Wealth Strategies
Sustainable Bonds Are Booming, But Is This A Fad â Do Markets Need Such Variety?
The following article examines the fast-growing world of sustainable bonds, and how investors should address these assets. The insights come from Aviva Investors.
The following article on this topic is by Steve Waygood, chief responsible investment officer, Aviva Investors.
Link to the live article for reference: Sustainable bonds: Everybody wants one - Aviva Investors
The first smartphones had few apps, wi-fi connections were patchy and data costs prohibitive. Despite these drawbacks, smartphones are now ubiquitous. The universe of sustainable bonds is developing in a similar way. After years where only green bonds were on offer, recent years have seen demand and supply surge.
According to data provider Refinitiv, issuance of sustainable bonds totalled a record $544.3 billion in 2020, more than double the previous year. While green bond issuance of $222.6 billion was also a record, an entire new ecosystem has emerged, including social, sustainability, sustainability-linked and climate transition bonds.
The market is growing for several reasons. The first, and most powerful, driver is the recent crop of regulation by big companies and national and supranational entities setting net-zero emissions targets, such as the European Unionâs (EU) Sustainable Finance Action Plan, aiming to support the transition towards sustainability after COVID-19 (1) .
Companies are also keen to tap into the surge in demand. âFirms are realising this is an opportunity to obtain financing to achieve any of their broader strategic goals, and we are seeing growth in all parts of the market,â explains Richard Butters, ESG analyst at Aviva Investors.
Illustrating the point, $164 billion of social bonds were issued in 2020 â ten times higher than 2019âs total â while the $127.6 billion of sustainability bonds were more than triple that seen in 2019. In comparison, because the sustainability-linked bond principles were only published in June 2020, just four companies had issued under the framework as of September 2020: Enel, Suzano, Novartis and Chanel.
Figure 1: ESG bond issuance 2013-2020 ($ billion)
Source: Bloomberg, Morgan Stanley Research, as of 8 January 2021
Issuers come from an increasingly diverse set of industries, after years of being concentrated in the financial, real estate, utility and renewable energy sectors. In 2020, they included automobile companies, consumer and luxury goods firms and mobile phone operators (2).
However, investors must take care to read the small print when deciding whether a sustainable bond meets their criteria. Firstly, are some sustainable bonds better than others? Secondly, if a label cannot provide enough of a guarantee against greenwashing, how can investors ensure that their allocations make a difference?
1. What bond?
The International Capital Market Association (ICMA) has created
four sets of principles that provide a framework for sustainable
bonds: the Green Bond Principles (GBP), Social Bond Principles
(SBP), Sustainability Bond Guidelines (SBG) and the
Sustainability-Linked Bond Principles (SLBP), as well as the
âClimate Transition Finance Handbook 2020â (3).
ICMA-recognised green, social and sustainability bonds each have four components â use of proceeds, project evaluation and selection, management of proceeds, and reporting â to be verified through independent external reviews (4).
Sustainability-linked bonds (SLBs) aim to increase the development role that debt markets play in funding and encouraging sustainability. Compared with the first three types, they are more forward-looking (5).
The ICMA also states: âThere is a market of sustainability themed bonds, including those linked to the Sustainable Development Goals (âSDGsâ), in some cases issued by organisations that are mainly or entirely involved in sustainable activities, but their bonds are not aligned to the four core components of the Principlesâ (6).
Outside the ICMA ecosystem, the Climate Bonds Initiative (CBI) provides a âClimate Bonds Standardâ certification of bonds and loans as being either green or aligned to the targets set out in the Paris Agreement.
2. Decisions, Decisions
This wide variety of conventions can be confusing; investors need
to be aware of the source of the âgreenâ or âsustainableâ
labelling, then analyse the criteria and decide whether these
meet their investment guidelines.
Within the ICMA taxonomy, green bonds have been around the longest but, as the transition accelerates, they appear to be limited in scope. Proceeds have not always been used to âdark greenâ ends, and this has been traditionally difficult to monitor. As an example, in 2017, Repsol issued a green bond with the proceeds intended to improve the efficiency of oil refineries (7, 8).
As a result of such controversies, green bonds have tended to be the near-exclusive purview of already green or sustainable companies, limiting the options for more carbon-intensive firms to finance their transition efforts. For investors, this also creates concentration risk.
In addition, many âuse of proceedsâ bonds fund prior investments. While this demonstrates an issuerâs ability to use proceeds responsibly, it raises questions as to how much of the funding should be retrospective.
As the transition began to accelerate, markets needed new types of bonds that could embrace the transformation efforts of the corporate world more effectively. Enter SLBs and climate transition bonds.
âI love sustainability-linked bonds, which are linked to a companyâs whole business. A structure where companies release whole-business KPIs and then issue bonds attached to those is brilliant,â says Tom Chinery, investment-grade credit portfolio manager at Aviva Investors.
In addition, because they allow financing beyond allocating proceeds to specific projects, it gives investors an opportunity to support meaningful efforts from a wider variety of companies.
âSome of the worst companies that have ambitious targets will make far more difference to the environment than a clean company that commits to shaving off 0.1 grams of carbon emissions a year. This is why I like the Enel approach: it is talking about massive global reductions in carbon emissions (8). That is meaningful,â explains Chinery.
There are live debates about the best way to implement SLBsâ impact framework and whether there is a need for specific climate transition bonds when so many other categories already exist. But whether through a green bond, conventional bond or SLBs, the key for investors is to understand what is happening at a company level and whether the proceeds will help it become more sustainable.
3. Influence and
engagement
Sustainable bonds have two limitations. First, even the greenest
bond does not necessarily mean that its issuer is becoming more
sustainable (10).
Of course, fundamental analysis on companies can be resource intensive; for investors with smaller teams, buying green bonds may seem like an easy way of participating in the transition. However, the impact can be limited, as green bond projects do not necessarily translate into comparatively low or falling emissions at the firm level (11).
In addition, investors need diversification to mitigate risk, and cannot allocate solely to green sectors.
âHistorically, when investing in green bonds, it has been a struggle to achieve sector and name diversification, making it more difficult to run traditional risk mitigation and portfolio construction,â says Chinery.
This is where engagement makes a difference, improving company disclosure on key metrics, which in turn allows investors to engage more effectively. And, as disclosure improves, smaller investors with fewer resources can also benefit.
There is a misconception that credit investors lack influence because they donât have voting rights. That is not the case, particularly when they join forces, whether through industry bodies like ICMA, or internally, across credit and equity teams.
âWhen we engage at the issuer level, it can often set a precedent
for cross-business activities. But the rise of sustainable debt
also provides a new gateway for our voice to be heard, provided
we engage with issuers to highlight any concerns of green or
social-washing we might have when they use one of the sustainable
bond frameworks,â says Butters.
4. No fad
One other aspect investors and issuers will follow keenly is the
cost of sustainable bond issuance versus conventional bonds.
It is too early to draw conclusions, but interesting insights emerge. The yield on Volkswagenâs 2028 green bond, for example, is lower than its conventional bond of similar maturity (0.5 per cent versus 0.42 per cent as of 9 February 2020). This may reflect the relative familiarity of European investors with sustainable bonds â the region accounted for over half of global issuance in 2020.
Meanwhile, in the US, the yields on Citigroupâs 2024 social bonds (0.61 per cent) and green bonds (0.86 per cent) are higher than its conventional bonds (0.53 per cent). Perhaps that is reflective of the US being behind Europe when it comes to sustainability, although who is to say that those spreads wonât narrow quickly as the market evolves?
What we can say with more certainty is that there is serious momentum behind the sustainable bond market globally.
On 9 February, Total committed to issuing all new bonds through sustainability-linked debt â the first company to do so (12). Although investors will have to watch out for greenwashing, if enough issuers follow in Totalâs footsteps, it could be game changing.
âThe more investors focus on ESG, the more the bad operators will see their borrowing costs rise,â says Chinery. âWe are not at a point now where there is that level of dispersion, but it is the direction of travel.â
Note
For the purposes of this article, we refer to the universe
encompassing green, social, sustainability, sustainability-linked
and climate transition bonds as "sustainable bonds."
References
1. âRenewed sustainable finance strategy and
implementation of the action plan on financing sustainable
growthâ, European Commission, 2021
2. âTracking the environmental footprints of
corporate green bond issuers,â Scope Group, 1 February 2021
3. âGreen Bond Principles (GBP)â, International
Capital Market Association, 2021
4. âSustainable financeâ, International Capital
Market Association, 2021
5. âSustainability-Linked Bond Principles
(SLBP)â, International Capital Market Association, 2021
6. âSustainability Bond Guidelines (SBG)â,
International Capital Market Association, 2021
7. Sophie Robinson-Tillet, âAnalysis: Investors
divided by green bond from Spanish oil company Repsolâ,
Responsible Investor, 11 May 2017
8. âOur approach: Research-based, independent
and relevantâ, CICERO Shades of Green, 2021
9. âSustainability-Linked Bondsâ, Enel Group,
2021
10. Neil Unmack, âBreakingviews - Green bonds
could slide into irrelevanceâ, Reuters, 17 September
2020
11. Torsten Ehlers, Benoit Mojon and Frank
Packer, âGreen bonds and carbon emissions: exploring the case for
a rating system at the firm levelâ, BIS, 14 September 2020
12. Francois de Beaupuy and Priscila Azevedo
Rocha, âTotal to sell only ESG-linked bonds in first for debt
market,, Bloomberg Law, 9 February 2021
Get in touch
If you would like to find out more about Aviva Investorsâ products and services, please visit our website or contact your usual sale representative.
Website: www.avivainvestors.com
Tel: 020 7809 6000*
*Calls may be recorded for training and monitoring purposes, and to comply with applicable law and regulations
Important information
Except where stated as otherwise, the source of all information
is Aviva Investors Global Services Limited (AIGSL). Unless stated
otherwise any views and opinions are those of Aviva Investors.
They should not be viewed as indicating any guarantee of return
from an investment managed by Aviva Investors nor as advice of
any nature. Information contained herein has been obtained from
sources believed to be reliable but has not been independently
verified by Aviva Investors and is not guaranteed to be accurate.
Past performance is not a guide to the future. The value of an
investment and any income from it may go down as well as up and
the investor may not get back the original amount invested.
Nothing in this material, including any references to specific
securities, assets classes and financial markets is intended to
or should be construed as advice or recommendations of any
nature. This material is not a recommendation to sell or purchase
any investment.
In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In France, Aviva Investors France is a portfolio management company approved by the French Authority âAutoritĂ© des MarchĂ©s Financiersâ, under n° GP 97-114, a limited liability company with Board of Directors and Supervisory Board, having a share capital of 17 793 700 euros, whose registered office is located at 14 rue RoquĂ©pine, 75008 Paris and registered in the Paris Company Register under n° 335 133 229. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.
In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.
The name âAviva Investorsâ as used in this material refers to the
global organisation of affiliated asset management businesses
operating under the Aviva Investors name. Each Aviva investorsâ
affiliate is a subsidiary of Aviva plc, a publicly-traded
multi-national financial services company headquartered in the
United Kingdom. Aviva Investors Canada, Inc. (âAICâ) is located
in Toronto and is registered with the Ontario Securities
Commission (âOSCâ) as a Portfolio Manager, an Exempt Market
Dealer, and a Commodity Trading Manager. Aviva Investors Americas
LLC is a federally registered investment advisor with the US
Securities and Exchange Commission. Aviva Investors Americas is
also a commodity trading advisor (âCTAâ) registered with the
Commodity Futures Trading Commission (âCFTCâ) and is a member of
the National Futures Association (âNFAâ). AIAâs Form ADV Part 2A,
which provides background information about the firm and its
business practices, is available upon written request to:
Compliance Department, 225 West Wacker Drive, Suite 2250,
Chicago, IL 60606.
161422 - 22/02/2022