Sustainable bonds: Financing the transition and beyond

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Transitioning to a more sustainable future requires ample financing. In 2018, the United Nations (UN) estimated that $3.3-$4.5 trillion per year would be needed to achieve the Sustainable Development Goals (SDGs) by 2030¹. 

Much has changed since, with the COVID-19 pandemic and military conflicts pushing humanity further away from some of its sustainability targets². In 2023, UN Secretary-General António Guterres warned that developing countries now face an annual funding gap of around $4.2 trillion to achieve the SDGs³. While this may seem like a huge sum, the good news is that it equates to just 1% of total assets held by global banks, institutional investors and asset managers⁴, and there are now more investment options available to us than ever before.

Debt markets are a crucial source of funding for the transition because bonds, unlike equities, can be issued by a wide range of stakeholders, including governments, government agencies, development banks and international organisations. Sustainable bond issuance has been growing at pace since the first Green Bond was issued in 2007. Total issuance in 2023 exceeded $1 trillion, with the cumulative amount issued in the market reaching $4.9 trillion⁵. The public sector continues to be a major contributor, representing 31% of the total issued amount⁵. Demand is also increasing, as more investors aim to not only generate an attractive risk-adjusted return, but also finance initiatives that could make our world a better place. 

What are the options for investors? 

Green Bonds

The biggest category within the sustainable bond space globally is Green Bonds, making up around 64% of total issuance in 2023⁵. Green Bonds finance new and existing projects with environmental benefits. For example, some of the Green Bonds issued by German state-owned development bank KfW are financing the construction of wind turbines and energy efficient housing in Germany⁶. Meanwhile, some of the Green Bonds issued by the UK Treasury are funding the expansion of the UK’s electric rail network, which aims to reduce the reliance on diesel, and supporting the Nature for Climate Fund (NCF) Tree Planting Programme⁷. 

Organisations that issue Green Bonds, and sustainable bonds in general, typically publish frameworks outlining the types of projects that are eligible for funding, any exclusions and, in some cases, highlight alignment to global initiatives, such as the UN SDGs. Many established issuers also publish comprehensive impact reports with details about the projects their bonds are financing globally, and the progress made, which provides greater transparency for investors.

Although not always included within the sustainable bond universe, it’s also worth briefly mentioning Transition Bonds. These bonds are typically issued by companies operating in industries with high greenhouse gas emissions, which can’t issue bonds under the ‘Green’ label. Transition Bonds help corporates fund their transition towards a lower carbon future. 

Social Bonds

The second-largest category within the global sustainable bond space is Social Bonds, which made up around 14% of total issuance in 2023⁸. Social Bond proceeds are allocated to projects with clear social objectives, such as providing clean drinking water and affordable housing, funding education and healthcare initiatives, or promoting food security and job creation. These projects typically support more vulnerable segments of the population and provide much-needed financing to developing countries. 

Social bond issuance exploded during 2020 as the COVID-19 pandemic took hold, increasing 1022% from the previous year to $249 billion⁹. Pandemic bonds made up 34% of social bond issuance that year⁹, and financed important initiatives aimed at strengthening healthcare systems, providing access to critical medical equipment, supporting hospitals, and rolling out immediate-response health programmes.

Sustainability Bonds

Some bonds finance or re-finance a combination of both green and social projects and these are known as Sustainability Bonds¹⁰. Together, Green, Social and Sustainability Bonds are often referred to as GSS Bonds. 

Sustainability-Linked Bonds

In 2019, we also saw the emergence of Sustainability-Linked Bonds (SLBs). The bond categories discussed earlier are mainly issued by sovereign states or supranational organisations and are typically ‘use-of-proceeds’ bonds, meaning the money raised will be allocated to specific projects. SLBs, on the other hand, are not ‘use-of-proceeds’ bonds and are most often issued by corporates. 

Rather than funding specific projects, the performance of these instruments is linked to sustainability or ESG performance targets, as defined by the issuer. For example, Schneider Electric launched its first sustainability-linked convertible bond in 2021, which promised to pay an amount equal to 0.5% of the nominal unit value of the bond (in addition to the usual bond payments) if the company fails to meet a pre-determined minimum sustainability performance score by the end of 2025¹¹. The sustainability performance score in this case is based on Key Performance Indicators (KPIs), ranging from emissions reduction targets to gender diversity metrics. 

Blue Bonds

While much of the Sustainable Bond market is still focused on financing climate-related projects, there is growing interest in funding a wider range of initiatives, in line with the Sustainable Development Goals. 

In 2018, Seychelles was the first country to issue a Blue Bond, raising $15 million dollars¹². This bond was partially guaranteed by the World Bank and was designed to support sustainable marine and fisheries projects, including the protection of marine-protected areas. In 2023, Fiji followed suit, issuing its first sovereign Blue Bond and raising circa $8.7bn¹³. Supporting life below water is one of UN’s 17 SDGs and although the blue bond market is still in its infancy, these issuances pave the way for more projects within this space. 

Orange Bonds

Orange Bonds have also emerged in recent years. The Impact Investment Exchange (IIX) launched the first Women’s Livelihood Bond (WLB) in 2017¹⁴. Since then, the Orange Bond Initiative was developed as a solution to financing gender equality¹⁵. The initiative is a key component of the wider Orange Movement, which aims to mobilise $10 billion by 2030 to benefit 100 million women and girls worldwide¹⁶. 

Orange Bonds are distinct from Gender Bonds, which fall within the Social Bond category, as they aim to address a wider range of issues. Their goal is to attract more funding to support SDG 5 (Gender Equality), while also contributing to the other SDGs. 

The Women’s Livelihood Bond 5 (WLB5), launched in 2022, was recognised as the world’s first Orange Bond. The proceeds of this bond are expected to be used to make loans to companies in Cambodia, India, Indonesia, Kenya and the Philippines operating within the clean energy, sustainable agriculture, water, sanitation and affordable housing sectors¹⁷. 

The outlook for sustainable bonds

Global sustainable bond issuance fell in 2022, amid tougher macroeconomic conditions and higher interest rates, but was strong in 2023 and is expected to grow modestly over 2024¹⁸. Lower interest rates would be supportive, but, more importantly, there are several structural drivers at play, including regulation, transparency initiatives and the push from investors for companies to adopt more sustainable practices. 

The EU Corporate Sustainability Reporting Directive (CSRD) is now coming into force, which introduces further reporting requirements for corporates. This, together with IFRS S1 and S2 sustainability- and climate-related disclosures, should improve transparency and help investors better assess the ESG and sustainability characteristics of companies. 

Currently, Europe is leading the market in terms of Sustainable Bond issuance, but Asia Pacific (and China in particular) is not too far behind¹⁹. In the US, the Inflation Reduction Act, which was signed into law in 2022, could drive more issuance in the future as demand for transition financing increases, but in the immediate term, uncertainty around the upcoming presidential election may hold issuance back. Within emerging markets, Chile is one of the largest sovereign issuers and, unlike developed market sovereigns which are more focused on Green Bonds, emerging market sovereigns issue more Sustainability Bonds (which finance a combination of green and social projects)⁵. 

Overall, sustainable bonds can offer investors a range of options to drive positive outcomes globally. However, in-depth investment due diligence, together with a comprehensive sustainability assessment process, will be essential to navigate the opportunities and risks in this growing market.

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