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The sustainable debt market is growing rapidly as issuers face increased pressure from investors and regulators to finance a more sustainable future (Figure 1). In 2021, sustainable debt issuance doubled to over US$1 trillion, and it is predicted to exceed that figure in 2022 despite an expected decrease in overall primary supply. Green bonds remain the most common product within the labelled bond universe and are forecast to account for 52% of the total sustainable bond supply in 2022, while sustainability-linked bonds (SLBs) are the fastest-growing segment.1
We explore the importance of establishing a robust framework to assess the suitability of labelled issuance for our portfolios and highlight how we can use our engagement edge to combat greenwashing.
With their key performance indicators (KPIs) and use of proceeds (UoP) outlined at issuance, green, social and sustainable bonds allow investors to target social and environmental objectives through their fixed income allocations, complementing traditional fixed income securities within an impact portfolio.
We have also identified some secondary benefits which we feel further enhance the appeal of UoP bonds:
SLBs allow issuers to raise finance without ring-fencing the proceeds for a social or environmental project. Instead, they tie the future coupon payment to a sustainability performance target (SPT) which measures improvements in the borrower’s sustainability profile — for example, an overall reduction in greenhouse gas emissions associated with products manufactured. Some issuers have faced criticism for SLBs that lack robustness or incentive to allocate the proceeds with sustainable objectives in mind.
Nevertheless, we see a place for robust SLBs within our portfolios. We have identified some secondary characteristics enhancing their appeal:
We recognise that labelled bonds are a useful part of the public debt market toolkit in the pursuit of generating impact. We have developed a labelled bond framework which aims to ensure we stay true to our commitment to high-integrity impact investing and combatting greenwashing. Below, we outline our best practices:
SLBs’ more flexible structure, combined with a lack of regulation, creates opportunities for greenwashing. We pay close attention to SLBs’ structure to ensure that the issuance aligns with our high-integrity approach to impact investing:
Our labelled bond framework is complemented by Wellington’s Fixed Income Syndicate Trading desk, which benefits from its relationships with the sell side. Through our engagement, we highlight structural deficiencies in labelled bond offerings to be communicated to the issuers through their advisors. We also meet the issuer during the pre-marketing phase of a future deal and advise how to robustly structure a sustainable bond. Engaging in dynamic discussions both on the structure of sustainable debt issuance and on specific ESG-related questions allows us to develop a fuller understanding of the issuer’s approach to sustainability and identify whether it is serious about working towards its sustainability goals.
Below, we highlight three examples of our engagement:
We expect the labelled bond market to keep growing rapidly, given the nascent stage of the sustainable debt market, the continuing establishment of carbon reduction commitments by corporations and governments and increased demand from investors. This evolution will pose challenges for investors using an ESG or impact lens.
While regulation in the labelled bond market is currently lacking, we expect the proposed European Green Bond Standard — if implemented — to increase the transparency and robustness of green issues. This may lead to a new gold standard for green bonds, pressuring issuers to obtain the label. The same principles could also be used to develop a social and sustainable bond standard, leading to greater uniformity across sustainable debt issuance. Conversely, the European Green Bond Standard could reduce the appeal of existing green bonds which don’t meet the proposed standard. This could create a “haves versus have-nots” pricing dynamic, incentivise stronger, more ambitious terms and support the transition to a sustainable future.
Irrespective of regulation, we believe that it is essential for responsible asset owners to have a robust framework for analysing labelled issuance and that this will ultimately help to establish more robust ESG standards in the market and increase the likelihood of generating real-world impact.
1Data source: Crédit Agricole