by Harrison Zane Cole

Abstract

Since the end of the pandemic the market capitalization of green bonds and investor interest in sustainable investments has grown massively. The tidal wave of ESG funds has accompanied many claims of greenwashing and extreme variation in investment quality. While many investors focus on doing their own due diligence, second party ratings are an important source of information for capturing overall risk and characteristics of a security. This paper aims to take a deeper look at how HIP Investor’s (a popular ESG rating firm) ratings correlate to real-world yield and bond characteristics. Yield refers to the annualized return that investors receive from a bond, and lower yields at issuance reduce borrowing costs for the issuer. It is generally established in popular and academic literature that green bond designation does not directly lead to a benefit for issuers in terms of their cost of capital expressed through interest rates. This paper examines the yield at issuance effects for degrees of “actual greenness” and other inputs that may lead to a security to fit well in an ESG focused or impact fund. Within a sample of green bonds, the estimated yield to worst spread premium for a best-in-class (environmentally) ESG issuer is -23.9 basis points compared to a worst-in-class issuer holding all else equal. When considering non-environmental factors such as human health, the effect is larger at -71.4 basis points. For social wealth considerations, the directionality is reversed at 17.9 basis points. More research is needed to better understand and apply these results. This decrease in interest rates can result in millions of dollars of savings for larger issuances.

Professor Lawrence Kreicher, Faculty Advisor
Professor Michelle Connolly, Faculty Advisor

JEL Codes: G1, G12, G14

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