The Bund's green twins: Green Federal securities

In the second half of 2020, the German Federal Government will launch green Federal securities for the first time. An amount between € 8 and 12 bn is expected to be issued through these instruments this year.

What makes them so special? The German Federal Government's new, green securities will always be issued with the same characteristics as an existing, conventional Federal security – creating twin bonds, identical in maturity and coupon. Their issuance volume, however, will be different, with conventional issues being placed at significantly larger volumes than its green twin. They will also differ in their ISIN code. Germany plans to offer twin bonds at two-, five-, ten- and thirty-year maturities, building a green yield curve in the medium term.

The first Green Federal security will be a 10-year Green Federal bond (ISIN DE0001030708). Its new issue is scheduled for September. It will thus become the green twin of the conventional 10-year Federal bond newly issued on 17 June 2020 (ISIN DE0001102507).
The first Green Federal note is scheduled to follow in the fourth quarter.

Rhyme and reason

The expenditures defined as 'green' are to make a contribution to climate and environmental protection.

With this issuance of green Federal securities, and the reporting that comes along with it, the Federal Republic of Germany will create a high degree of transparency on the federal budget's green expenditures. The Government has looked to established market standards for guidance on the definition of green budget positions, such as the UN Sustainable Development Goals or the Green Bond Principles formulated by the International Capital Market Association (ICMA).

Furthermore, the German Federal Government and the Finance Agency also intend to substantially strengthen and decisively develop the market for green and sustainable forms of investment. The concept of twin bonds provides investors with a deep insight into market structures, as regards both the price difference between conventional and green bonds, and market participants' demand preferences for various green bond maturities.

German twin bonds

Benchmark status calls for prudent action

German Federal securities serve as a reference for all interest rate products in the euro area. To be able to fulfil this important function reliably, they must have special characteristics: the German Federal Government's extraordinary credit quality and the securities' high level of liquidity. Investors must be certain that the instruments can be bought and sold at any time, even in large quantities. This certainty requires considerable volumes in circulation for each German Federal security; in the case of a 10-year Bund, this would be more than €20 billion. Against this background, the Federal Republic of Germany always takes great care when preparing to issue a new financing instrument. After all: the introduction of green Federal securities would, all else being equal, reduce the issue volume of conventional Federal securities.

Liquidity in conventional Federal securities

Strictly speaking, issuing green Federal securities would result in a decrease of the outstanding volume of the conventional Federal securities by exactly the issuance volume of the green twins. The Finance Agency removes this disadvantage by increasing its own stock of conventional bonds at the time it issues the green Federal security and by exactly the same amount.

These additional own holdings in conventional securities can be used on the secondary market, for repo transactions or for lending activities. The high level of liquidity associated with conventional German Federal securities therefore remains unchanged vis-à-vis a situation excluding the green twin, and the Bund's benchmark status remains well supported and secured.

Enhanced value for investors

Holders of German Government securities appreciate the fact that they can trade them in high volumes at any time. The issuer's credit quality, a reliable market presence and a transparent issuance policy are highly valuable unique features to them. This applies to both conventional and green securities. For the latter, additional transparency on green spending in the federal budget will be created in future. Therefore, according to the joint assessment of the German Federal Government and the Finance Agency, the value of the green Federal securities should in general exceed the value of their conventional twins. From the issuer's perspective, this warrants at least equal pricing for green Federal securities compared to their conventional twins.

Implementing the twin concept on the primary and secondary markets

On the primary market, a new Green Federal security will be sold either through the Federal Government's well-established tender process or in a syndicate after its inaugural issuance in a syndicate. This means: The auction originally forseen for the conventional twin will be transferred into an auction for the new Green Federal security. At the same time, the government's own holdings in the conventional twin will be increased. This happens in an amount which is exactly equal to the issuance amount of the Green Federal security - and, as already indicated, outside the official auction process.

On the secondary market, the Finance Agency will increasingly perform its activities established for conventional Federal securities for their green twins. The twin concept and higher own holdings in conventional bonds will facilitate combined and debt-neutral sale-and-purchase transactions (“switch trades”) between both bonds. The latter enable the Federal Government to carry out its activities in a transparent and economically sensible manner, reflecting the higher value of green federal securities compared with their conventional twins.

What’s next?

Conventional German Federal securities serve as interest rate benchmarks for the euro area. Going forward, Germany plans to establish a green yield curve for the euro area, with the common key maturities of the conventional curve: two, five, ten and thirty years. It is the Federal Government's ambition to establish the yields of green Federal securities as the reference for the Euro green finance market.

Market participants with relatively short (e.g. central banks), medium-term (e.g. investment funds) or relatively long (e.g. pension funds) investment horizons will soon have a green, transparent investment opportunity with highest credit quality at their disposal.

The Finance Agency will provide further details on the issuance plans for green Federal securities with the publications of its quarterly issuance outlook.

Green Bund curve

Green and conventional Federal securities will be issued as twin bonds going forward. A yield curve for green Federal securities and therefore a green interest rate benchmark for the euro area will emerge in due course. The Finance Agency will assume an active role for green Federal securities on the secondary market.