Green, social and sustainable bonds are a type of debt instrument issued mostly by governments, supranationals, corporates and municipalities. In almost every respect they are identical to the traditional bonds that investors are already completely familiar with, and probably already hold as a core allocation in their portfolios.
In a traditional bond the issuer has complete freedom to use the money raised for just about any purpose they wish. This use is often not even disclosed beforehand, except in a very general sense. However, when a bond is categorized as green, social or sustainable (GSS) then it simply means the issuer intends to use the proceeds to fund a specific environmental, social or governance (ESG) project, achieve a goal or fulfll an ambition.
The great majority of GSS bonds are so-called ‘use of proceeds’ bonds where the proceeds are earmarked for particular investment purposes – these can be new projects, or the money may be used to refinance spending that has already happened. In other cases, rather than specify a particular use of proceeds, some GSS bonds raise funds to help companies or governments meet certain ESG goals or targets. In both cases, however, these securities are otherwise identical to conventional bonds.
What can be called a ‘green’, ‘social’ or ‘sustainable’ bond is not legally defined (certain market standards and conventions are emerging). That said, the following summary highlights what characteristics investors might expect to find in bonds with the various labels.
- Green Bonds – the bond proceeds are invested, for example, across activities in renewable energy, green buildings, sustainable water or clean transport.
- Social Bonds – the bond proceeds fund activities that achieve positive social outcomes or address a particular social issue, such as investment that targets poverty or provides access to essential services, affordable housing or healthcare.
- Sustainability Bonds – the bond proceeds are used to refinance a combination of green and social activities described above.
- Sustainability-linked bonds – the bond proceeds are not targeted at a particular investment but the issuer agrees to hit certain key performance indicators, in green or social themes, and usually accepts certain financial penalties if these are not met. For example, an increase in the bond coupon if a certain CO2 emissions target is not met in the future.
Whatever the label, the key point to bear in mind is that in every other respect these bonds will be identical in form to conventional bonds issued by the same entity. They will have a regular coupon and a fixed maturity date. And, importantly, the same seniority as conventional bonds. So if the worst happened, and the issuer defaulted, the GSS bonds and the conventional bonds will rank equally. In other words, they carry the same credit risk.
Market size and structure
Although the first ‘green’ labelled bonds were issued as recently as 2007 the market has grown a lot since then. On one hand this follows the need of issuers to address climate change in a meaningful way and, more recently, the efforts by governments, corporates and investors to drive positive change on a broad range of social and sustainability metrics. The evolution of the market has also been supported by the wide acceptance of various voluntary principles discussed below.
Using the ICE Green, Social and Sustainable Bond Index as a reference point, the total market value of qualifying GSS bonds today is about USD 1.6tn, and comprises about 1,700 bonds. Despite the rapid growth we should not forget that GSS bonds are still a relatively new phenomenon and it will not be a surprise to learn that they constitute just a fraction of the broader bond universe. For instance, the Bloomberg Global Aggregate Index (a popular bond benchmark tracked by many investors) has a market value today of USD 65tn, across nearly 33,000 bonds.
Europe has a much higher weighting in the GSS index and European governments are becoming key issuers in this market. In part this reflects regulatory and policy initiatives such as the European Green Deal which is the plan to make Europe climate-neutral in 2050 and the EU’s Pandemic Recovery Fund which aims to raise 30% of the funding with green bonds. In the US, to date, issuance has been led by corporates and municipals and the government has played a less active role than is the case in Europe.
Here you'll find the complete report 'Demystifying ‘Green,’ ‘Social’ and ‘Sustainable’ Bonds' from UBS Asset Management.