Risk factor disclosure in green bond prospectuses and investor compensation

This paper examines green bond risk factor disclosure in European corporate prospectuses and investigates their impact on investor risk compensation. We extract six risk factors disclosed in 602 prospectuses corresponding to 1160 green bonds issued from 2015 to 2024 using non-negative matrix factorisation (NMF) topic modelling. Novel risk factors disclosed include green-listing, EU Taxonomy compliance, ESG, Second Party Opinion (SPO), asset framework and GBP compliance. Green-listing, ESG, SPO and GBP compliance are the dominant risks disclosed by issuers, yet investors seek greater compensation for EU Taxonomy compliance and asset framework risk factors. We observe time variation as the introduction of EU regulatory initiatives recalibrates investor risk premia, leading to heightened demand for risk compensation. The findings underscore the clarity that European sustainable finance regulatory initiatives have brought to investors; however, the lack of scrutiny on the underlying assets financed with European corporate bonds may lead to an underestimation of systemic risk in the market, including physical, transition and greenwashing risks. We present a possible solution by calling on national competent authority prospectus approvers to categorise the assets financed with corporate green bonds. This would constitute an informed, targeted, early warning assessment of systemic risk in the green bond market that could positively impact financial stability. The paper contributes to the academic literature on green bonds, risk disclosure and textual analysis and helps inform European regulators as they navigate the evolving sustainable finance landscape.