The most eye-catching trend of 2020 has been the social bond market breaking out of its niche and becoming a big and vibrant market.
“The main lesson of the crisis,” said Tanguy Claquin, head of sustainable banking at Crédit Agricole in Paris, “is the value of the proposals that were put on the table. At the beginning of the Covid crisis, we have seen a biodiversity explosion, with a number of different structures, with or without the use of proceeds, with or without a framework.”
Social and sustainability bonds “used to be 5% of the ESG bond universe,” said Jarek Olszowka, head of sustainable finance at Nomura in London, “but this year they have grown exponentially — there has been more social bond issuance than in all the previous years.”
This has partly hidden the fact that, after a dip in issuance in the first half of 2020, caused by the Covid-19 pandemic, the green bond market is also once again in record issuance territory.
The parade of issuers joining the green and sustainable bond markets for the first time is as impressive as at any time in the market’s history: Germany, Sweden, Volkswagen and Daimler to name but a few.
To Ashley Schulten, head of responsible investing in global fixed income at BlackRock in New York, the growth in government green bond issuance is “incredibly welcome. When you construct portfolios, you need to have exposure to lots of different issuers and asset classes. Getting sovereign exposure here allows us to … be well rounded and have liquid instruments.”
Shrey Kohli, director of fixed income and funds at the London Stock Exchange Group, said the demonstration effect of governments issuing green bonds would be particularly true outside developed markets.
Partly this was because "a range of local players", including banks, audit firms, ratings providers and exchanges, would get involved. "And it does signal to the rest of the market the importance of sustainability as part of the sovereign strategy," he said. "So companies which are listed on the blue chip exchange segment of the local market pay attention and they want to do the same, and investors pivot to it as well. So in that sense, it is hugely important, even though in terms of additionality, I think perhaps there's more to be seen."
Meanwhile, the market is also diversifying. Luxembourg and Mexico have issued sustainable bonds in September — an unusual step for governments, though as Olszowka pointed out, Ecuador, Guatemala and South Korea had previously issued social or sustainable bonds.
“Adding social, I would see it as being beneficial, especially for smaller countries, which might not necessarily have sufficient eligible expenditures to be able to issue [green bonds] in benchmark size, and so not to have to pay illiquidity premiums,” said Olszowka.
But he said this should ideally be done as part of a national transformation plan, tied to the Sustainable Development Goals, rather than “just looking at what I happen to have in my budget”.
Robust plans
The need for sustainable finance to be tied to a robust transition plan was the common thread running through the discussion.
After a year’s wait, the sustainability-linked bond format pioneered by Enel in September 2019 has returned to the market, with deals this month by Suzano, the Brazilian pulp and paper company, and Novartis, the Swiss pharmaceuticals group.
In this structure, the issuer is free to use the proceeds as it wants; the deal’s sustainable nature comes from the issuer offering the investors a coupon step-up if it fails to hit a sustainability target such as cutting greenhouse gas emissions by a certain date.
In such deals, one of the vital points is setting the target in a way investors find sufficiently robust and stretching.
“There are more eyes on this market than ever before,” said Schulten. “I think issuers and underwriters are being really careful about what they bring to market. The threat of greenwashing is scary — we don’t want to go down that road.”
Alessandro Canta, head of group finance at Enel, said there had been a risk of greenwashing in the past, but this had been diminished by the decade of experience market participants now had in sustainable finance. “I think that the reputational risk prevents a lot of companies from playing around with their name,” he said.
On the contrary, companies could gain an advantage by being sustainable, he argued. “On the markets [during the crisis] sustainable companies have been more resilient than anybody else,” Canta said. “A lot of companies have realised more than any other times in our life that being sustainable has got a premium in respect of stock performance and most likely also in bond performance.”
Kohli said this communication with investors was part of the point of issuing all these instruments. “The act of issuing or going through the process of setting up a framework and setting up your governance itself presents you in a better light to investors," he said. "Investors are increasingly wanting a more holistic strategy, which will incorporate ESG in the full form."
As Claquin put it: "Green bonds, social and sustainability bonds are not E or S products, they are G products." He said they showed "the quality of the governance at company level" — and this even applied to governments, where ministries sometimes run by politicians of different parties needed to work together.
"It shows a level of maturity," he said. "And that is very interesting information for investors."
To watch the full debate, which explores many more questions including whether ESG finance is becoming commoditised, whether green and social bonds outperformed during the Covid crisis, the pros and cons of sustainability-linked and transition bonds, and how ESG analysis is converging with credit analysis, register here. The conference is free for issuers and investors and the content is available online until October 15.