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.
This year has seen something of a growth spurt for green bonds with the market heading toward the $1 trillion milestone, according to data from the Climate Bonds Initiative and Bloomberg. As well as significant government bond launches, there has been increased issuance from the corporate sector and from a wider range of businesses and industries.
Here we look at some of the recent market developments and changes, and consider the implications.
Do you think there is any particular reason for the increase in issuance this year, particularly since March?
The investor base in sustainable fixed income has grown and widened. Certainly in Europe, but we have seen more issuers in the US dollar and UK (sterling) markets. It makes sense they try to take advantage and diversify their investor base into (ESG) fixed income investors.
With economies hurting badly due to Covid-19 lockdowns, the policy response from governments has included green and social investment programmes. Germany issued green Bunds and we have had EU SURE social bonds, part of the Next Generation EU programme, which includes green investment initiatives. These policies have encouraged companies from Europe, and in-turn we have seen a meaningful increase in the size and liquidity of the market, creating something of a virtuous circle.
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 this 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.
Novartis, the Swiss healthcare company, issued an 8-year maturity bond which carries a coupon step up linked to ESG targets. Novartis’ target is to increase access to medicines in low and middle income countries by 200% by 2025. If not, the bond coupon (or interest) increases by a quarter percentage point.
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.
Are the voluntary industry frameworks such as International Capital Markets Association (ICMA) and Climate Bonds Initiative (CBI) effective?
The International Capital Markets Association (ICMA) has evolved over time, with regular consultation from ESG bond investors and specialists. While voluntary, with no penalty for laggards but recognition for leaders by dedicated investors, ICMA initiatives have been effective in setting a minimum standard, which useful in informing an assessment of a green bond issuer.
ICMA provides ongoing guidance around the purpose of green bonds for instance this year underlining the relevance of social bonds in addressing the coronavirus pandemic. It provided guidance for eligible related projects, such as healthcare research and investment, particularly vaccine development or investment in equipment.
CBI aims at setting more or less the gold standard for green bonds, providing certification, however issuers need to pay for this, on top of a second party opinion. The CBI certification for example for Barclays latest sterling green bond makes it eligible for some data providers like Refinitiv to classify it as a green bond which might help green bond only funds. For Barclays as a whole one needs a clearer strategy on their transition plan with clients underwriting of fossil fuel related business.
Whether meeting the inclusion criteria for the MSCI green bond index or getting a CBI certificate, for a green bond issuer the best thing is to be as transparent and as future proof as possible through ICMA guidelines and help from credible second party opinion agencies. Using the green bond roadshow to highlight overall ESG strategy, the incentive, commitment and challenges of taking whole business greener and impact metrics and milestones upfront.
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?
For us it is important to also 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. Our team of credit-cum-ESG analysts and portfolio managers 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.
Do you think there are any specific rules that would be useful to apply, for example should it be possible for the ESG certification to be revoked retrospectively?
There is no avoiding the responsibility of ESG investors to carry out due diligence and to engage directly with companies and industry bodies, alliances, regulators to dynamically improve and contribute to a greener, sustainable society. A credible second party opinion on an ESG bond is helpful, but the analysts’ issuer assessment is crucial. As with a credit rating from an agency, social or green certification plays a role, but is not the sole factor for active engaged investors.
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.
The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal.
Issued in the Channel Islands by Cazenove Capital which is part of the Schroders Group and is a trading name of Schroders (C.I.) Limited, licensed and regulated by the Guernsey Financial Services Commission for banking and investment business; and regulated by the Jersey Financial Services Commission. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.