Making sense of impact bonds
Whether it be green or blue bonds, social or rhino bonds, impact1 investing offers a remarkable growing array of opportunities. But regardless of the opportunity, investors should be wary of “impact washing”, says Insight Investment head of responsible investment and stewardship, Joshua Kendall.
Impact investing isn’t a niche opportunity but a way for investors to encourage a positive environmental or social impact with their investments. The approach is seeing increasing popularity. While there was only about US$50bn of impact bond issuance in 2015, by 2020 annual issuance rose to around US$500bn2, with issuance in the first half of 2021 outpacing the entirety of 20203.
Push and pull factors have both had a role to play in this growth which can be summarised as follows:
- Shifting attitudes – As society and generations shift to cater for the values and priorities of so-called millennials and Generation-Z, then so too investors are increasingly seeking out companies that consider their environmental and societal impact.
- Demonstrating commitment to achieve positive environmental and societal impacts – More and more businesses recognise the importance of supporting local communities and environments. While for corporates, multi-nationals and sovereigns the issuance of impact bonds can demonstrate their commitment to achieving sustainability strategies and to wider efforts such as the Paris Agreement and UN Sustainable Development Goals.
- Regulatory pressure – In some sectors, such as utilities, regulation has threatened corporate business models and without change some companies in sectors such as energy may face uncertain futures. For example, commitments to phase out coal power require replacement technologies that needs funding.
- Ease of issuance – It is easier than ever before to come to market with an impact bond. There is more advice and support for issuers ( from bodies such as the International Capital Market Association) and investors are increasingly asking for impact investments.
To date, green bonds, which fund projects that foster a net-zero emissions economy, protect the environment, or improve resilience and adaptation to climate change, have dominated the impact bond market. Green bonds kicked off the impact bond market in 2007 when the European Investment Bank issued its inaugural impact-based issuance. However, over the past five years, issuance of social and sustainable bonds appear to be rapidly catching up.
Social bonds fund projects which aim to address or mitigate a specific social issue or seek to achieve positive social outcomes. They often target essential services such as healthcare, education and financial services, affordable housing, and basic infrastructure such as sanitation, transport, and clean drinking water. Over the past year, social bonds have also been issued to help fund Covid-19 medical response activity, such as research and development and to support welfare responses.
The third major category of impact bonds fund a combination of green and social projects and are dubbed sustainable bonds.
Smaller markets include blue bonds which focus on marine and ocean-based projects, gender bonds which strive for gender equality and opportunities and transition bonds to help companies of all types support the transition to a low carbon economy. In 2021, the World Bank launched rhino bonds with US$45m of issuance for which investors’ rate of return will depend upon the success of raising the numbers of black rhinos in the wild.
While the growth and acceptance of impact bonds is generally seen as a force for good, investors need to be aware of what they are buying. Standards of disclosure can be lax. This is a significant enabler of ‘impact washing’ – where an issuer claims to be impact-focused but has potentially little or superficial demonstration of positive impact. This, in turn, creates challenges around comparability in the issuance of, and reporting on, so-called impact bonds. Likewise, a lack of consistent reporting renders it difficult for investors to identify whether bond proceeds are used as initially marketed or are simply impact in-name-only.
The International Capital Market Association (ICMA) has attempted to address this with a set of voluntary principles. ICMA’s Green Bond Principles set standards of transparency and disclosure with the stated intention of helping to promote “integrity in the development of the green bond market”. Its Social Bond Principles and its Sustainability-Linked Bond Principles have similar aims.
The growth of the impact bond market gives more choice for investors who seek to address challenges around climate change and inequalities. However, the efficacy and validity of each impact bond varies and investors should always have robust processes in place to analyse each issue to help them choose wisely.
¹ Insight Investment has its own broad definition of impact bonds which encompasses a wider variety of impact bond definitions than other investment firms might use. For Insight, blue bonds, gender bonds and transition bonds are just some fixed income instruments that would all fall under its definition of ‘impact’ bonds (as would social impact bonds).
² ESG Clarity. Impact bond issuance reaches record levels. 04 February 2021.
³ Insight Investment. Responsible investment in fixed income quarterly update. 29 April 2021.