In focus

Green and ESG bonds: what’s behind their rise?


Green bonds have been attracting attention for some time, being a key element of the development and growth of sustainable or environmental, social and governance (ESG) investing in fixed income. A green bond is, in short, an instrument to fund projects that have a positive environmental and/or climate impact. More recently, we have seen the emergence of social bonds, used for social investments with aims such as expanding access to healthcare and education.

Here we look at some of the recent market developments and changes, and consider the implications.

Given the inhospitable market conditions, was it easier to issue green bonds because of the strength of ESG industry trends?

Yes and no. Let us not forget that ESG investors actually ask more questions, or at least they should be, about issuers’ environmental, as well as financial metrics, while buying ESG bonds. This means the issuers need extra resources and commitment, and a good plan in place for sustainability.

Central bank actions have brought many corporate bond issuers to market last year, across the board, as companies sought to ensure they had sufficient capital as operations were hit by lockdown. Selective issuers have used their green or social or sustainability bond issuance to emphasize their environmental and social initiatives, partly as they reassess their responsibilities in the new world, with the pandemic underlining many of the world’s vulnerabilities.

Assessing these bonds from an ESG as well as purely financial perspective gives greater understanding and conviction, positive or negative, in otherwise volatile and uncertain markets.

Have there been any interesting trends emerging amid the increase in issuance, in terms of valuations, use of proceeds, which industries and companies are issuing?

We were happy to see ESG bonds from new sectors, rather than just utility and banks as before. We have seen innovation in terms of sustainability and social bonds, often linked to impact metrics or to UN Social Development Goals (SDGs).

Burberry became the first fashion retailer to issue an ESG bond providing a detailed update on its sustainability strategy. Burberry’s aims are: (1) carbon neutrality of operations by 2022 – focusing on energy efficiency and green buildings, (2) focus on sourcing sustainable raw materials, notably cotton certified by the Better Cotton Initiative, this links to the Life on Land SDG, and (3) sustainable packaging. This is an example of how ESG and business considerations can dovetail, given the importance of these considerations to younger consumers.

The issuance of high yield green bonds is a new development. Volvo’s China subsidiary and Getlink, the operator of Eurotunnel, both issued BB-rated green bonds. Volvo Car is focused on electric vehicle development. Getlink will use the proceeds to fund clean transportation, energy efficiency, recycling facilities and air conditioning. The framework includes reporting on how proceeds are spent. In the US market we saw pandemic and diversity bonds.

Have you observed any reduction or variance in quality of the new ESG bond issuance? Has the increase in ESG issuance created opportunities?

Opportunities for sure: for investors, but also for society, given the clear drive among businesses to improve energy efficiency and reduce carbon emissions, and issuers committing to all stakeholders. We do not want to pay too much added premium for ESG bonds, unless we think through improved sustainability the overall sustainability adjusted credit profile improves for good.

It helps sustainable credit investors to create impact on one hand by engaging with issuers and on the other by investing in various SDGs and social and climate causes through increasing public and liquid ESG Bond market.

How do we measure, assess and analyse the credentials or structure of a green or social bond, and ensure proceeds are being used in the right way?

It is important to assess the overall culture, strategy and direction of any green or social bond issuers. You can then think of the ESG bond as a way of enforcing financial as well as management commitment. We look at various company metrics and use of proceeds, including carbon intensity reduction and avoided carbon emissions, or hospital beds and social/healthcare facilities created, the number of students helped. Ideally the proceeds are focused on new development but with some allowance for a lookback period (maximum of three years).

In addition to quantitative and qualitative annual reporting on the ESG bond itself, sustainability reports and increasingly the Task Force on Climate-related Financial Disclosures (TCFD) reporting, as well as supplement while financial reporting as well as regular issuers meetings and sector specific ESG analysis are highlights.

What is your view on more prescriptive measures, such as segregated accounts for ESG bond proceeds?

I think those types of measures represent the ideal, but are not always realistic or practical, and they are not essential. Of equally, if not greater importance is the greenness or the positive social impact of the use of proceeds, which is best monitored through engagement.

A separate account might tick a box for auditors, but it can be onerous, creating admin. It’s more important that the ESG bond is not just a one-time venture, it should be part of adoption of a greener or more socially-minded orientation, and activities consistent with this on a larger scale.

What are we seeing in terms of trends or developments in ‘Use of Proceeds’, and what is it telling us about companies’ key ESG considerations and priorities?

Overall, we see companies thinking bigger, expanding their ESG horizons. Green considerations are not just about a company itself, but aligning with the goals of the Paris agreement. The issue of green buildings has been a success story, particularly around certification of new buildings; it is now widening to energy efficient renovation and its role in a circular economy, including waste and water management.

Social was often about affordable housing, but it is incorporating access to education and medicine. A responsible issuer looks at inclusion in its business from racial, gender, income, mental and physical capability, and issues a social or sustainable bond for this purpose. We have seen early moves here.

What are the main advantages of green bonds in a corporate bond portfolio?

The main advantage of credible and topical green or social bonds in a corporate bonds portfolio is increased exposure to sustainable investment and diversifying exposure to future themes.

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