03-02-2022 12:39

3 reasons for Denmark’s large green bond premium

The Kingdom of Denmark's first green bond auction in January drew strong investor demand and a large green bond premium, or "greenium," of 5 basis points. Our experts explain why.
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Anders Skytte Aalund, Chief Analyst, Nordea Markets

The Kingdom of Denmark made an impressive debut in the green bond market in January, attracting strong investor demand and a hefty premium that gives the country access to cheaper funding for its green transition.

At the auction on 19 January, Denmark sold 10-year bonds worth around DKK 5 billion ($760 million). The order book was oversubscribed by almost five times that amount at DKK 23.5 billion, the highest at an opening auction for Danish government bonds since 2008. Investors were willing to pay a green bond premium, or “greenium,” of 5 basis points – one of the largest for a high-grade sovereign issuer.

One person who was not surprised by the large greenium was Anders Skytte Aalund, the fixed income analyst behind Nordea’s forecast. Nordea was the only bank to predict the 5 basis point yield spread, which was at the top end of forecasts.

“The Danish pension sector is huge, and there’s also strong demand for being part of the green transition here in Denmark,” says Aalund. “Given the significant investor appetite, we needed to make our forecast fairly aggressive.”

Given the significant investor appetite, we needed to make our forecast fairly aggressive.

Anders Skytte Aalund, Chief Analyst, Nordea

Jacob Michaelsen, Head of Sustainable Finance Advisory, Nordea

What explains Denmark’s large greenium?

Jacob Michaelsen, head of Nordea’s Sustainable Finance Advisory team, worked closely with Danmarks Nationalbank in Nordea’s role as sole structuring advisor for Denmark’s green bond framework. He points to three main factors driving the large greenium:

  • The decision to go with a traditional green bond format
  • A diligent effort to align with the EU Taxonomy
  • The rarity and desirability of a Nordic green bond

Opting for a traditional green bond over a certificate structure

January’s auction came after a years-long process in which the Danish central bank examined various potential models for its inaugural green issuance. The main challenge was finding a structure that would attract investor interest while also taking into account liquidity concerns, given Denmark’s strong public finances and limited need for financing.

One novel approach under consideration was to use a so-called “certificate” structure where a conventional bond would carry a green label that could be stripped off the underlying bond and sold separately.

However, the Danish central bank ultimately decided to adopt a model used by Germany for its 2020 inaugural green issuance: the twin-bond approach. The conventional bond and a green bond are sold as twin bonds, with the same financial characteristics, but where the green bond’s proceeds are earmarked for green projects. The model addresses liquidity concerns by allowing investors to switch to the more liquid conventional bond at any time.

“I suspect no investors will want to go back and make the change, which carries a small cost. But they know that they have that option,” says Michaelsen.

He adds that the fact that the green bonds are traditional green bonds that follow the Green Bond Principles of the International Capital Market Association (ICMA), rather than a novel type of bond with a strippable certificate, was a selling point for investors.

No other country has gone to the same lengths to try to align their green bonds with the EU Taxonomy.

Jacob Michaelsen, Head of Sustainable Finance Advisory, Nordea

Jan Størup Nielsen, Chief Analyst, Nordea

High standards under the EU Taxonomy

Michaelsen attributes the bulk of the greenium to the Danish green bond’s high standards and reliance on the EU Taxonomy, the European Union’s ambitious framework for classifying green investments.

The framework focused on expenditures related to climate change mitigation – one of the climate-related parts of the Taxonomy that became law in late 2021. Denmark’s framework lays out the defined costs within the production of sustainable energy and for financing the Danish transport sector’s green transition. The different expenditures are assigned to the EU’s NACE industry classification codes used in the Taxonomy.

“Hold Denmark’s framework up to that of any other sovereign,” says Michaelsen. “No other country has gone to the same lengths to try to align their green bonds with the EU Taxonomy.”

He does note that one challenge for sovereign issuers in particular is meeting the Taxonomy’s “do no significant harm” requirement, given that some of the bond proceeds go towards subsidy programs set up decades ago, long before the do-no-significant-harm principle was in place.

A rare chance to be part of Denmark’s green transition

Finally, Michaelsen pinpoints the Nordics’ reputation as frontrunners in the green transition, as well as the rarity of Nordic sovereign green bonds, as another driver of the Danish greenium.

“With less new issue, more investors will fall over their feet to get hold of this type of bond,” he says.

Aalund adds that if investors want to be part of the green transition and own Danish sovereign green bonds, they will likely need to buy them at an auction. Denmark’s expected green issuance volume for 2022 is DKK 15 billion.

Nordea Chief Analyst Jan Størup Nielsen expects the keen investor interest to continue going forward, both among traditional Danish investors and among foreign investors, attracted by Denmark’s strong public finances and reputation as a green trailblazer. What’s more, the strong interest could also spill over to the pricing of conventional government bonds, he says:

“The supply will be smaller, and the launch of green bonds could attract new investors to the Danish government bond market.”