The International Capital Market Association chief executive outlines how the fast-evolving bond markets are playing a powerful role in driving forward the global ESG agenda.

Martin Scheck

The international bond markets have long been successful in mobilising both private and public capital at scale in the cause of driving economic growth. They offer issuers a flexible and diverse source of capital to satisfy the investment needs of a wide spectrum of investors, and allow funds to flow across borders to ensure that resources are allocated when and where they are most needed.

Green bonds – a comparatively recent innovation in this long-established market – provide a mechanism to direct capital market funding towards sustainable economic development, often in the transport, energy and building sectors. Under the ‘use of proceeds’ concept, funds raised are used to finance (or refinance) specific green projects and assets.

Together with detailed reporting on the environmental impacts and through an independent review process, bond investors now know exactly how their money is being used to support defined environmental objectives. The publication of the Green Bond Principles in 2014, and the work of the eponymous market initiative known as the GBP for which International Capital Market Association (ICMA) acts as secretariat, were a major driver in boosting issuer and investor confidence in the integrity of the market and facilitating its growth. In 2019, annual green bond issuance exceeded $260bn.

So far so good, but this amount is still a small (although rapidly expanding) fraction of the total issuance in global bond markets. However, in assessing the value of green bonds, we must look beyond their direct role in successfully raising finance globally for green projects.

The indirect impacts are significant: green bonds have considerably increased the visibility of green finance as a whole among investors and issuers, and have catalysed the wider public policy debate about sustainability. The emergence of green bonds has also greatly progressed the discussion on the definition of what is ‘green’ and seen the growth of independent services which can review and audit green projects.

Green bonds have created the underlying framework which has been successfully mirrored in the green loan market, broadening the scope of green financing and making it accessible to a range of borrowers who may not have direct access to the bond markets – small and medium-sized enterprises and households, for example. Policy-makers presented with a flourishing, largely market-driven example of green investment have been inspired to look at ways of supporting its development. This, together with rising public awareness and activism around the climate emergency, has contributed to the current situation where almost every major economy globally now has a sustainable finance strategy.

Reacting to Covid-19

Green bonds were very much the forerunner of the sustainable bond markets and, up to the beginning of this year, the dominant focus of the environment, social and governance (ESG) bond market.

The pandemic has radically changed this situation. In the same way that Covid-19 has accelerated trends in other aspects of our lives (the use of fintech and remote working for example), it has kick-started the previously small social bond market, where bond proceeds are earmarked for expenditure with a social objective.

Social and sustainable bonds (which combine elements of both social and environmental objectives in the use of proceeds) are the fastest growing segment of the sustainable finance spectrum this year, with issuance exceeding $90bn by the end of August 2020, already in excess of the 2019 full-year totals. As much as 60% of 2020’s social-bond issuance references Covid-19, and the vast majority of issuance is aligned with the ‘social bond principles’ (SBP) and/or ‘sustainability bond guidelines’ also released by the GBP and ICMA.

This welcome development is a further illustration of how capital markets can be a force for good. Companies, especially those in the health sector, have entered the social bond market for the first time to finance expenditures such as medical equipment, health infrastructure or vaccine research and development, and other issuers have chosen to channel the proceeds to mitigate the socioeconomic impact of the crisis – such as the hardships caused by related unemployment. Significantly, in the public sphere, the European Stability Mechanism has announced that it will issue social bonds, at scale, to address the socioeconomic impacts of Covid-19 in the EU and that its issuance programme will explicitly align with the SBP.

This emphasis on social and sustainable bonds does not detract from the importance and relevance of the green bond market in the light of the ongoing climate emergency. On the contrary, it creates a more balanced complementary ESG agenda where, up until now, the focus has overwhelmingly been on the environmental rather than the social or governance aspects.

Building back better

As the focus shifts from the immediate healthcare crisis to stimulus measures for economic recovery, there has been a great deal of discussion around ‘building back better’. The June 2020 Organisation for Economic Co-operation and Development paper of the same title urges the need for economic recovery packages to aid ‘the transition to more inclusive, more resilient societies with net-zero greenhouse gas emissions and much reduced impacts on nature’ — in other words, avoiding a return to business as usual.

This is an opportunity for the capital markets to play a major role and it is encouraging that at least some of the major refinancing programmes from national and regional authorities to rebuild prosperity are ‘hard wiring’ both environmental and social aspects into both the financing and disbursement side. The EU recovery package is a notable example of an environmentally friendly stimulus programme, with 30% of the overall €750bn ($830bn) package directed towards ‘green’ initiatives, including targeted measures to reduce dependence on fossil fuels and enhance energy efficiency.

The proliferation of national and international sustainability initiatives can be confusing and their interplay complex. But it is again encouraging that governments around the world are looking to help the sustainable bond markets develop, and want asset managers and consumers to be confident to embrace sustainability by putting their savings to work in a market which is robust and has integrity. Inevitably, this involves moving from a developing market which relies solely on guidelines and principles to a more mature framework where these self-regulatory initiatives are augmented by legislation and regulation where appropriate. This is where we are now.

The future of sustainable bond markets

The challenge, of course, in this ‘journey’ is to ensure that the legislation and regulations are fit for purpose and achieve their goals, without stifling market growth by overburdening issuers and investors with regulatory requirements which act as a disincentive to get involved in the sector. This is a difficult balance requiring partnership and extensive dialogue between the private and public sector, and this is where ICMA will continue to add value. The issue is particularly complex in a global market where different countries and regions are acting at different speeds and have different priorities within the sustainable finance agenda.

Meanwhile, market-led innovation in sustainable finance continues. We have witnessed the narrative in our markets gradually shifting from financing of individual green or social projects to issuers’ overall sustainability strategy, likely fuelled by the increased awareness of climate-related risks and opportunities, as well as investor activism and regulatory pressure. Preceded by developments in the loan markets, the new sustainability-linked bond principles were released in July, to help new players come to the sustainable bond markets at an earlier stage of their transition to more sustainable operations.

Under these, issuers will commit explicitly to future improvements in sustainability outcomes within a predefined timeline, with their chosen key performance indicators assessed against predefined sustainability performance targets. The funds raised by sustainability-linked bonds, are for general purposes, directed toward meeting sustainability objectives rather than to finance specific assets or projects, as in the case of green and social bonds. They are ambitious and designed to ensure a high level of transparency and integrity for a new market which has great growth potential. They are also versatile enough to serve a wide universe of sustainability themes, such as climate change, green transition, social issues, governance standards, gender and diversity concerns, all contributing to the UN Sustainable Development Goals.

ICMA’s global membership embraces all types of buy- and sell-side participants in the capital markets – most of them are increasingly involved in financing a more sustainable economy. Whether through our work providing the de facto global standards for the sustainable bond markets, through our engagement with our members and stakeholders, or through our input into the development of supportive regulation and legislation in Europe and in Asia, we remain deeply committed to continued and substantive engagement in the sustainability agenda.

There are good reasons to be optimistic about the future of the sustainable bond markets and their contribution to the extraordinary problems we face. The convergence of private and public sector initiatives, along with the realisation that we all need to tackle the climate emergency and rebuild economies in a fair and sustainable fashion, creates a rare opportunity to position sustainability even further into the mainstream of finance.

Martin Scheck is chief executive of the International Capital Market Association.


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