuance of green bonds going forward. This model minimises the loss of liquidity, as fragmentation of the issuance programme is avoided, but it will put considerable demands on the amount of green expenditures, since it requires having enough green expenditures each year to ensure that the bonds are built up to sufficient outstanding volumes.
A NEW MODEL FOR SOVEREIGN GREEN BONDS
Danmarks Nationalbank is therefore working on a model for sovereign green bonds that enables the Kingdom of Denmark to preserve liquidity in the market for Danish government bonds, and at the same time allows for green financing to the extent desired by the government.
What makes this model new?
A conventional sovereign green bond comprises two commitments.
- A financial commitment in terms of coupon payments, redemptions etc. – as for all bonds.
- A commitment that the expenditures for green projects and initiatives at least match the proceeds from selling the sovereign green bonds.
In the new model, these commitments are split (stripped) into two. This is also illustrated in the chart. The financial commitment will be issued as a conventional government bond, while the green part of the commitment will be issued as a green certificate. Owning both the conventional government bond and the green certificate is equivalent to owning a sovereign green bond. Hence, the green certificates constitute a commitment by the Kingdom of Denmark, that the green expenditures at least match the proceeds from selling a package of a conventional government bond and a green certificate.
Government bonds and certificates are sold together at green auctions
The green certificates will be sold at green auctions as part of a package containing a conventional government bond and a green certificate. If an investor's bid at the auction is accepted, the investor will receive green certificates with a nominal value corresponding to the nominal value of the allocated government bonds. When the investor buys a package containing a government bond and a green certificate, the investor de facto owns a Danish sovereign green bond. Green auctions, at which the green certificates are sold, will replace some of the conventional auctions. The number of green auctions depends on the amount of green expenditures.
The green certificates can be traded separately
The green certificates can only be matched with the bond they are sold with, e.g. a certificate maturing in e.g. 2029, can only be matched with a government bond maturing in 2029. The certificates will have their own ISIN codes and can be traded separately in the secondary market. Consequently, investors will have the opportunity to buy a sovereign green bond by purchasing the green certificate and the matching government bond as a package, e.g. at the auctions, or by buying both of them in the market. In technical terms, the green certificate is a zero-coupon bond with zero redemption at maturity. Hence, there are no financial commitments or corporate actions connected with the certificates. The green certificates will cancel at the same maturity date as the matching government bond they are sold with.
Same as conventional green bonds – but better
The new model is identical to conventional sovereign green bonds. Firstly, the government commits to ensure that the green expenditures at least match the proceeds from the green issuances. Secondly, the government will commit to provide investors with transparent reporting on the use of proceeds and to report on the positive environmental impact. The model for green issuance in Denmark will follow international best practices in terms of identification of eligible green expenditures, documentation and reporting.
Hence, buying a package of a conventional government bond and a green certificate will enable investors to support the green agenda to exactly the same extent as if they had bought a conventional sovereign green bond.
Work on the new model continues as it enables the Kingdom of Denmark to issue sovereign green bonds without compromising liquidity to the beneficitof both the Kingdom of Denmark and the investors.