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Opinion 16 August 2019

Green, social and sustainable bonds: long-term profitability

Angel Tejada, BBVA’s head of green and sustainable bonds, analyzes the activity in the green, social, and sustainable bond market during the first half of the year and explains the outlook and opportunities that this exponentially growing market represents.

The first six months of 2019 have confirmed the undeniable importance of green bonds as a tool for financing the United Nations sustainable development goals and the commitments adopted in the Paris Agreement. These bonds have undoubtedly taken root among institutional investors and issuers alike.

The market in 2019 has witnessed record growth in volume, having exceeded $125 billion,  and BBVA forecasts that volumes will reach $220 billion by the close of the year. The number of such deals has also grown, fueled by first-time (inaugural) issuers across different sectors and countries.

The burgeoning worldwide market for green, social, and sustainable bonds has been boosted by different factors. On one hand, businesses have reaffirmed sustainability as a cornerstone of their corporate strategies. Yes, sustainability can be a strategy that generates competitive advantages. On the other hand, we are faced with a sense of urgency related to the fight against climate change and the implementation of the sustainable development agenda, which is backed by important initiatives like the European Commission’s Action Plan on Sustainable Finance. Similarly, it must be pointed out that institutional investors are including environmental, social, and governance (ESG) criteria in their investment strategies and policies. This approach is known as socially responsible investing. It has evolved over the years moving from a purely risk management approach to an alternative that can both generate long-term value and positively contribute to society and the sustainable development goals defined in the UN's Agenda 2030.

Sustainability can be a strategy that generates competitive advantages

Therefore, when we talk about the green, social and sustainable bond market, we are talking about a market that has both a long-term focus and impact. We're talking about a market that is founded on transparency; one that relies on the proper alignment of the issuances with the issuer’s sustainability strategy; a market that depends on the environmental and social impact of the projects, activities, investments, and programs that are financed by these bonds and on which the issuer will have to periodically report to its investors.

The exponential development of the market in 2019 has resulted in the participation of new sectors: the debut of the telecommunications sector is a good example. This is a sector that is quite relevant in the fight against climate change given that it represents numerous projects that can be financed through green bonds. Last January, BBVA took a leading role and acted as bookrunner for the first green bond for a telecoms company worldwide with Telefónica’s issue totaling €1 billion; later in May the bank led Vodafone’s issuance for €750 million.

Government involvement in the market has also been significant. Some governments have issued green bonds to finance their commitments made under the Paris Agreement as well as national energy and sustainability plans. Good examples include Chile and Holland’s recent green bond issuances, which may be followed by Sweden, Germany and Spain issuing their own sovereign green bonds.

Fotografía de Ciudad, sostenible, verde, bosque, edificios, gris, centro financiero, árbol, medio ambiente

The incorporation of some governments into the market has been very relevant.

The positive growth trend in the market and increased access to new issuers will be supported in the coming years by the recently proposed ‘green’ taxonomy, which was published by a group of experts at the request of the European Commission. Supporting the transition to climate neutrality, this work applies a standard definition to a universe of activities that will be important for prosperous, modern, and competitive economies that aim to be climate neutral by 2050. Thus, we hope to see an increase in green bond issuances in areas related to the circular economy, sustainable water and waste management, and the financial sector. In addition, the green taxonomy definitions will help institutional investors establish socially responsible investment strategies and launch new products aligned with ESG criteria. The new European green taxonomy, together with those already in play and the International Capital Market Association (ICMA) Green Bond Principles and Social Bond Principles will be key for market growth in regions such as Mexico, North America, and Latin America.

The European Commission Action Plan on Sustainable Finance represents an opportunity for banking inasmuch as banks will be able to increase their focus on and activity in financing deals that are aligned with the transition toward a low carbon economy. At BBVA we are clear that "the future of banking is in the financing of the future", and we will continue to support the development of sustainable finance markets, ensuring that our customers have the solutions that best fit their business models.

Green, social, and sustainable bonds are providing issuers access to additional capital, to a new group of investors, and to specialized funds that look for long-term sustainable profitability in projects, sectors, and companies that will be important for the future. Furthermore, the increased cost of these kind of issuances – arising from the need to contract ESG expertise to verify the sustainable structure of the bond issues  – compared to the issuing of standard debt instruments, is being offset by the outstanding reception institutional investors are giving these deals. With this warm reception, issuers are finding attractive financing terms, even improving on the terms of standard bond issuances.

These potential price benefits are not always initially apparent; in many cases, they are  buoyed by technical factors such as market timing, exchange rate, the issuer’s credit rating, and/or the volume of green bonds on offer. Still, if Europe decides to support the green bond market with policies and incentives in the medium term, this will represent a decisive step for the growth of the market and will lead to a shift in the valuation of this instrument.