Alongside a booming green bond market, interest in social and sustainability bonds is growing as investors increasingly commit to social prosperity as well as environmental welfare
The rise of impact investing in fixed income is reflected in the growth of the green bond market, which is making a positive contribution to environmental welfare. The market was extended with new impact investing products in the form of social and sustainability bonds to support social prosperity as well. A vivid growth in green, social and sustainability bonds started with the Paris climate accord and the publication of the UN Sustainable Development Goals (UN SDGs). Since then the green bond market grew at a far faster rate than the market for social and sustainability bonds. Currently, the green bond market is worth EUR 300bn, eight times the value of the social and sustainability bond markets combined.
The emergence of new impact investing products in fixed income is beneficial to all stakeholders. These products provide an innovative financing model for issuers, and they boost market transparency by requiring issuers to communicate their ESG policies. Moreover, the use of proceeds of green, social and sustainability bonds contributes to society as a whole by enhancing environmental and social welfare. We expect demand for impact investment products to continue growing. This FocusPoint examines the origins and characteristics of green, social and sustainability bonds.
Defining green, social, sustainability bonds
Green, social and sustainability bonds share financial characteristics (structure, risk and returns) similar to those of traditional bonds. They can be corporate- or government-related, vary in credit quality ranging from investment grade to non-investment grade, differ in maturities (short-term or long-term) and have various types of interest rates and yields. Most green, social, and sustainability bonds are “use-of-proceeds” bonds and are usually backed up by the issuer’s entire balance sheet. They tend to have the same security as conventional bonds. Yields and expected returns are therefore comparable to those of the same issuer’s normal bonds. The main difference between the green, social and sustainability bonds lies in their allocation of proceeds.
- Green bonds are financial instruments whose proceeds are predominately used to partially or fully (re)finance new and/or existing climate- or environment-related projects. Investments in renewable energy and low carbon building and energy efficiency are the most common use of proceeds.
- Social bonds are used to partially or fully (re)finance new and/or existing social welfare investments for an identified target population (i.e. poor, unemployed, vulnerable, undereducated and other), with a neutral or positive impact on the environment. Affordable housing and community development are the most common use of proceeds.
- Sustainability bonds are a mixture of both green and social bonds. They are expected to provide environmental and social benefits for the identified target population. As is the case for green and social bonds, sustainability bonds can be used to partially or fully (re)finance new and/or existing projects. Education and sustainability research, modernization of education and public health facilities are among the many ways the proceeds are used.
Over the last four years green, social, and sustainability bond markets experienced a significant boost driven by factors such as stronger environmental legislation, increasing awareness of social impact and a shift in investor perception towards a more sustainable allocation of their wealth without sacrificing returns.
Governments and financial institutions dominate the green, social and sustainability bond market. We believe social and sustainability bonds will be further driven by governments, which are more likely to finance social prosperity initiatives than corporations would do.
The green bond market overshadows the issuances in the social and sustainability bond market, which means green bonds remain a more liquid option for investors. Compared to social and sustainability bonds, green bonds are more diverse in terms of all main criteria: country, sector, currency and credit rating.
Europe as a whole continues to be the main market for green, social and sustainability bonds. The Asia-Pacific market, driven solely by China, is not far behind but investment opportunities are often not available for foreign investors. The majority of issuances from China are onshore.
Bram Bos, Lead Portfolio Manager NN Investment Partners
