(Environmental and) social justice warriors

SSA issuers, particularly agencies, have been among the most prolific issuers in the sustainable development bond market. The idea was that issuers could demonstrate their commitment to issues that resonate with customers, investors and voters, while also funding on competitive terms.

SDBs help public sector borrowers achieve their mandated political objectives, be that the promotion of renewable energy with Green bonds, cleaning up water resources with Blue bonds or increasing provision of affordable housing with Social bonds. Existing loans were repackaged and sold as bonds to investors-cum-philanthropists, who would also make a healthy return.

The Green bond market was the first to really take off, and remains the biggest. KfW, which claims to provide one third of Germany’s Green loans, commenced its Green bond programme in 2014. The German lender issues on average €1bn-€3bn of Green bonds per year, with around €14.5bn outstanding across five currencies, mostly euros. It represents around 60% of the German market in Green bonds.

The Nordics have also been huge supporters of Green bonds, with around 7% of the total cumulative Green bond issuance between 2007 and 2018, according to the Nordic Investment Bank. NIB has played a significant role in that: its first Green bond came in 2011, and by 2018 it had issued a total of €3.5bn in environmental bonds, with at least one issue every year in that period.

Since 2014 NIB has issued benchmark deals – at least 500m in size, whether in euros or, on one occasion in 2014, US dollars. Its deals tend to be for seven to eight-year tenors, with one Swedish krona transaction coming as a five-year.

Maturities tend to be determined by market conditions, said Jens Hellerup, head of funding and investor relations at NIB. “The dollar market provides good short-maturity deals and euros typically add more value in longer maturities.”

Annual Green bond issuance has generally trended upwards, although it dipped in 2018 due to the distraction of its first Blue bond deal. NIB issued €920m of NIB Environmental Bonds in 2017, and €500m – a single bond – in 2018, though it expects issuance to resume its upward trajectory in 2019.

The appeal of the Green bond market is clear. Petra Wehlert, head of capital markets at KfW, said: “The environmental/climate challenge is the biggest issue the world faces. But our focus on Green bonds is because that is where the liquidity is. We think by developing this market we are also supporting others, like the Blue bond and Social bond markets, which will grow as Green bonds grow.”

For SSA borrowers in particular, the biggest motivation is a desire to develop the market, to lead by example, both in terms of the size and the structure of their issuance.

KfW did not need to provide a second party opinion on the green assets, given investor trust in its expertise. “We decided to do so because we believe that should be best practise in investors’ interest. That is our role in the capital markets; we set the benchmark for smaller issuers to follow,” said Wehlert.

“SSA issuers consider themselves as being leaders in market developments, including Green bonds. We can issue the requested volumes to get international attention and we can create the infrastructure for the market to grow,” she said.

Leadership can take many forms. ICO, which was on the road with its inaugural Green bond in March, hosts events that bring together investors, banks, issuers, ratings agencies and others, to promote the concept of SDBs.

But there is more than pure altruism at play here. Green bonds provide a price advantage for issuers of around 0bp-2bp on average. The latest offering from the European Investment Bank, which in April issued a €500m Climate Awareness Bond due November 2042, is fairly typical, pricing with at 1bp through mid-swaps, equivalent to 59.9bp over the July 2042 Bund.

This is an additional cost for investors, but, with that, they are buying things such as greater transparency and impact reporting. These additional costs can be a hurdle for issuers looking to do their first deals, though subsequent transactions are easier.

Lars Eibeholm, head of treasury at NIB, said: “Issuers tell us that the additional work required to do the first Green bond deal creates a really positive internal dynamic within the institution. There are many intangible benefits around Green bonds, they cannot be measured. But once you have issued, it is easy to see.”

Despite rapid growth in recent years, the market is still in its infancy. This summer, the European Commission is due to publish a Green bond standard outlining what should be included in Green bond prospectuses. Stock exchanges and ratings agencies are still developing their infrastructure to service this growing business.

Hellerup said: “It will be at least two or three years before we have a common taxonomy for Green bonds, and even longer before impact reporting is fully standardised. There is a lot of work to do before this market has matured.”

A market to suit every need

The assets available usually determine which SDB market borrowers issue in. Hellerup said: “We have decided to focus on the Green bond market because it fits better with our assets. We do have some social assets that could be used for a Social bond, and we might do that at some point in the future, but it is quite difficult to find eligible assets for a Social bond. We have a lot of Green loans though, and there is a lot of demand for Green bonds, so that makes sense for us.”

ICO has issued more Social bonds – four in euros and one in Swedish krona – because it has more of the relevant assets. It uses its loans to SMEs in Spanish regions with GDP per capital below the national average, excluding sectors not considered socially responsible. Those loans qualify because of the jobs they create or preserve.

Rodrigo Robledo Tobar, head of capital markets at ICO, said: “We look to continue printing Social bonds every year, typically with a three to five-year maturity, to match the durations of the loans used in the bond. We would like to do Green bonds regularly too, but it is harder for us to commit to doing it annually at this stage. These bonds are likely to be three to five-years, although we could print longer ones due to the longer durations of the assets.”

Others have made tentative steps in the relatively young Blue bond market, financing projects related to wastewater treatment, prevention of water pollution and water-related climate change adaptation. In January, NIB issued its first Nordic–Baltic Blue Bond, a five-year deal to raise SKr2bn (US$216m).

In October 2018, the European Investment Bank, along with The Agence Francaise de Developpement and KfW, launched the Clean Oceans Initiative, a five-year plan to support the development and implementation of sustainable projects to reduce pollution, particularly plastics, in oceans.

Demand for SDBs of all types is consistently healthy. Wehlert said: “Green bonds tend to trade tighter in the secondary market compared to conventional bonds; in primary markets they price closer to the curve too. We see more and more investors looking at the Green bond market; demand is increasing much faster than supply.”

NIB’s €500m 7.5-year Green bond in 2018 received more than €850m of orders, with many coming from green investors, and many of those new to NIB. The German region North Rhine-Westphalia has issued five Sustainability bonds since 2015, raising €8bn to finance both social and green projects. Its most recent, raising €2.25bn, attracted orders of €8bn, with two-thirds coming from dedicated SRI investors.

Many investors appreciate the direct link between their investments and the projects they fund, which makes impact reporting essential. Having worked on both Green and Social bonds, ICO’s Robledo said measuring impact in Social bonds is particularly challenging, making them harder to arrange.

“With Green bonds, you can measure things like avoided GHG emissions, capacity of renewable energy installed, amount of waste managed or kilometres of railway financed, among others. That means that more work needs to be done to develop standardised KPIs for Social bonds,” said Robledo.

Kirsten Haeger, head of sustainable finance for NRW, agreed. “It is definitely more difficult to get the necessary data for impact reporting on social assets compared to Green bonds, and fewer indicators have been established,” she said.

“It will improve over time as issuers learn from each other, but there will always be gaps due to the nature of the data. Investors understand this challenge, though, and it will not be a problem for issuers as long as they provide full transparency with regard to their approach.”

NIB’s Eibeholm said: “Social bonds have the advantage of following in the footsteps of Green bonds in things like use of proceeds, but they also have their own unique challenges. They have to work out how to engage private investors in a sector that is being dominated by the public sector, which I believe will require some financial engineering.”

Long-term growth requires private sector issuers to follow the SSA lead. Haeger said: “The growth of the market is limited by the amount of eligible assets available. NRW is already issuing as much as we can based on our assets, and with the debt brake from 2020, we will not be able to increase that much.”

Under this debt brake (Schuldenbremse), Germany’s Laender will be forbidden from running structural deficits.

“We want to encourage the private sector to run environmental projects such as running solar plants and wind farms, and actively do so by offering [things like] consultation. So, future growth in Green or Sustainability bonds will require increased private sector involvement,” said Haeger.