The market for sustainable bonds to fund activities that have a positive impact on the environment or society is booming. But there are many factors to consider before investing. Not least among them is a crucial question: is your money really being used to fund the activities promised?
Booming demand and supply
Bonds have long been a feature of financial markets. The concept is simple: a company, government or other organisation borrows money and promises to return that money in the future, while paying the lender an income on a regular basis during the intervening period.
Companies are now using these instruments to finance or refinance “green” projects and other activities that have a positive impact on society. Demand for “sustainable” bonds, as they have become known, is surging – as is their supply. A record $544.3 billion of sustainable bonds were issued in 2020: more than double the level of the previous year.1
We could compare the way sustainable bonds are developing with smartphones
We could compare the way these bonds are developing with smartphones. Early handsets had few apps and suffered from patchy wi-fi connections and prohibitive data costs. Despite these drawbacks, the technology quickly improved to the extent that smartphones are now everywhere and used for a huge range of purposes. Indeed, most people couldn’t imagine life without them.
The market for sustainable bonds is growing for two main reasons:
- New regulations are forcing businesses to address environmental issues, such as the emission of harmful gases.
- Companies are keen to take advantage of growing demand for these bonds to finance their activities.
The sustainable bond market is growing due to regulation and investor demand
In the corporate world, sustainable bonds were initially concentrated in the financial, real estate, utility and renewable energy sectors. Now the likes of automobile companies, consumer and luxury goods firms, and mobile-phone operators are following suit.2
Spoilt for choice?
The term “sustainable bond” covers a wide variety of subsectors, including:
- Green bonds: created to fund projects that have positive environmental benefits.
- Social bonds: whose proceeds are used to fund initiatives that help society, such as low-cost housing.
- Sustainability bonds: where the proceeds are used exclusively to finance a combination of green and social projects.
- Sustainability-linked bonds: where the issuer promises to meet a target linked to environmental, social and governance (ESG) issues (“governance” refers to the way the company is managed, how it treats its workforce and suppliers, executive pay and other factors).
Figure 1: ESG bond issuance 2013-2020 ($ billion)
Factors to consider
There are various things to consider before investing in sustainable bonds. First, you have to decide which sector you wish to invest in. Then you need to be aware of the issue of “greenwashing”, where funds are not actually used to promote an improved environmental outcome or where it is difficult to measure whether the money raised has had the desired effect.
Is it better to invest in a bond issued by a company with a poor record on carbon emissions or one that has very low emissions?
There is also the question of whether it is better to invest in a bond issued by a company with, for example, a poor record on carbon emissions, or by a business that has very low emissions. Arguably, the impact on climate change will be greater if an investor buys a bond issued by the former, which will use the proceeds to cut its emissions significantly, rather than the latter, which has limited scope to cut emissions further.
The returns from investing in sustainable bonds is another factor, although some investors may be willing to give up some level of return if they are confident the investment will have a positive impact on the environment or society. The yield on Volkswagen’s 2028 green bond, for example, is less than its conventional bond of similar maturity (0.42 per cent versus 0.52 per cent as at 9 February 2020).
More generally, there is serious momentum behind the market for sustainable bonds. In February 2021, the French energy giant Total committed to issue all new bonds through sustainability-linked debt – the first company to do so.3 Although investors should watch out for greenwashing, if enough issuers follow in Total’s footsteps the move could be game-changing.
Three points to remember
- Demand and supply of sustainable bonds is growing rapidly and that trend looks set to continue.
- There are a wide variety of sustainable bonds and it is possible to target investments in a particular area of interest, such as climate change.
- It is important to monitor how the proceeds are being used to ensure they make a real difference rather than are used for ‘greenwashing’ purposes.