The global head of public sector and sustainable financing at HSBC, Ulrik Ross, has helped to oversee the recently launched appendix to the Green Bonds Principles. He speaks to Michael Watt about the impact of this development and the health of the GSS bonds market in general.

In the past couple of years, green, social and sustainability (GSS) bonds have gone from being a high-finance curio, interesting but niche, to a mature and increasingly popular part of global debt markets. A record $37bn-worth of green bonds were issued in 2014, including the largest ever dollar-denominated green bond – $1.5bn – issued by German development bank KfW.

Though activity has slowed slightly this year, issuance is spreading beyond the traditional western European hub and into emerging markets and North America. The ethical investment space is deemed to be so important that some banks are reshuffling the structure of their debt capital markets business to take specific aim at it. 

The sector developed from Japanese retail bonds with an environmentally friendly tinge in the 1990s, and ever since has been dominated by a green aspect. Other instruments in the socially responsible universe – based upon returns from social housing, healthcare or education, for example – have been out of the spotlight for two reasons. First, the huge upsurge in renewable energy projects, and ensuing green bond issuance, has elbowed these other forms of ethical investment out of the market. Second, green bonds are easy to define, and a clear structure has been built around their use over the years.

October 2013 saw the publication of the Green Bond Principles, a set of standards based around the reporting and use of proceeds of green bonds that helped form a framework for issuance in that sector and mirrored the environmental, social and governance principles that have been present in the equity market for more than a decade.

Green principles 

The principles have been updated on a number of occasions since then, and are credited with helping push forward last year’s boom in the green bond market. In comparison, there is no such document to help bring structure to other parts of the do-gooder debt market. 

Until now, that is. In July this year, HSBC, Crédit Agricole and Rabobank launched an appendix to the Green Bonds Principles that provides voluntary guidelines for the development and issuance of social and sustainability bonds. It covers the same ground as the principles for green bonds, and provides a clear definition of what social and sustainability bonds should look like, and how they should behave. 

Ulrik Ross, the global head of public sector and sustainable financing at HSBC in London, has been at the forefront of these developments. “We saw it was important to further facilitate investment in social and green bonds. With a clearer distinction between the two we can mobilise for more capital for these purposes,” he says. “With this appendix, we now have three distinct categories for the bonds in this market – green, sustainability and social. There is clarity on issues such as use of reporting and management of proceeds for each.” 

Mr Ross goes on to mention the problems issuers have had in aiming social and sustainability bonds at green investors. “When it comes to social housing, healthcare or education, we didn’t have a format to capture them and make it clear they were suitable for inclusion in ethical investment mandates,” he says. “We’ve seen quite a few such bonds brought to the market that have arguably been suitable for inclusion in the green bond framework, but investors have often had difficulties in assessing benefits beyond green.” 

The appendix was developed and cultivated through investor engagement, but Mr Ross stresses it was the banks that led the way. “No one asked us to do this. We spotted the problem and saw the appendix as a natural and beneficial development for the market,” he says.  

Gradual growth 

Growth in social and sustainability bonds is gradually picking up. In early June, the Climate Bonds Initiative held a one-day conference on the subject in Madrid, and in terms of actual market development there have recently been several notable steps forward. In September 2014, the Inter-American Development Bank launched its inaugural social bond, the proceeds of which will be devoted to education, youth and unemployment causes. Weighing in at $500m, the instrument has a four-year tenor and was snapped up by public and private investment bodies. Earlier this year, Lloyd’s Banking Group spoke to The Banker about its £250m ($390.6m) environmental, social and governance bond issued in mid-2014. The proceeds from this issuance will go to ethical and regeneration projects in some of the UK’s most deprived communities. 

“I’d say there are probably about 15 sizeable social or sustainability bond deals out in the market at the moment,” says Mr Ross. “The green bond market is clearly dominant, but the other two types of ethical issuance are equally relevant and serve equally valid purposes. With the appendix in place, there is more clarity around instrument definition and I believe more and more investors will include all three types of bond in their mandates. Social and sustainability bonds may not be for everyone but they will be very attractive for the vast majority.” 

For Mr Ross, the increasingly global spread of the GSS market is a source of huge optimism. “GSS bonds are spreading beyond Europe and into emerging markets in Asia, Africa and Latin America, helped by the significant increase in renewable energy and anti-poverty projects in these regions. Investors who are not already committed to this market are thinking about how to commit,” he says. 

Mr Ross has also noticed a greater willingness among investors to go wider in the credit spectrum. Due to healthy market scepticism, GSS bonds started out as exclusively high-grade investments issued only by well-rated and well-established entities. Thanks to its strong market performance and low default rate, the ethical investment market is expanding into high-yield issuance. In July this year, renewable energy firm Terraform Global issued a whopping $810m seven-year senior green bond with a coupon of 9.75%. 

“In recent years, the GSS market has experienced very few setbacks from a credit perspective," says Mr Ross. "There have been very few entities that have issued this type of instrument and not met their obligations to investors. GSS bonds have built such a strong reputation that any default can now be treated as an idiosyncratic, issuer-specific problem, not a technical problem with the entire market or the structure of the GSS platform. There is now huge interest from asset managers of all types.” 

A second stream 

The next evolution for the ethical investment market may be the entry of non-green companies into the issuance game, resulting in a two-tiered structure. “We may soon see two streams of GSS issuance – one originating from purely GSS companies or projects, where the use of proceeds is exclusively for specifically ethical projects, and another from corporates who want to be greener over time and are investing in green or socially responsible business lines,” says Mr Ross. “If this second type of so-called ‘grey’ issuance, from industrial companies and the like, gets under way, then it could mean a huge boost for GSS market share.” 

In Mr Ross’s eyes, one key advantage that GSS bonds have over their non-GSS counterparts is quality of execution. “There is a better execution of GSS bonds because we have a normal investor base and an additional investor base who are solely after this type of instrument. That means we can fill the book faster with a higher quality of investor, and achieve a good outcome and potentially better price for the issuer,” he says. 

The creation of a ‘captured’ market for GSS bonds via investment mandates should provide some immunity to the patchy liquidity in the debt markets, a topic that has worried participants and regulators alike in recent years. Increased regulatory and capital costs have forced many banks to reduce the amount of securities that they can churn in and out of their trading books, removing significant liquidity capacity from the market. Some in the industry have suggested that a radical overhaul of bond issuance, with a reduction in the creation of new instruments to support the liquidity of existing ones, is just one of the options on the table.

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