Social and sustainability bonds follow green credit boom
The green bond market has seen a rapid expansion, with new issuance in 2017 reaching EUR 112bn, up from EUR 73bn in 2016, driven by improving guidelines and taxonomies, strong political support and a sharp rise in investor demand. Alongside this growth, the market has been extended with new impact investing products in the form of social and sustainability bonds that commit to social prosperity as well as environmental welfare. The key differentiator of these products is their use of proceeds, with social bonds used to finance new or existing social welfare investments, and sustainability bonds providing a combination of green and social benefits. Such products are beneficial to all stakeholders, providing an innovative financing model for issuers, boosting transparency in the market and contributing to society as a whole through ameliorating environmental and social welfare.
Since the Paris climate accord and the publication of the UN Sustainable Development Goals, which accelerated the uptake of such products, the green bond market has largely broken away from the less prominent social and sustainability bonds. In 2017, issuance of green bonds alone saw a volume seven times larger than social and sustainability bonds combined. We expect new issuance of green bonds in 2018 to reach EUR 120bn.
Although growing quickly, social and sustainability bonds are not yet a mainstream product. Still, we have seen rapid growth – although from a relatively low base - which could be further strengthened by a larger number of multinational corporations stepping into the market, with recent examples including Starbucks and Danone.
Bram Bos, Lead Portfolio Manager Green Bonds at NN Investment Partners, comments: “Despite lagging behind green bonds, we’re confident that interest in social and sustainability bonds will continue to grow. As happened with the green bond market when ICMA introduced the first GBP in 2014, we believe more standardization and guidance is yet to come, which will fuel the social and sustainability bond market. With the introduction of the UN SDGs we are seeing demand for bonds which are focusing on SDGs not covered by green bonds”
In recent years, the growth in popularity of green bonds has led to considerable diversification in the market. The Paris Climate Accord positively contributed to the green capital landscape with a larger number of countries and corporations participating, with notable issuances from countries including France, China and the US.
Although green bonds are still largely euro-denominated, there has been some diversification in currency to attract more foreign investment; 61% of the issues on the Bloomberg Barclays MSCI Global Green Bond Index are euro-based.
Green bonds also exhibit a relatively diverse rating spectrum, ranging from investment grade (69%) to non-investment grade (5%). AAA bonds constitute 21% of the total. However, more than a quarter of all green bonds are not rated.
In terms of issuers, thus far the green, social and sustainability bond markets have been dominated by government-related issuers such as sub-sovereigns and agencies. The governments of multiple countries have targets for fostering investments in ESG-related projects and thus finance them by issuing green, social or sustainability bonds. Ultimately, government bodies have accounted for more than EUR 150bn of all issues, the majority of which were in green bonds.
However this trend is beginning to change. Financials represent the second-largest sector participating in the green, social and sustainability bond market, issuing 32% of green bonds and 19% of both social and sustainability bonds.
Bram Bos comments: “Looking forward, we expect the green bond market to undergo a transformation from a sector point of view. In the first half of 2018, we have observed increasing participation among both financials and corporations - especially companies that operate in utilities and industrial sectors.
“In contrast to green bonds, social and sustainability bonds lack diversity in terms of country, sector, currency and credit rating, and will need more time to close the gap. As the market matures, we believe that social and sustainability bonds will be driven by governments, which are more likely to finance social prosperity initiatives than corporations.
“As these markets continue to mature, we expect the breadth of green, social and sustainable bonds to increase across country, sector, currency and credit rating. For investors looking for a more sustainable allocation of their wealth, this will provide yet more opportunities to invest in social prosperity and environmental welfare without sacrificing strategy or returns.”
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