Financing decarbonization

Success with a number of funding applications has allowed us to develop an extensive body of work over the last couple of years to address issues linked to the challenge of financing decarbonization. This is linked to the requirement for consistent taxonomies in the use of “green” finance; premiums in the issuance of green bonds; liquidity and volatility in bonds; market segmentation across sectors as well as the policy implications of these.

In one of our papers, we claim that yield discounts of green bonds (the greenium) should be estimated as a function of non-green bonds. By doing this we find the relationship to not be linear between green and non-green and indeed that the spread widens for higher yield spreads. At the same time we identify a mismatch between the pricing of green bonds and the issuer’s credit risk. This alerts us to possible negative effects in financing the energy transition by the possibility for cascading defaults if the market recognises these instruments as overvalued.

Currently under review is work on market segmentation and how green taxonomies can lead to uncertainty, which could delay the green transition. We also have papers in draft linked to liquidity in this market; ESG scores; credit risks; stakeholder analysis; and policy implications. As we have also started working on the AI implications we expect to reach substantial new insights.

IDRIC project 3.3 Risk in Decarbonization Finance
IDRIC project 3.6 Opportunities in Financing the Green Transition
Enabling CO2 Capture Using AI

Rethinking greenium: A quadratic function of yield spread; Chih-Yueh Huang, David Dekker, Dimitrios Christopoulos; Finance Research Letters, Volume 54, June 2023

Abstract
A greenium is the yield discount of a green bond compared to a similar non-green bond. Here we challenge implicit assumptions of a conventional estimator of greenium, which takes the difference between yield spreads of green and non-green bonds. We propose that the greenium should be estimated as a function of non-green bond yield spread. We find that the greenium increases for higher levels of non-green bond yield spread and that this occurs at an increasing rate. Further analysis indicates that at least partially this non-linearity accounts for the effects of credit spread and coupon rate differences.