Debtholders are the major source of financing for new projects and growth. Shareholders may vote, but debtors can facilitate new projects – or choke them by demanding higher rates for poor uses of funds.
Challenging Times, Challenging Capital Needs
Collective action is needed to tackle the Environmental and Social challenges we face. Long-term investments must begin now, with capital required this decade.
Consider some examples:
- On the Environmental side, the EU targets emissions reductions of at least 55% by 2030, reaching net zero by 2050. The US has also announced emission reduction targets for 2030, a zero-carbon electricity sector target by 2035, and carbon net neutrality by 2050.
- Social challenges are increasingly coming to the attention of the investment community. Fewer than half of the global population was covered by essential health services as of 2017, before Covid-19. Education, too, needs investment. Roughly 258 million children were not in school in 2018, nearly one-fifth of the global school-age population.
Fixed Income Markets Play a Key Role
International capital markets are indispensable in the decarbonisation of the global economy and the reduction of social inequality. The fixed income market is the largest asset class in the global financial landscape, offering a steady source of new capital.
The Sustainable bond category, which aims to finance environmental or social projects or to demonstrate sustainability objectives, is growing rapidly. Following strong issuance and investor interest in 2021, the Sustainable bond category has grown to $1.9 trillion, and could exceed $5 trillion by 2025.
A Record Year
Issuance of Sustainable bonds -- including Green, Social, Sustainability, and Sustainability-linked categories -- reached $886 billion through November of this year, a 115% over the full-year 2020 supply. Green bonds from corporates, and especially from governments, rose 95%. Social Bonds saw an increase of 57% with the EU and organizations such as CADES and UNEDIC remaining solid contributors to the category.
While Green bonds continue to dominate the Sustainable bond category with a 60% share of outstanding, Social and Sustainability bonds are making impressive progress. Emerging sovereign issuers led the way in the 142% increase in Sustainability bonds, including Chile, Peru, Benin, and Malaysia, joined by issuance from development banks.
Sustainability-linked bonds were first introduced in 2020, with $7 billion issued. In 2021, $112 billion of these bonds were issued, with interest rates linked to specific Key Performance Indicators, or KPIs. A number of High Yield issuers have tapped the Sustainability-linked market, such as Rexel, Teva, Verallia, and Faurecia.
On average, green and sustainable bonds were more oversubscribed than conventional bonds, reflecting strong investor appetite. The 'greenium', or green premium, is slightly negative; that is, green bonds are currently offering spreads between 2 and 5 basis points below conventional bonds. Since September, the pace has accelerated; as year-end approaches, half of the overall new debt issuance at the moment is in the sustainable bonds categories.
A little nomenclature
The Sustainable Bonds asset class, itself quite new, consisted solely of Green Bonds until very recently. Now, the Sustainable Bonds asset class encompasses four categories:
- Green Bonds – financing projects with specific green impacts
- Social Bonds – financing projects with Social impacts
- Sustainability Bonds – projects with a mix of Green and Social projects
- Sustainability-Linked Bonds – these do not finance specific projects; however their coupons are linked to ESG topics and the interest rate paid depends on meeting pre-defined Key Performance Indicators
ICMA – International Capital Market Association
NACE – Statistical Classification of Economic Activities / Industries in EU
Data Sources: all market and issuance data from Bloomberg.
The EU Carries the Banner
The EU Next Generation post-Covid-19 Recovery Plan, supporting green and digital activities, expects to raise 30% of its program funds through the issuance of green bonds. With potentially €250 billion to be issued from 2021 through 2026, the EU will be one of the largest green issuers worldwide.
The EU issued €12 billion in October 2021 alone, with strong success. We expect a further €40 billion of EU issuance in 2022. The Next-Gen Green Bond Framework, unveiled in September 2021, is consistent with the Commission's global ESG strategy, aligned with ICMA Green Bond Principles, and meets all but one of the conditions of the EU Taxonomy (the mention of NACE-defined industry codes). The proceeds are earmarked for research and innovation, along with digital technologies supporting the green transition, energy efficiency, clean energy, climate change adaptation, water and wastewater management, clean transport, nature protection, rehabilitation and biodiversity.
More than $1 Trillion New Sustainable Financing for 2022?
We forecast more than $1 trillion in Sustainable debt issuance of all four types in 2022, with $500 billion in green bonds as corporates seek greener solutions. Nations have a strong interest in financing their green transitions. Volume expected for sustainability bonds could be around $250 billion. Emerging issuers particularly will continue to explore this segment. Sustainability linked bonds will continue to attract strong interest particularly from high yield issuers and sectors such as capital goods or consumer non cyclicals. We forecast around $200 billion in the usage of Sustainability-Linked Bonds. Social bonds will continue on their trajectory but the market needs more clarification about Social taxonomy before getting a 'push'.
Increasingly Meticulous Investors
Investors are becoming increasingly particular, detailed, and demanding when it comes to Environmental, Social, and Governance (ESG) claims and investments. One advantage for debt investors is that debt instruments can be restricted to particular assets or projects. As investor demand for ESG clarity and impact increases, issuers recognize that instruments financing definable impact are easier to sell, and are offering more transparency.
Growing Opportunities!
The Sustainable bond market already offers depth, diversification as well as opportunities. We expect it to continue to grow into a substantial asset class. By investing in instruments with objectives such as aiding in decarbonisation and supporting the other UN Sustainable Development Goals, investors have additional options for responsible fixed income investing beyond ESG integration.
Regulation, supply and investor behaviour will drive the trend. As the asset class grows in size and complexity, more options are available, and more skill and selectivity is necessary.