Based on the exponential growth of the issuance of green, social and sustainable bonds in the past 12 months, it is fair to say that we are no longer talking about a passing fad, but rather a phenomenon that is here to stay. More companies, as well as investors, are incorporating ESG (Environmental, social and corporate governance) objectives in their investment agendas. BBVA Global Markets Research discusses the ESG bond market, its volumes and main topics in their report ‘ESG Bonds: Key topics and trends for 2019 and beyond - Getting the harmony right’.
Without a doubt the growth of the ESG bonds market has been more than evident. Throughout 2019 the issuance of these bonds has consistently been above the monthly averages of the previous three years, with May showing a record of USD35bn, 175% above the three year average. During the same month the percentage of ESG issuance was the highest, with around 6.7% of total bond issuance being labelled either green, social or sustainable.
There are other factors to support the consolidation of the ESG bond market. For instance, the issuance outside of the dominant markets is steadily increasing and more and more sovereign issuers are turning to green bonds to achieve their sustainable development strategies. The fact that the ESG bonds are appealing to a broader, more diverse range of investors, particularly in the emerging markets, will likely further increase demand and potentially lead to some pricing advantages.
Europe leading the way on green bond market harmonisation
Work done by the European Commission’s High-Level Expert Group on Sustainable Finance (HLEG), established in 2016, has been crucial to lay out standards and guidelines for how European issuance of green, social and sustainable bonds can be further harmonised as well as to: ‘steer the flow’ of capital towards sustainable investments.
Establishing a common taxonomy, a framework, for the ESG bonds market has been the priority of the EU’s Technical Expert Group on Sustainable Finance (TEG). Providing ESG bond market participants with a comprehensive classification of 76 economic activities from seven industry sectors serves as a substantial foundation and will hopefully prove to be a landmark moment in this market. TEG’s recently published report on the EU Taxonomy for ESG bonds is a significant step in the right direction, but it is only a first iteration of the important work to come in the future.
Establishing a common taxonomy for the ESG bonds market has been the priority of the EU’s Technical Expert Group
Key topics in the ESG bond market:
Some of the key topics that are currently under discussion in the ESG bonds market are:
- ‘Greenium’ concept: The presence of a ‘greenium‘ would suggest that bonds labelled as green, social or sustainable would trade at tighter levels than those of conventional (read: ‘brown’) bonds. Greenium is an important concept, as the potential for issuers to gain a clear economic benefit from issuing green bonds, as opposed to non-green, will be a key driver for the growth of the market. Alas, as it stands, there is no such clear economic incentive.
- Additionality effect to issuing ESG bonds: Some experts argue that there is no additional benefit to issuing a green-labelled bond than a traditional one. BBVA analysts’s view is that green bond issuers provide investors with greater clarity due to greater reporting requirements, the alignment of the wider issuers corporate strategy with various environmental targets, and increasing market participation from investors, other issuers, central banks, regulators etc.
- PG&E example serving as a cautionary tale: US utility company PG&E (Pacific Gas and Electric Company) filed for bankruptcy in January 2019 as a result of an estimated USD30bn of liabilities arising from wildfires in 2017 and 2018, the starting of which had been linked to the company’s equipment. This was the first recorded bankruptcy that has been linked to climate change factors. As a consequence, the investors are now demanding more transparency regarding ESG risks in order to be able to gauge their exposure more efficiently.
- Millennial generation driving socially responsible investment: A study released by First State Investments, in conjunction with Kepler Cheuvreux, detailed to what extent the ‘millennial’ generation is actively engaged with socially responsible investing. 81% of the sample were either ‘interested’ or ‘very interested’ in the concept of investing in socially responsible or sustainable investments.