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The market for labelled, or sustainable, debt continues to expand, with an estimated US$3.5 trillion outstanding as of 31 May 2023.1 Despite a slowdown in 2022, we believe supportive policy and commitments from governments and corporates to meet sustainability targets should continue to drive new issuance. Improving bond structures may provide additional tailwinds. Here, two Wellington experts take stock of the rapidly growing sustainable debt market.
Tom: Labelled-bond issuance was slower than expected in 2022, falling 23% from 2021’s record high of approximately US$1 trillion.1 In my view, last year’s slowdown was the result of two main forces. First, lower primary volumes reflected rising interest rates and higher financing costs. Second, issuance of social and sustainability bonds — popular means of meeting surging social needs during the COVID-19 pandemic — declined.
Despite this drop in overall supply, sustainable debt issuance as a percentage of overall corporate debt supply rose (Figure 1). We expect this trend to continue as issuers tap capital markets to meet sustainability challenges — from net zero and decarbonization to closing the funding gap to achieve the United Nations Sustainable Development Goals (SDGs). In 2022, nearly one-third of euro-denominated investment-grade corporate new issuance was in sustainable debt format, up from 25% in 2021.2
Separately, the volume of sustainability-linked bonds (SLBs) — previously the fastest-growing segment — declined most. Increased scrutiny of SLB structures could continue to hamper their issuance in the short term. Longer term, though, as corporates and sovereigns look to meet their commitments, we expect sustainable debt issuance to increase across the board.
Tom: Sustainable debt is a relatively new segment of the market, without robust regulatory frameworks that could help weed out bad actors and prevent “greenwashing.” We continue to see proliferation of debt labelled green, social, sustainable, and so forth, and increasingly from issuers who are opaque about their sustainability goals. Greater regulatory focus on green bonds in the form of an “EU Taxonomy Alignment” and a potential “EU Green Bond Standard” are steps in the right direction. Policies like these could promote increased transparency, not only on how proceeds are used, but also on how green bonds align with an issuer’s broader sustainability credentials.
I believe 2023 should also be an eventful year for sustainability-linked bonds. The International Capital Market Association (ICMA) tightened voluntary standards for SLBs halfway through 2022, and we sense that the market is becoming more cautious about sustainability-performance targets (SPTs) that lack ambition or are indistinguishable from activities conducted during the normal course of business. Many SLB issuers will approach their first SPT observation dates in 2023, and it will be interesting to gauge their performance relative to key performance indicators. We would not be surprised to see the market start to “price out” SLBs that lack appropriate embedded targets, relative to more ambitious issuers.
As a syndicate-desk trader, my regular conversations with issuers and their advisors are an opportunity to highlight what we believe are structural deficiencies in labelled-bond offerings. And as we often meet issuers during the pre-marketing of future deals, we can suggest ways of structuring sustainable bonds, including robust SPTs. This is one way we help promote better industry standards to ensure that capital is deployed in the most impactful manner possible.
Campe: In my eight years looking at debt markets through an impact lens, I’m pleased to say that standards have improved, although there is still work to be done. In our fixed income impact strategies, we invest in both labelled- and non-labelled issuance that we believe can have a positive environmental and social impact. In doing so, we apply our impact framework to every issuer and security from the bottom up. To address the suitability of labelled issuance for those portfolios, we apply a robust labelled-bond framework.
Ultimately, we think it is essential to look beyond a bond’s label. For us to understand whether a financed project will have positive social or environmental impact, not only do we need to be comfortable that the labelled bond is robust in structure, we also need to know as much as possible about that issuer and its commitment to creating sustained positive impact. Ongoing, constructive engagement with issuers about a range of subjects, including fundamentals, bond structures and ESG- and impact-related questions, helps us develop a fuller understanding of issuers’ approaches and intentions.
Tom: Issuance themes are becoming more diverse and sophisticated, and we are interested to see what the rest of 2023 brings. Issuers often have specific targets in mind, from human rights to biodiversity and more. For example, the world's first orange bond was issued earlier this year, named for the color of the icon of UN SDG 5: Gender equality.
Campe: One area I am closely monitoring is blue bonds, which support marine ecosystem conservation. While this market is in its infancy, recent developments could trigger much more issuance. With the new UN High Seas Treaty, signed in March, nations around the world agreed to support marine biodiversity — specifically designating 30% of international waters as protected areas by the end of this decade. The accord could lead to a surge in financing of ocean-conservation investment. Prospective issuers are awaiting guidance from the ICMA on blue bond structures, expected later this year.
Campe: We remain excited by the growing opportunities to generate impact across public fixed income markets, whether through labelled debt or investing in the traditional debt of high-impact issuers. Genuine, honest application of labelled-bond structures remains a top priority in our assessment of securities for our impact portfolios. We are committed to a bottom-up, research-driven approach that evaluates both financial fundamentals and sustainable bona fides, as we believe this approach serves us well in identifying new investment opportunities.
1Bloomberg NEF, Bloomberg LP. Includes green, social, sustainable, or sustainability-linked bonds as determined by Bloomberg. Excludes municipal bonds and asset-backed securities.| 2Barclays Research.
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