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Capital market evolution – Part 2: ESG’s massive growth in new issue markets

Keenan Choy, Fixed Income Trader
2021-12-31
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The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

Global ESG debt issuance is growing exponentially, now topping US$3 trillion outstanding. While it took more than a decade to reach the first US$1 trillion, it's taken just six months to add the latest.1 This growth was accelerated by the pandemic, the race to net-zero emissions, global green fiscal stimulus plans, and record-low interest rates.

The trend continues as 2021 issuances are roughly 90% of 2020’s record already, including the rapid expansion of the loan format as well as increases in social, sustainability, and sustainability-linked bonds to complement the original green bonds. Notably, the growth of loans may be somewhat misleading as the figures are based on the size of companies’ loan programs rather than what they are actually borrowing (which is often much smaller).

In this blog, we explore the potential benefits of this growing market and highlight the importance of avoiding greenwashing...

Sustainable bonds’ potential benefits

End investors are increasingly interested in investments that promote sustainability and social advancement, instead of solely focusing on economic returns. Inflows to ESG funds are now going mainstream, growing faster than conventional bond funds. Likewise, issuers seem eager to burnish their ESG credentials by issuing sustainable bonds. This emphasis on ESG creates a virtuous circular feedback loop that encourages and validates more sustainable bond issuance.

In addition to the subjective “PR” benefits for the issuer to promote its commitment to sustainability, it can now be argued that issuance of sustainable bonds may even have a pricing advantage (or a “greenium”). The generic and often-quoted number is that sustainable bonds trade roughly five basis points +/- tighter than conventional bonds.2 In my view, this premium is more applicable for green bonds, where there is a greater sample size, though it often isn’t an apples-to-apples comparison.

Sustainable bonds can also expand the issuer’s investor base and offer access to new capital for companies who are in industries considered to be less ESG-friendly. End investors can see their investments align with advancing ESG goals and may also benefit from sustainable bond investments starting to outperform the broader market, especially in times of market duress (as they often represent a more defensive play).

Avoiding greenwashing

The current risk to the sustainable bond market, in our view, is whether the governance and best-practice framework can keep pace with the growth in volume and rapidly evolving deal structures:

  • Are we structured as an industry to support robust governance around whether the “Use of Proceeds” meets the higher standards and timing for eligible projects?
  • Do we have a rigorous enough process to evaluate market participants’ ambitiousness with respect to the timing and impact of future sustainability (e.g., environmental and/or social) targets?
  • Is there a stiff enough economic disincentive to promote adherence and avoid greenwashing?

We believe the key to longer-term success is the establishment of appropriate standards and disclosures, which would maintain and strengthen the integrity of the market. Fortunately, new regulations coming this year, led by European regulators (“EU Taxonomy Regulation”) and increased attention from the SEC, will bring more focus on "green" transparency and could reorient flows to sustainable businesses through standardization. In Europe, these regulations will establish an EU Green Bond Standard, create an EU-wide sustainability classification system (“taxonomy”), and require more robust disclosure of sustainable risks/activities benchmarked against the taxonomy for both issuers and investors.

In addition, Wellington is one of only a few buy-side firms that have established a dedicated syndicate desk to specifically focus on execution and best practices in the primary/new issue market. As such, we are in a differentiated position to help prevent greenwashing given our direct relationships with the bankers actually structuring these sustainable bond deals with companies. Working closely with Wellington’s ESG Research Team, we use these opportunities for direct engagement with companies/bankers to both evaluate the validity of the deals and share our views on how companies can improve their ESG profiles.

Bottom line on sustainable bonds

The rapid growth of ESG debt offers compelling potential for investors to both promote progress and benefit from attractive investment opportunities. However, it does raise questions about possible greenwashing. We are therefore excited about upcoming EU regulations and increased SEC attention on this issue. Furthermore, we leverage our syndicate desk to actively communicate with companies and the sell side to help advance the goals of a vibrant sustainable finance market, minimize the threats of greenwashing, and preserve the integrity of the ESG debt market.


1Source: Bloomberg. Data as of 10 June 2021. | 2Source: Barclays ESG Research Report, 28 May 2021.

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