How impact bonds are making their mark
While the burgeoning impact bond market is driving greater choice and diversity of products, just how impactful are some of these investments and how can their positive influence best be measured? Here, Insight Investment considers market developments.
The world is in flux with rising geopolitical risks, public health concerns and the threat of global warming coming into increasing focus. Combined with mega-trends such as the effects of climate change and rising social inequality, they represent some of the biggest risk factors investors face today.
Finding ways to measure and analyse these risks are increasingly important. Yet these trends have become so pervasive they are also causing an evaluation of whether ‘financial success’ is the only metric on which investment portfolios should be judged. Articulating a ‘purpose’ is also becoming an essential part of the modern investment world.
Increasingly, it is necessary for investors to think about the outcomes they wish to achieve through their investment beyond purely financial ones. For many investors, this will involve expressing their values in portfolios as both a way of reducing risk and ensuring a broader positive societal and/or environmental impact.
Impact bonds can offer access to impact key performance indicators (KPIs) such as the annual greenhouse gas emissions avoided or the new renewable energy generated annually via targeted investments. By pulling this data from an issuer’s impact reporting, investors can measure the impact generated for strategies focusing on impact bonds.
By any measure this is a growing market. Outstanding impact bond issuance surged to more than US$1 trillion in 20211 and the rise in issuance of over 70%2 since the first corporate impact bond was launched in 2013 marks an important development for fixed income investors. Sovereign and supranational impact bond issuance has continued to grow, with the UK and European Commission both issuing their first green bonds last year.
“Use-of-proceeds” bonds are debt instruments issued with the proceeds raised being directed towards projects that will meet an environmental or social objective. This is the type of instrument most commonly referred to when people use the term impact bond. The three most common types of use-of-proceeds impact bonds are green, social and sustainability bonds.
The classification of a bond as green, social, or sustainable is determined by the issuer based on its primary objectives for the underlying projects. There are some commonly used frameworks and standards that provide issuers with information on reporting, verification and bond frameworks (such as the International Capital Market Association’s (ICMA) Green Bond Principles). However, alignment with these principles is not mandatory and regulation is essentially voluntary.
Sustainability bonds are bonds where the proceeds will be exclusively applied to finance or re-finance a combination of both green and social projects and which can hold sustainability targets which, if achieved, may result in a change in terms of the bond.
Green bonds continue to dominate the impact bond issuance market. More than US$1.43 trillion has been raised in green bond issuance since 2007, with more than 500 other entities to issue green bonds since then3.
In turn, social bonds have been following green bonds’ trajectory, particularly since the emergence of Covid-19. As the sector grows, the market is seeing the emergence of more varied impact bond type offerings as issuers cater to the sophisticated impact investor.
Emerging sub-classes in this area include blue bonds, gender bonds, transition bonds and even a rhino bond. Investor demand and global needs continue to bolster impact issuance. However, although issuance of social bonds in 2021 increased by some 1.4 times compared to 20204 , the focus of the impact bond market has shifted to climate change. Issuance of green and sustainability bonds have both more than doubled over the same period.
Historically, impact bonds have been issued mostly by government, financial and utility issuers. However, more sectors have begun engaging in impact bond issuance, with other corporate sectors gradually catching up as well as sovereign bonds.
However, against this backdrop of expanding issuance, and a lack of regulation, so-called ‘impact washing’ has become a concern. The term itself refers to issuers labelling their bonds as impactful in nature, with little intention of using the proceeds toward any demonstratable impact.
The new EU green bond standards and the EU taxonomy – a classification system, establishing a list of environmentally sustainable economic activities – should introduce more market standardisation and give access to more complete information that will be genuinely relevant to investors over time. However, while markets await more formal frameworks to be enforced, it is vital for investors to carry out appropriate due diligence to avoid falling victim to impact washing.
For issuers, alignment with the ICMA Green Bonds Principles, along with external verifications, should help support them in avoiding making any unintentional impression of impact washing.