Stripping “Greenness”: Analyzing the Effect of Denmark’s Green Certificate Proposal on Sovereign Green Funding Costs

Abstract

Sovereign nations can issue green bonds to take advantage of investors’ preferences for financing environmentally friendly projects. Due to the sustainability aspect, investors are willing to pay a premium and accept lower yields for these green bonds compared to regular bonds, and the issuing country should be able to benefit from lower funding costs through these lower yields. However, obtaining lower financing costs is often not so straightforward since green bond issuances are generally smaller and less liquid than their conventional counterparts. Liquidity considerations obscure the true green premium and cause the funding costs of green bonds to be less favorable. This paper explores a theoretical solution to the liquidity problem proposed by the Kingdom of Denmark that involves stripping off the “green” part of a green bond into a green certificate that trades independently from the bond part. After creating a measure of the liquidity of the green premium itself, I find that transitioning to the green certificate system has the potential to dramatically improve the green premium for issuers in the sovereign green bond market. However, in the case of countries whose bonds are already very liquid, I find there is little to no benefit to adopting the green certificate model.