A Pandemic-Driven Surge in Social Bond Issuance Shows the Sustainable Debt Market is Evolving

Originally published: June 22, 2020

Key Takeaways:

  • We expect social bonds to emerge as the fastest-growing segment of the sustainable debt market in 2020. This stands in sharp contrast to the rest of the global fixed income market, for which we expect issuance volumes to decline this year.
  • We believe recent growth in social bond issuance indicates that the COVID-19 pandemic has not turned issuers’ or investors’ attention away from sustainable finance, but rather interest seems to be growing.
  • Corporations and financial institutions will become more active in the social bond market as the pandemic accelerates private issuers’ interest in social considerations.
  • While significant steps have been made to standardize social bond disclosure and reporting, we believe issues persist and improvements have been slow to proliferate.

During the past few months, the COVID-19 pandemic has dragged countries around the world through a period of economic disruption, the depths of which have not been seen since the Great Depression. Increased unemployment, rising fatality rates, and strained health care systems have placed a spotlight on a future fraught with social risks. In parallel, corporations and financial institutions have been looked to for leadership in addressing these unforeseen challenges. This call for a greater focus on mitigating social risks has spilled over into the capital markets, particularly through the rapid rise of social bond issuance, which has more than quadrupled so far this year, even as credit conditions have weakened sharply.

Social bonds, which finance projects with primarily social objectives, have emerged as an unlikely tool in the economic fight against the virus to address the demands of consumers and communities that are increasingly aware of current social issues. The growth of social bonds is outpacing that of green bonds, portending a pivot away from a historically climate-centric sustainable debt space and reflecting a diversification of sustainability objectives financed by investors. And, while the recent surge may have been precipitated by COVID-19, the appeal of social bonds as a sustainable finance instrument may endure long after its effects have subsided.

In response to this recent proliferation of social bonds, the International Capital Markets Assn. (ICMA) updated its Social Bond Principles (SBPs) in June 2020 to include an expanded list of social project categories and target populations. We believe the updated principles could encourage greater issuance of social bonds, potentially leading social bonds to emerge as the fastest-growing segment of the sustainable debt market in 2020. In our opinion, as this trend continues, social bond reporting and disclosure practices will gain importance particularly as concerns around “social washing” – when an issuer misrepresents the social impact of its financed projects – grow in the investor community given the challenges of tracking the impact of social bonds. This challenge is compounded by the fact that benefits are often more qualitative than quantitative. We believe the updated SBPs could be a key step in addressing these risks. Yet many social bonds issuers do not follow the governance and reporting practices ICMA recommends, so we expect improvements in tracking and disclosure could be relatively slow. Nonetheless, echoing the growth of the green bond market, as social bond issuance picks up, we anticipate market demand for transparency will grow and social bond impact reporting will be imperative to developing a harmonized social bond market.

Social Bond Issuance Has Reached Record Levels

ICMA defines social bonds as bonds whose proceeds fund new and existing projects with positive social outcomes such as improving food security and access to education, health care, and financing. They constitute a relatively small part of the overall sustainable debt market, which also includes green bonds, sustainability bonds, green loans, and sustainability-linked loans and bonds. Of the $400 billion in sustainable debt issuance in 2019, according to the Climate Bonds Initiative (CBI), social bonds made up approximately $20 billion, or 5%.

However, social bonds’ share of the market is growing rapidly. According to Morgan Stanley, US $32 billion of “social” and “sustainability” bonds were issued in April 2020. This marked the first month in which social and sustainability bond issuance surpassed green bonds. Undoubtedly, much of this rapid growth can be attributed to the effect of the COVID-19 pandemic, which has accelerated issuance of social bonds to finance both public and private responses and create positive social outcomes, especially for target populations. In March 2020, ICMA underlined the relevance of social bonds in addressing the coronavirus pandemic and provided additional guidance for eligible social projects, which could include coronavirus-related health care and medical research, vaccine development, and medical equipment investments.

According to the International Capital Markets Assn.: “Eligible social projects can include for example COVID-19-related expenditures to increase capacity and efficiency in provisioning healthcare services and equipment, medical research, small to medium-sized enterprise (SME) loans that support employment generation in affected small businesses, and projects specifically designed to prevent and/or alleviate unemployment stemming from the pandemic. The general population is likely to be affected by the pandemic, including by any resultant socioeconomic crisis, and social bonds, while seeking to achieve positive social outcomes for target populations, may also serve to address the needs of the general population.”

The increased scope of projects eligible to be considered under the social bond designation likely led issuers, particularly supranationals, to become more active in the space. In March 2020, the International Finance Corporate (IFC) completed its largest social bond issuance since its social bond program was launched in 2017, to finance its response to the coronavirus. Soon after, the African Development Bank launched a $3 billion “Fight COVID-19” social bond, which according to the Institute of International Finance (IIF), was the world’s largest dollar-denominated social bond transaction to date. Furthermore, in April 2020, Guatemala became the first country to issue a sovereign social bond aimed at financing COVID-19 response efforts. The proceeds were allocated to initiatives such as health infrastructure improvements and food security, support for businesses and professionals, and preventative health and medical practices. As the crisis unfolds, we believe a number of supranational, government agency, and corporate COVID-related issuances will likely follow.

These recent issuances indicate that the pandemic has not turned issuers’ or investors’ attention away from sustainable finance; in fact, interest in this space seems to be expanding. We do not believe that market engagement in green bonds or loans will tail off entirely, as issuance stands at over $72 billion so far this year according to the CBI. However, as the sustainable debt market grows, we anticipate social bonds will make up a significantly larger share. We further believe diversification in the types of issuers using social bonds to fund a variety of issues (medical equipment shortages, public health infrastructure improvements, and employment/income generation) will continue in the longer term.

Supranationals have historically dominated the social bond space, but we expect this to diversify. Supranationals’ unique social mandates allow them to prototype, raise awareness for development priorities, and support growth in the sustainable debt markets, and as a result these issuers have dominated much of the activity in the social bond space, contributing the market’s credibility and liquidity. However, according to data from Environmental Finance, an online news and analysis service, this trend seems to be changing; government agencies became the dominant issuers of social bonds in 2019 with a 10.5% increase in share, while corporates also became significantly more active, increasing their share to 13% in 2019 form 3% the previous year.

Corporates and financial institutions are becoming more active in the social bond market

We expect diversification among issuers to continue at a steady pace. For example, financial institutions are playing an increasingly important role in the social bond market, representing about 30% of issuance 2019. In 2020, new market entrants included the Bank of China and Spanish financial institution Banco Bilbao Viscaya Argentaria (BBVA). Aside from financial institutions, in January 2020, Ecuador became the first country to issue a sovereign social bond and most recently, in June, the U.S.-based Ford Foundation announced it will issue US $1 billion of social bonds, making it the first nonprofit foundation to offer a labeled social bond in the U.S. corporate bond market.

In our opinion, the diversification of the social bond market mirrors that of the green bond market, which was also largely driven by supranationals in its early years. Similar to how the green bond market rose off the back of climate policies and the transition to a low carbon/net-zero economy, we believe renewed interest from organizations and investors in social risk factors could have a galvanizing impact on social bond issuance. Some emerging trends could also support long-term growth in social bond issuance, including aging populations in developed countries, increased concerns over food security, and growing health-driven consumer preferences. However, we ultimately expect social bond issuers to include more public issuers such as sovereigns, sub-sovereigns, public agencies, and foundations/not-for-profits since they have a wider mandate to provide social services than private institutions.

Social bond issuance is growing in emerging markets. Europe has consistently represented the largest portion of new social bond issuance, reflecting its unique regulatory and political push for sustainable finance. However, Europe’s 40% share of the market year to date is notably down from the 80% that it represented in 2016. At the same time, emerging market issuance has continued to rise. According to Bloomberg, social bond issuance across emerging market sovereign and corporate borrowers has more than doubled to $5.2 billion so far this year, compared with $2.3 billion in 2019. Asia-Pacific and Latin American have shown the fastest growth, representing 29% and 7% of issuance, respectively, so far this year. On the other hand, the U.S. has been relatively absent from the social bond market, whereas it has been very active in the green bond space over the past few years. In our opinion, this trend indicates that riskier investments earmarked for social objectives may be drawing increasing investor interest.

The rapid growth in social bond issuance sharply contrasts the rest of the global fixed income market, for which we expect issuance volumes to decline 9% in 2020. On one hand, public social bond issuance in both mature and emerging markets is providing debt managers with a more diverse investor base as government deficits are set to sharply increase, according to the IIF. However, in our opinion, private social bond issuance has also gained rapid momentum because it is a way for companies to demonstrate support for stakeholders, including employees, customers, and local communities. This is particularly important as consumers are more attuned now than ever to social issues, putting company reputations increasingly at risk. We believe a company’s response to these social disruptions can provide visibility into its level of preparedness, not just for pandemics, but for unforeseen risks in general. As a result, even amid today’s tumultuous economy, we expect social bond issuance will persist as companies demonstrate sensitivity to a variety of social issues and work avidly to mitigate their exposure.

We believe tracking and reporting on social bonds is still nascent and remains largely unstandardized. Historically, green bonds have been more popular than their social bond counterparts, partly because their impact can be tracked using more easily quantifiable and science-based metrics (i.e. reduction in greenhouse gas emissions or energy use) that are well understood by investors. This mitigates the risk of “greenwashing,” where a company misuses the “green” label by overstating the true environmental benefit of a transaction and, in doing so, misleads market participants. The standards surrounding social bonds, however, are more complicated because assessing social impacts tends to be more qualitative and less standardized than for green projects. As interest in social risks grows, particularly amid the COVID-19 pandemic, investors now face a new issue – social-washing – which, in our opinion could arise if the proceeds are labeled as “social” but the implied social benefits are questionable.

In an attempt to standardize the definition of social projects and mitigate this risk, ICMA developed a set of SBPs in 2019, which it later updated earlier this year. The principles encourage companies to define what they consider “eligible projects,” structure their transactions to avoid misallocation, and regularly report on use of proceeds. Adherence to the SBPs is generally valued as a sign of credibility and market integrity given enhanced transparency and standardized disclosure practices. However, the guidelines are voluntary and unlike for green bonds (where around 80%-90% of issuances are aligned with the Green Bond Principles) a number of institutions have issued COVID-19 and other self-labelled social bonds that are not aligned with ICMA’s SBPs. In addition, with so many issuers currently accessing the social debt market, speed to market has become the most important factor, with many issuers foregoing external verification/review. Therefore, while we are seeing growth in social debt for crisis response, improvements in tracking and disclosure are experiencing a significant lag.

Perhaps conscious of rallying market interest and support around social bonds in recent months, ICMA updated its SBPs on June 01, 2020, to expand the list of eligible projects and include a broader range of vulnerable communities. In its SBP guide, ICMA recommends that issuers exhibit impact through qualitative performance indicators complemented by quantitative performance measurements such as the number of new houses built in a deprived area, patients or students served, or microfinance loans made. As social bond issuance picks up, we anticipate expectations for transparency will grow and social bond impact reporting will be imperative to developing a more standardized social bond market.

Suggested Project Categories and Target Populations Under the Social Bond Principles

Social project categories include, but are not limited to, providing and/or promoting:

  • Affordable basic infrastructure, e.g. clean drinking water, sewers, sanitation, transport, energy
  • Access to essential services, e.g. health, education and vocational training, health care, financing, and financial services
  • Affordable housing
  • Employment generation, and programs designed to prevent and/or alleviate unemployment stemming from socioeconomic crises, including through the potential effect of SME financing and microfinance
  • Food security and sustainable food systems, e.g. physical, social, and economic access to safe, nutritious, and sufficient food that meets dietary needs and requirements; resilient agricultural practices; reduction of food loss and waste; and improved productivity of small-scale producers
  • Socioeconomic advancement and empowerment, e.g. equitable access to and control over assets, services, resources, and opportunities; equitable participation and integration into the market and society, including reduction of income inequality

Looking Ahead

Although still small, we believe the social bond landscape is growing and evolving rapidly and that the correct steps are being taken to ensure sustained capital flows toward socially beneficial objectives. The recent surge in social bond issuance to address the COVID-19 pandemic has given investors the rare opportunity to evaluate an entity’s commitment to its stakeholders – including employees, customers, and communities – in the short-term. Improved transparency and reporting practices will ultimately help reduce some of the social bond risks, including social-washing, and solidify investors’ confidence in the asset class as it grows, ultimately propelling further issuance.

The Expanding Universe of Fixed Income Impact Investments

Originally published 6th November, 2019

Key Takeaways

  • In our view, impact investments can drive positive societal and environmental outcomes, improve portfolio diversification and risk management, and generate competitive returns.
  • As the market expands into new fixed income sectors and across more impact themes, it is now possible to construct more diversified portfolios that combine labeled green bonds with a variety of other high-impact bonds. The resulting portfolios better replicate the broader fixed income indexes while avoiding some of the pitfalls and idiosyncrasies of green and impact bond indexes.
  • Not all impact investments are created equally, and a robust ESG research framework can help fully vet the level of impact generated, the embedded credit risks and the risk-return potential.

How to realize impact investment benefits

Last year marked the seventh consecutive year of record issuance in the sustainable bond markets and 2019 is off to a fast start.

Continued growth and innovation present new opportunities to benefit from what impact investing has to offer. In our view, impact investments can drive positive societal and environmental outcomes, improve portfolio diversification and risk management, and generate competitive returns.

As the market expands into new fixed income sectors and across more impact themes, so does the portfolio construction playbook and the ability to add value through ESG due diligence. In this article, we’ll cover our ESG fixed income approach and provide examples of impact investments that we’ve invested in and some that we’ve avoided.

Impact Investing Is Growing, and for Good Reason

The growing demand for sustainable fixed income products is driven by investors’ increased interest in finding solutions that combat climate change and social inequality. Also, there is a growing body of evidence of ESG risk materiality and the recognition that ESG-managed portfolios can offer strong risk-adjusted returns.

While labeled green bonds continue to make up the largest part of the market, at $167 billion, attention is shifting to a broader range of sustainable bonds and loans. Such non-labeled green bonds experienced the most growth in 2018 (Exhibit 1), fueled in part by greater adoption of the UN Sustainable Development Goals (SDGs).

Exhibit 1: Global Sustainable Debt Issuance 2012 – 2018

Source: BloombergNEF

Casting a Wider Net to Construct Better Impact Portfolios

These are welcome developments, creating new opportunities to achieve impact, generate competitive returns and build more diversified portfolios across a broadening range of fixed income sectors.

As a specialist asset manager with 20 years of sustainable fixed income investing experience, we’ve witnessed, and in some instances helped shape, market innovations firsthand. We launched the first high yield bond fund focused on ESG factors in 1999. Concerning impact investing, we were an early investor in the green bond market, with Bank of America’s first Green Bond transaction in 2010. We also helped smaller organizations such as Envest Microfinance issue impact notes to a broader market. More recently the Pax Core Bond Fund became the sole investor in The World Bank’s first U.S. dollar denominated gender-linked bond.

Drawing on our investment grade and high yield expertise, we believe we can build income-oriented portfolios that better replicate the broader fixed income indexes while avoiding some of the pitfalls and idiosyncrasies of green and impact bond indexes.

For example, traditional green bond indexes have very long durations and heavy sector concentrations. Our team is able to combine labeled green bonds with a variety of other high-impact bonds, such as those from corporate issuers as well as asset backed securities (ABS), to create more diversified portfolios that better match the Bloomberg Barclays Aggregate Bond Index from a fundamental characteristics perspective, while achieving a better sustainability profile on measures such as carbon intensity and exposure to fossil fuel risks.

ESG Analysis & Fixed Income

The transition to a more sustainable global economy provides both risks and opportunities that inform our fixed income investment process. Impax’s ESG framework reflects our core belief that this transition will drive growth for well-positioned companies and create risks for those unable or unwilling to adapt, which is why we:

  1. Invest in issuers that are developing innovative solutions to global sustainability challenges and securities that finance positive societal and environmental outcomes
  2. Mitigate fundamental risks through sector-focused ESG research and ongoing ESG due diligence
  3. Avoid higher-risk ESG laggards
  4. Engage with companies to improve their ESG and financial performance

Our definition of impact bonds includes more than green bonds. Specifically, all fixed income securities under consideration for investment are reviewed for impact potential. A security is identified as an impact bond if its use of proceeds is aligned with one or more of the impact focus
areas listed in Exhibit 2. By leveraging the full opportunity set of impact focus areas, we can make an impact on climate change issues, which remain at the forefront of investors’ minds, as well as other issues, such as gender inequality.

Exhibit 2: Eight Impact Focus Areas Most Relevant to the Fixed Income Asset Class

We also believe that ESG analysis is an effective way to identify material credit risks. With a close eye on how sustainability impacts a company’s financial outcomes, our process tilts away from issuers that are exposed to higher ESG risks or those operating in industries that are at greater risk when it comes to the transition to a more sustainable economy — for example, energy sector issuers significantly involved in the production of high-carbon commodities.

Conversely, we tilt toward companies that we believe understand these key risks and have appropriate policies and procedures in place to mitigate them. We believe these companies, because they are more strategic in their thinking, will incur fewer regulatory challenges and fines and, overall, will be more resilient in the face of change.

Lastly, while engagement is a tool not commonly used by most fixed income managers, it is a key part of our ESG process. As both an equity and fixed income manager, Impax benefits from crossover engagements that add insight and can potentially influence our view of an issuer. And since bondholders are an essential source of financing, company management tends to be inclined to maintain good relationships and have meaningful engagement. The benefits are twofold — engagement helps improve our ability to fully vet ESG-related risks and opportunities, and it can
help improve an issuer’s ESG transparency and performance going forward.

For example, we recently supported a shareholder resolution filed at a large U.S.-based cable company. The resolution sought increased transparency on key sustainability issues. We wrote a letter of support to that company’s investor relations team, explaining that comprehensive sustainability reporting is additive to our standard credit analysis and, in our view, may help stem mismanagement of significant regulatory, legal, reputational and financial risk. Nearly a third of shareholders supported the proposal at the company’s annual meeting, which is a strong measure of support.

Impact Investment Examples

Exhibit 3 and the following examples of Pax Core Bond Fund and Pax High Yield Bond Fund investments illustrate the broad range of issuer types that comprise the impact universe today.

Exhibit 3: Impact Investments Span the Spectrum of Traditional Issuers

The World Bank Gender-Linked Bond

The World Bank gender-linked bond is the first U.S. dollar denominated sustainable development

The World Bank gender-linked bond is the first U.S. Dollar denominated sustainable development bond that mobilizes financing to address the importance of investing in women to accelerate economic development, reduce poverty and build sustainable societies. Impax leveraged our long-standing relationship with The World Bank to structure this innovative form of financing, and the Pax Core Bond Fund is the sole investor in the $4 million, 3-year, AAA-rated security. We view the World Bank’s gender-linked bond as an important step in creating a new financing solution to achieve positive social impact and gender equality. Over the past two years, the World Bank Group has invested $3.2 billion in 21 countries toward programs that provide girls with access to quality education and has also dedicated more than $200 million toward operations that address gender-based violence.

We are pleased to have partnered with The World Bank to introduce this first-of-its-kind sustainable development bond to the U.S. markets.

Mosaic Solar Loan Asset Backed Securities

Mosaic Solar Loan ABS are securitizations of residential solar loans. Solar loans are relatively new but have quickly become a mainstream form of financing used to promote renewable energy use. The decreasing costs of solar panels and the rapid growth in sales of rooftop solar systems have fueled the growth of solar loans.

We see enormous growth potential in U.S. residential solar demand. Increasingly, the demand is driven by legislation that promotes renewable energy. For example, in 2018 the California Building Standards Commission passed a measure on building energy efficiency standards that requires all new homes to feature solar panels starting in 2020.

Solar ABS is a relatively new asset class and trades at attractive spreads compared to the benchmark ABS and similarly rated corporate bonds. Despite the specialized nature of this asset class, we believe solar ABS is poised to become a mainstream sector within the securitized markets as it’s an efficient way to finance climate solutions.

Sustainable Solution Providers

Sustainable solution providers are companies that generate revenues from products or services that address global sustainability challenges. We believe companies that are well-positioned for the transition to a more sustainable economy should possess stronger future earnings, greater resilience to economic challenges and more favorable credit outlooks than companies ill-prepared for the transition, leading to higher risk-adjusted returns.

Here are two examples from the high yield sector.

Terraform Power

Terraform Power is a utility company focused on renewable energy that owns and operates a fleet of wind and solar projects. It is one of the few “pure play” renewable energy companies in the high yield universe. Because many companies within the Utilities sector of the ICE BAML High Yield Index are heavy consumers of fossil fuels for electricity production, given the significant environmental and regulatory risks associated with fossil fuel combustion, we feel it is important to reduce environmental and regulatory risks by having strong renewable energy representation in the portfolio.

Standard Industries

Within the High Yield Building Materials sector, we focus on finding companies that can help reduce buildings’ energy consumption. As the leading global producer of roofing shingles, Standard Industries may not be an obvious impact investment candidate, but the company has a fast-growing solar roofing product that we believe could be significant in the future. The product is very innovative, providing easier installation than traditional solar panels and a large cost advantage to “solar shingles.” Standard Industries enjoys a very strong competitive position and market share, while demand for roofing materials is very stable due to repair and replacement dynamics in the industry.

Beware False Flags

We believe combining ESG and impact due diligence helps us better understand risks and opportunities and avoid certain problematic investments:

We avoided bonds offered by one U.S.-based utility company because of the company’s poor management of toxic emissions and waste. Despite its certified green label and being one of the largest green bond offerings by a utility, the company’s involvement in recurring coal ash pollution incidents raised questions for us.

We also avoided residential Property Assessed Clean Energy (PACE) ABS which are authorized by local governments and often promoted as a form of energy-efficient financing.  The residential PACE loans were high interest rate loans typically originated with lax underwriting standards that failed to check borrowers’ ability to repay. Moreover, such loans were often offered to low-income homeowners, and some loans were made for energy efficiency projects we would describe as dubious. Even though these securities typically have a certified green label from a sustainability rating vendor, we have avoided these ABS due to the lack of nationwide consumer protection regulations.

Lastly, bonds from a producer of utility-grade wood pellets were marketed as a “green” opportunity. However, we believe that the environmental benefits of biomass as an energy source have been overstated. A 2015 report from Climate Central, a climate change research organization, found that switching from coal to wood increased carbon dioxide (CO2) emissions at a UK power station by 15 –20 percent for each megawatt produced.

Positioned to Benefit

Impact investing is a relatively new yet fast evolving area of the fixed income market, with an increasingly diverse range of options available beyond labeled “green” bonds. The expanding universe offers new opportunities to build more diversified portfolios akin to traditional fixed income indexes as opposed to the more limited green bond indexes. That said, not all impact investments are created equally, and a robust ESG research framework can help fully vet the level of impact generated, the embedded credit risks and the risk-return potential.

Our ESG leadership, issuer engagement and expertise positions us to benefit from the continued growth and innovation in the sustainable bond market. Our aim is to generate competitive returns along with positive societal and environmental impact through portfolios well-positioned for the transition to a more sustainable economy.

Learn more about the Pax Core Bond Fund and Pax High Yield Bond Fund .

1According to research company BloombergNEF, the sustainable debt market comprises labeled bonds and loans that finance projects with green benefits, social benefits or a mixture of both.

2“Green Bonds: The State of the Market 2018,” Climate Bonds Initiative.

3Sustainable development bonds are issued to finance projects that solve one or more of the 173 Sustainable Development Goals set by the United Nations. These include initiatives to reduce poverty and gender inequality, mitigate climate risk and decrease environmental degradation, and promote peace and justice.

Diversification does not eliminate the risk of experiencing investment losses.

Risks The Pax Core Bond Fund yield and share price will vary with changes in interest rates and market conditions. Investors should note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short term. Mortgage related securities tend to become more sensitive to interest rate changes as interest rates rise, increasing their volatility. There is also a chance that some of the fund’s holdings may have their credit rating downgraded or may default.

The Pax High Yield Bond Fund can invest in “junk bonds,” which are considered predominately speculative with respect to the issuer’s continuing ability to make principal and interest payments when due. Yield and share price will vary with changes in interest rates and market conditions. Investors should note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short term. Mortgage related securities tend to become more sensitive to interest rate changes as interest rates rise, increasing their volatility. There is also a chance that some of the fund’s holdings may have their credit rating downgraded or may default.

About the Indexes

The Bloomberg Barclays US Aggregate Bond Index is a broad base index maintained by Bloomberg L.P. often used to represent investment grade bonds being traded in United States.

The ICE BAML High Yield Index tracks the performance of below investment grade, but not in default, U.S. dollar denominated corporate bonds publicly issued in the U.S. domestic market and includes issues with a credit rating of BBB or below, as rated by Moody’s and S&P.

One cannot invest directly in an index.

The top 10 holdings of the Pax Core Bond Fund as of 09/30/19 are as follows: United States Treasury Note, 3.375%, 11/15/48 4.6%; United States Treasury Note, 2.625%, 2/28/23 4.3%; United States Treasury Note, 2.750%, 9/30/20 2.4%; United States Treasury Note, 2.125%, 11/30/23 2.2%; United States Treasury Note, 0.375%, 7/15/27 1.5%; United States Treasury Note, 4.500%, 2/15/36 1.4%; United States Treasury Note, 4.375%, 11/15/39 1.2%; United States Treasury Note, 3.500%, 2/15/39 1.1%; United States Treasury Note, 2.250%, 3/31/26 1.0%; United States Treasury Note, 2.375%, 3/15/21 1.0%. Holdings are subject to change.

The top 10 holdings of the Pax High Yield Bond Fund as of 09/30/19 are as follows: Altice France Sa, 7.375%, 5/1/26 0.9%; Hat Holdings I LLC, 5.250%, 7/15/24 0.8%; Fly Leasing, Ltd., 6.375%, 10/15/21 0.8%; Air Canada, 7.750%, 04/15/21 0.7%; Parkland Fuel Corp., 6.000%, 4/1/26 0.7%; Cco Holdings LLC, 5.375%, 6/1/29 0.7%; Tempur Sealy International, Inc., 5.500%, 6/15/26 0.7%; Williams Scotsman International, Inc., 6.875%, 8/15/23 0.7%; Kar Auction Services, Inc., 5.125%, 6/1/25 0.7%; Prestige Brands, Inc., 6.375%, 3/1/24 0.7%. Holdings are subject to change.

The statements and opinions expressed are those of the authors of this report. All information is historical and not indicative of future results and subject to change. This information is not a recommendation to buy or sell any security.Paragraph


Yvonne Tai

Senior Fixed Income Analyst, Pax Core Bond Fund, Assistant Vice President

Yvonne Tai is a Senior Fixed Income Analyst for the Pax Core Bond Fund and is an Assistant Vice President at Pax World Funds. Yvonne began her investment analysis career in 1997 and has extensive experience in securitized products.

Greg Hasevlat

Sustainability Research Analyst, Impax Asset Management LLC

Greg Hasevlat is a Sustainability Research Analyst at Impax Asset Management LLC and Vice President, Sustainable Investing at Pax World Funds.

Impax Asset Management LLC, formerly Pax World Management LLC, is investment adviser to Pax World Funds.

Pax World Funds are distributed by ALPS Distributors, Inc. ALPS Distributors is not affiliated with Impax Asset Management LLC.

You should always consider Pax World Funds’ investment objectives, risks, and charges and expenses carefully before investing. For this and other important information, please download a fund prospectus. Please read it carefully before investing.

Impax Trademarks

Impax and SmartCarbon are trademarks of Impax Asset Management Group Plc. Impax is a registered trademark in the EU, US and Hong Kong. SmartCarbon is a registered trademark in the UK, the EU and the US.

‘Social Bonds’ are Surging as Conscious Investing Turns Mainstream

Originally published June 23, 2020

Key Points:

  • According to S&P Global Ratings, social bond issuance has quadrupled so far this year as conscious investors combine purpose with profit
  • Social bonds are already being used to address rising inequalities created by the coronavirus pandemic
  • Morgan Stanley says $32 billion dollars of social and sustainability bonds were issued in April 2020 alone

New research shows the issuance of social bonds has reached record levels and more than quadrupled so far this year, as conscious investors combine profit and purpose to address rising inequalities created by the coronavirus. 

According to S&P Global Ratings, “Recent growth in social bond issuance indicates that the COVID-19 pandemic has not turned issuers’ or investors’ attention away from sustainable finance – rather, interest seems to be growing.”

Social bonds are a form of debt that allows investors to help raise funds for projects with positive social outcomes that in some cases, provide an investment return. They include projects on improving food security and access to education, as well as health care and financing.

With unemployment spiking around the world, rising fatality rates and strained health-care systems, S&P expects social bonds to emerge as the fastest-growing segment of the sustainable debt market in 2020, even as credit conditions weaken. 

It stands in sharp contrast to the rest of the global fixed income market, where issuance volumes are expected to decline 9% this year, according to S&P. 

“Undoubtedly, much of this rapid growth can ben attributed to the effect of the COVID-19 pandemic, which has accelerated issuance of social bonds to finance both public and private responses and create positive social outcomes, especially for target populations,” the firm said. 

Whoever cares wins?

While social bonds only make a small part of the multi-billion dollar global sustainable debt market, their popularity is surging in the midst of the pandemic. 

Morgan Stanley says $32 billion dollars of social and sustainability bonds were issued in April 2020 alone. It marked the first month in which social and sustainability bond issuance surpassed green bonds, which saw a total of $257 billion in issuance last year. 

A record $400 billion in sustainable debt was issued in 2019. The Climate Bonds Initiative (CBI) said social bonds made up approximately $20 billion of that, or around 5%.

Source: Climate Bonds Initiative, S&P Global Ratings

Major initiatives already underway

This year, countries such as Ecuador and Guatemala issued sovereign social bonds aimed at financing COVID-19 response efforts. In Guatemala, the proceeds are being used to finance health infrastructure improvements and initiatives in food security, support for businesses and professionals, and preventative health and medical practices, S&P said. 

The African Development Bank also launched a $3 billion “Fight COVID-19” social bond, becoming the world’s largest dollar-denominated social bond transaction to date. 

In June, the U.S.-based Ford Foundation announced it will issue US$1 billion of social bonds, making it the first nonprofit foundation to offer a labeled social bond in the U.S. Corporate bond market. 

“As the crisis unfolds, we believe a number of supranational, government agency, and corporate COVID-related issuances will likely follow,” S&P added. 

Source: Environmental Finance, S&P Global Ratings

S&P said measuring the impact and return of a social bond investment remains challenging, given the limited transparency and standardized reporting within the emerging sector. 

“This challenge is compounded by the fact that benefits are often more qualitative than quantitative,” said Lori Shapiro, one of the primary credit analysts at S&P. 

“Improved transparency and reporting practices will ultimately help reduce some of the social bond risks, including social-washing, and solidify investors’ confidence in the asset class as it grow, ultimately propelling further issuance.” 

How can we pay for sustainable investment?

Finance for sustainable development involves big numbers. If current levels of investment in sustainable development projects are anything to go by, developing countries will have a $2.5 trillion annual gap to plug. Most estimates suggest we need $6 trillion a year in infrastructure investment, much of which needs to be “greened”. More broadly, we need to align all global investments ‒ estimated to be between $20 trillion and $25 trillion ‒ with the goals of sustainable development.

What makes matters worse is that many sustainable development challenges are urgent for individuals, communities, and the world as a whole. We can’t wait for the “right” carbon prices, for technology costs to fall, or for citizens to voluntarily change their ways. We need to start making changes now, or the forces of nature will undermine any of our future efforts.

Plugging a multi-trillion dollar gap

Conventionally, the way to finance public goods is to use public finance – such as by subsidizing renewables. But because we are talking about trillions, not billions, there is simply not enough public finance to do the job. Even in China, where the state of public finances is comparatively good, at least at the national level, the People’s Bank of China estimates that public finance can only meet about 15% of green financing needs.

So private finance is needed: and lots of it. Global financial and capital markets handle over $300 trillion in financial assets, mainly through bank lending and the value of shares on stock exchanges and bonds. Today, little of these funds are being used to finance sustainable development, and quite a lot is being used to finance environmentally and socially unsustainable economic activities, from dirty coal and inefficient buildings to water and carbon-intensive agriculture. Indeed, much private finance is used for profitable short-term trading, not really touching the real economy, yet dragging much-needed funds away from more productive uses.

At the same time, the owners of the world’s financial assets – citizens – are also in crisis. With low interest rates, these people are unlikely to get the buying power and security they once hoped to see from their savings. The financial system is failing in its traditional role of effectively connecting the owners and users of financial wealth, threatening to impoverish generations of savers and damage the basis on which economic wealth is created – a healthy, inclusive, sustainable real economy.

The financial system we need

So when People’s Bank of China Deputy Governor Yi Gang took to the stage at the IMF/World Bank Annual Meetings in Lima earlier this year, he opened a new chapter in policy debate about the future of financial and capital markets. Announcing a new workstream on green finance under China’s G20 presidency, he was not simply recognizing the importance of sustainability or the climate: he was signaling the need to develop a global financial system fit for the 21st century.

Yi Gang’s comments place him on the right side of history. A quiet revolution is taking place, as growing numbers of central bankers, financial regulators and financial market standard-setters take practical steps to integrate sustainable development considerations into financial market reform and development. These are the core findings of a two-year inquiry from the United Nations, outlined in a report, The Financial System We Need.

Developing countries have led this development. The Indonesian financial services authority has set out a 10-year “sustainable finance roadmap” covering capabilities, information, and fiscal and regulatory measures. Brazil’s central bank has imposed environmental risk regulations on the country’s banking community and Kenya’s central bank has championed the introduction of mobile-based payment services as a means to increase financial inclusion. South Africa has adjusted its pension regulations to ensure that trustees take social and environmental considerations into account. The People’s Bank of China has made a series of regulatory, legal, fiscal, and institutional recommendations for greening China’s financial system that will be taken forward as part of the 13th Five Year Plan.

Some developed countries have also joined this leadership group. The Bank of England is a case in point, as is France, with its recent policy measures requiring financial institutions to report on their carbon footprint and climate risks. Almost 30 stock exchanges have signed up to the Sustainable Stock Exchange Initiative, committing to advancing sustainable development reporting in listing requirements. S&P ratings have incorporated climate risks into sovereign credit ratings, and guidelines have emerged to ensure continued robust growth in the issuance of green bonds.

The financial system, like the health or energy systems, has an overarching purpose – to ensure that financial flows support inclusive, sustainable prosperity. While exemplary banks or insurance companies show their leadership through social and environmental responsibility, the real task lies with policy-makers, regulators and standard-setters, who should be shaping the rules of the financial system to ensure it is meeting its broader goals.

The need to finance sustainable development is indisputable – whether this is understood through the lens of national development priorities or the need for international action in addressing global challenges such as climate change. Fortunately, the conditions are right to start better aligning the financial system with these needs.



Americans long thought that nature could take care of itself — or that if it did not, the consequences were someone else’s problem. As we know now, that assumption was wrong; none of us is a stranger to environmental problems. Industrial workers, for example, are exposed to disproportionate risks from toxic substances in their surroundings. The urban poor, many of whom have never had the chance to canoe a river or hike a mountain trail, must nevertheless endure each day the hazardous effects of lead and other pollutants in the air.

– President Jimmy Carter in a May 3, 1977 message to Congress

Hello and welcome again to the latest edition of the Socially Inspired InvestorSM.  In this edition we turn our focus to an investment option that really hasn’t been around for a long time – Green Bonds. 

According to State Street Global Advisors, “ESG considerations are becoming increasingly relevant in fixed income investment portfolios. While ESG is [now] at the top of many institutional investor’s agendas, the focus has primarily been on the equity portion of their investments; but this is changing.  Investors are now putting more thought into how to successfully embed ESG into their fixed income investments.”

This is so true. Without a doubt articles written on the subject of ESG investing today – and we read a lot of them – mostly feature equity solutions, which tend to be broad and aspirational but are only part of the solution and opportunity. Bonds – green, social, sustainable – are more targeted to address specific problems that exist today. They are also a critical component of a balanced portfolio. We have chosen this critical area to explore in this issue because of their unique applications and the dearth of objective information available to the average investor.  

When it comes to exploring the ins and outs of socially responsible investing in bonds, SII has brought together content from experts in the field. We will hear from Heather Lang, executive director, sustainable finance at Sustainalytics, a Morningstar company.   We also feature insights from Greg Hasevlat, sustainability research analyst at IMPAX Asset Management. In addition, as always, we have curated for you relevant articles you can find in our ESG in the news section.

“None of us is a stranger to environmental problems” – Pres. Carter said that over 40 years ago!

But we do see today and continue to be inspired by, the coming together of vast intellectual resources on a global scale focused on making the future better for ourselves and future generations. We should allow ourselves to be encouraged.

As investment solutions expand and mature, we become more and more inspired that the world will become a better, far more values-focused place to live. Investors are realizing that they can vote their investment dollars without having to disadvantage their return targets.

Our overall message is that we continue to be inspired, and it will take inspiration, and an ever-increasing awareness and commitment of time and treasure. 

Enjoy this issue. We hope you’ll find within it new insights.

What Are Green Bonds and How ‘Green’ is Green?

Originally published: March 24, 2019

Trillions of dollars of investment are needed to combat global warming. Enter green bonds, a way for issuers to raise money specifically for environmentally friendly projects – such as renewable energy or clean transport – and to be able to boast about it publicly. Fund managers also like the notes as a way of meeting growing investor demand for sustainable options. The market, which opened slowly more than a decade ago, has boomed in recent years, helping spur development of other socially conscious debt products. Because investors face the challenge of judging whether a note is truly green, regulators are working on standards to help guard against greenwashing, or misleading claims about just how good a friend to the environment an issuer is.

1. What do green bonds finance?

Green bond proceeds can go toward new or existing projects that are meant to have positive environmental or climate effects. Inside that, the range is vast. It covers energy, transport, waste management, building construction, water and land use. Some definitions also include communications and information technology.

2. How big is the global green-bond market?

A cumulative $580 billion of green bonds were sold through 2018, according to Bloomberg New Energy Finance. Another $170 billion to $180 billion are likely to be sold in 2019 based on what’s currently happening in the market, BNEF analyst Daniel Shurey says. The market is expected to keep growing, with Europe alone needing about 180 billion euros ($203 billion) of additional investment a year to achieve 2030 emission targets set by the European Union in the 2015 Paris Agreement on climate change. For now, however, green bonds are a tiny fraction of the more than $100 trillion global bond market.

3. Who sells green bonds?

Issuers from more than 50 countries have sold green bonds including supranational institutions such as the World Bank and the EU’s European Investment Bank. Companies are also in the market, along with local state and national governments. The first emerging-market green bond was issued in South Africa in 2012. Poland opened the sovereign market in 2016, followed by the likes of France, Belgium and Ireland. The U.S. is the largest source overall, led by the mortgage giant Fannie Mae and local governments selling notes to finance infrastructure such as sewerage upgrades.  

4. Who decides whether a bond is green?

It’s complicated. Many issuers say they follow the Green Bond Principles, endorsed by the International Capital Market Association in 2014 to bring transparency to the market. The principles are voluntary, covering how to spend and manage proceeds, how to evaluate if a specific project is green-worthy, and what type of reporting to put in place. A slew of companies offer services to independently assess, verify or certify a bond’s green bona fides.  They include ratings companies such as Moody’s Investors Service; the Climate Bonds Initiative, which created the first green-bond standard in 2010; and specialized firms such as Paris-based Vigeo Eiris, Amsterdam-based Sustainalytics, and Cicero Shades of Green, a unit of the Norwegian climate research institute Cicero. (Bloomberg LP, the parent of Bloomberg News, provides a green-bond tag and the related disclosures of issuers.)

5. Just how green are green bonds?

It can sometimes be difficult to say given the lack of globally accepted standards or consistent verification. The perception of what’s green can differ, too. China, the world’s biggest carbon emitter and No. 2 green-bond issuer, has faced criticism for using green bonds to finance coal-burning power plants, even if the new facilities are cleaner than predecessors. Reports say Chinese regulators may drop so-called clean coal from green-bond definitions to harmonize them with EU standards and win international investors. In its analysis, Oslo-based Cicero uses three shades of green:

  • Dark green for things that will lower carbon emissions in the long run like wind energy
  • Medium green for things that take a good step forward such as plug-in hybrid buses
  • Light green for environmentally friendly steps that won’t change the long-term outlook on their own, such as more efficient fossil-fuel infrastructure

New coal projects get labeled brown for being in opposition to what Cicero calls a “climate-resilient future.” There’s also debate over whether an issuer’s overall environmental commitment or carbon footprint should be taken into account. Poland’s sovereign green bonds were snubbed by at least one major investor because of the country’s reliance on coal and its mixed record on climate action. In 2017, Madrid-based Repsol SA became the first major oil company to sell green bonds.

6. Is there hope for a global green bond standard?

Yes. The EU is creating a Green Bond Standard, which will build on current market practices, such as the ICMA Green Bond Principles. Issuers from anywhere in the world will be able to cite compliance, if their plans are independently verified by an EU-accredited assessor. However, the new standard will be voluntary, rather than legally binding. The European Commission, the EU’s executive arm, has directed a group of experts to make recommendations. The International Organization for Standardization is also preparing a Green Bond Standard that will draw upon existing principles.

7. Who buys green bonds?

In general, it’s the same as the rest of the bond market – institutional investors including pension funds, insurance companies and asset managers. The overall green market is also getting a boost from investors seeking “responsible” or “sustainable” places to put their money. That has helped Europe’s listed green funds double assets under management since 2013 to more than 32 billion euros in 2017, according to Novethic, a sustainable finance data provider. In 2015, France became the first country to require institutional investors to report how they consider environmental factors. The EU is likely to encourage asset managers across the bloc to integrate sustainability requirements into investment decisions as part of its work on the Green Bond Standard.

8. Does green investing mean compromising on returns?

Not necessarily. The vast majority of green bonds are investment grade and they are priced similarly to conventional debt at issuance. Growing investor demand and relative scarcity could also help boost secondary market prices. In the euro market, green bonds returned 0.34 percent in 2018, while the overall investment-grade market returned 0.41 percent, based on Bloomberg Barclays indexes. But for issuers themselves, bringing a green bond to the market can entail additional costs to cover getting an external opinion and report annually on the use of proceeds.

9. Are green bonds the same as sustainable bonds?

No. Green bonds are used solely for environmental goals, while sustainable bonds combine both environmental and social objectives. There are also social bonds, whose proceeds are dedicated to projects aimed at improving social welfare or helping disadvantaged populations. The range of socially conscious instruments keeps growing as more investors look to do good while making money, and regulators look to the instruments to influence policy and investment decisions. There are now loans linked to specific environmental, social or governance targets, which give companies an incentive to achieve what they say they will. And in October, the Seychelles sold the world’s first sovereign blue bond, debt issued to finance marine and ocean-based projects that have positive environmental, economic and climate benefits.

Explaining Green Bonds

Helpful terminology

Rapid growth of the green labelled market

The green bond market has seen strong growth, with the market really starting to take off in 2014 when USD37bn was issued. In 2018 issuance reached USD167.3bn, setting yet another record.

The green bond market kicked off in 2007 with the AAA-rated issuance from multilateral institutions European Investment Bank (EIB) and World Bank. The wider bond market started to react after the first USD1bn green bond sold within an hour of issue by IFC in March 2013. The following November there was a turning point in the market as the first corporate green bond issued by Vasakronan, a Swedish property company. Large corporate issuers include SNCF, Berlin Hyp, Apple, Engie, ICBC, and Credit Agricole.

The first green muni bond was issued by Massachusetts in June 2013. Gothenburg issued the first Green City bond in October 2013. US states are major green bond issuers, but issuers also include Province of Ontario, City of Johannesburg, and Province of la Rioja (Argentina). Local government green bonds continue to grow.

SolarCity (now Tesla Energy) issued the first solar ABS in November 2013. The biggest ABS issuer is Fannie Mae. ABS includes solar ABS, green MBS, green RMBS, green CMBS, PACE ABS, auto ABS and receivables ABS – so far.

Using debt capital markets to fund climate solutions

Green bonds were created to fund projects that have positive environmental and/or climate benefits. The majority of the green bonds issued are green “use of proceeds” or asset-linked bonds. Proceeds from these bonds are earmarked(link is external) for green projects but are backed by the issuer’s entire balance sheet. There have also been green “use of proceeds” revenue bonds(link is external), green project bonds and green securitised(link is external) bonds.

Types of green bonds

Benefits for issuers outweigh costs

Green bonds have some additional transaction cost because issuers must track, monitor and report on use of proceeds. However, many issuers, especially repeat green bond issuers, offset this initial cost with the following benefits:

  • Highlights their green assets/business
  • Positive marketing story
  • Diversify their investor base (as they can now attract ESG/RI specialist investors)
  • Joins up internal teams in order to do the investor roadshow (environmental team with Investor relations and other business)

See the full list of green bonds issued here

Green Bonds are standard bonds with a bonus “green” feature

The green “use of proceeds” bond market has developed around the idea of flat pricing – where the bond price is the same as ordinary bonds. Prices are flat because the credit profile of green bonds is the same as other vanilla bonds(link is external) from the same issuer. Therefore, green bonds are pari pasu(link is external) to vanilla issuance.

Investor Appetite

Investors with $45tn of assets under management have made public commitments to climate and responsible investment – green bonds can help them achieve their pledges in fixed income. Read more here.

Climate Bonds for Beginners

A brief guide for understanding what climate bonds are and why they are important.

What is a bond? A bond is a type of loan or IOU which companies, governments, and banks use to finance projects. The issuer of the bond (the borrower) owes the holder (the creditor) a debt and, depending to the terms they agree on, is obliged to pay back the amount lent within a certain amount of time and with a certain interest.

What is a Climate Bond? Climate bonds are used to finance – or re-finance – projects needed to address climate. They range from wind farms and solar and hydropower plants, to rail transport and building sea walls in cities threatened by rising sea levels. Only a small portion of these bonds have actually been labelled as green or climate bonds by their issuers.

What is a Green Bond? Is it the same as a Climate Bond? A Green Bond is where proceeds are allocated to environmental projects. The term generally refers to bonds that have been marketed as “Green”.

In theory, Green Bonds proceeds could be used for a wide variety of environmental projects, or even parks development; but in practice they have mostly been the same as Climate Bonds, with proceeds going to climate change projects.

In some cases, a portion of proceeds have gone to areas seen as environmental but not necessarily related to climate change. For example, proceeds from RaboBank’s green retail bonds in the Netherlands may go to organic farm loans as well as to climate change related areas like sustainable buildings.

Who issues these bonds? Largely corporations and state-owned rail companies, with some from multilateral development banks and some asset-backed bonds.

The pioneer issuers of “labelled” green or climate bonds, where proceeds are allocated to climate projects, have been the World Bank and its sister organisation, the International Finance Corporation, with their Green Bonds, and the European Investment Bank, with their Climate Awareness Bonds.

Who buys climate bonds? The vast bulk of climate bonds have been bought by institutional investors like pension funds and fund managers. In the Netherlands and South Africa banks have also offered green bonds to individuals; and some fund managers have, using World Green Bonds, created special funds that individuals can invest in.

How big is the climate bonds market? The climate/green bond market includes all of those bonds which have been issued to help finance climate-friendly projects. At present, the climate bonds market has an estimated value of $346bn.

There are around $50 billion outstanding of labelled climate bonds and green bonds (as of October 2014).

What types of climate bonds are there? Broadly speaking, climate and green bonds can be categorized according to:

  • Their investment rating: most bonds receive a credit rating from agencies like Standard & Poor’s and Moody’s.
  • Their label: climate bonds may have been labelled “green” or “climate” – or not. Both types of bond are equally “green”, but labelled bonds are more easily identifiable.

Are climate bonds cheaper than other ones? They are about the same. The difference is that green bonds will attract new investors who are interested in climate friendly projects funded by all types of companies. However, these investors generally want to know that their funds are indeed being spent in a climate friendly way.

What are the benefits of green bonds? They offer the same returns as other bonds, but with the added benefit that funds are only going to climate change solutions. For a lot of people – like the $22 trillion of investors who are members of the Global Investor Coalition on Climate Change – this is important.

They give investors a chance to direct capital to climate change solutions, where at the moment there is little opportunity (“lack of deal-flow”).

Climate bonds satisfy the needs of issuers, bondholders and the environment.

So why aren’t more companies investing in green bonds? Many investors are aware of the problem of climate change, but translating that awareness into investment decisions is usually seen as a major challenge. However, many investors say that given the same conditions in terms of time and investment, they would choose green bonds over brown ones due to the climate change solution opportunities they offer.

This is a matter of perception; while they have generally assumed that climate bonds were high-risk investments, in fact, 89% are investment-grade.

What is the Climate Bonds Initiative and what does it do? The Climate Bonds Initiative is an international not-for-profit which promotes the development of climate bonds. It aims to raise awareness about the existence and benefits of climate bonds and promote investments in them; proposes standards that establish what a green bond is, helping identify and label green bonds so that they may be recognized as such; and develops project models in areas such as energy efficiency, forestry and other climate sectors.

What is the Climate Bonds Standard? The Climate Bonds Initiative has developed environmental standards with which projects must comply in order to achieve the corresponding Certification mark. Investors of these approved programs are therefore assured that their funds are being used for projects which support climate change; and the green bonds associated with these projects are easily labelled and identifiable.

Are Green Bonds As Good As They Sound?

Originally published November 26, 2019

Ask any private wealth manager what the safest investment to make is and they will invariably say an investment in a long-term US Treasury bond. Thought of as the “gold standard” of reliable investments, US Treasury bonds are a crucial part of most balanced portfolios as the dominant section of the securities category. Recently, both domestically and internationally, a new type of such government bonds is being discussed in legislatures and national banks: The Green Bond. A Green Bond is, generally speaking, equivalent to a normal bond issued by a large organization except for one key difference: the funds generated from selling Green Bonds are specifically earmarked for climate change and environmental projects. Green Bonds have been emerging as a trend in financial markets everywhere, with Bloomberg New Energy Finance analyst, Daniel Shurey, predicting that, in 2019, anywhere between $170 billion and $180 billion of Green Bonds would be sold. Even then, they make up a small fraction of the $100 trillion bond market.

The growing interest in Green Bonds is representative of an aggregate increase in impact-based investing, or investments with intended social and environmental benefits. These securities are a unique form of ESG (Environmental, Social, and Corporate Governance) investing and face many of the same issues and benefits as the larger impact investing market. These include struggling with defining objective metrics to value the impact achieved and incentivizing investors to divert their capital into more sustainable businesses and projects. Often cited as a key step forward in responsible investing, Green Bonds are important for any aspiring impact investor to understand.

To unpack the advantages and disadvantages of Green Bonds and to determine their validity as socially conscious investments, we must first understand how bonds really work. Essentially, bonds are a form of a loan from a private investor to a company or government. The issuer of the bond, usually the government or a corporation, asks groups of private investors for certain amounts of money. If the investors believe in the stability of a company and its ability to pay back its debts, they will loan the issuer the amount that they are asking for. In other words, this would be the investor purchasing the bond. These bonds have a set maturation date, which is the date at which the issuer will return the principal amount to the investors. At the time of purchase, the bonds will also have a set coupon rate, which is the interest that the bond pays to the investors. Bonds that are more unstable, less likely to reach maturation, and are paid back in a longer timeframe tend to be riskier investments, and are thus often compensated with high interest rates and high potential returns. Contrastingly, bonds from more financially predictable actors that reach maturation quicker tend to have lower interest rates because of their high probability of returns.

The key difference between bonds and other forms of traditional investments, such as stocks or derivatives, is that bonds do not actually grant the owner any ownership stake in a company or government. As a result, bonds tend to be more stable forms of investment, both for the loaner and the loanee, because the value of the money loaned does not fluctuate with the market or the success of the business. For the two parties that are involved in the initial financing of a bond, the values of the bond and interest do not change. Instead, a secondary bond market responds to changes within industries and businesses. If investors are not able to buy bonds during their primary financing with the face-value price, they can buy any bonds being sold through this secondary market. Within the secondary market, the sellers of the bonds can set prices and premiums based on a bond’s volatility and maturation date. This allows for financial interactions with bonds even after they are first released to investors.

With generic corporate and municipal bonds, the money raised can be distributed at the company or government’s discretion. This is where Green Bonds stray from the pack. Rather than just being loans for companies, money generated from Green Bonds are “required” to be used for environmentally friendly projects. These may include focusing on energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean transportation, sustainable water management, and the development of environmentally friendly technologies. For example, the Energy Security and Efficiency Enhancement Project in Jamaica raised 14.5 million USD through such bonds to create three wind farms, two solar farms, and a hydro plant. In spite of successes like Jamaica’s, one of the most common criticisms regarding Green Bonds is the wide variety of projects that can be financed.

Many critics claim that the wide scope of what constitutes a “green” bond allows the organizations that issue them to utilize the capital raised for projects promoting sustainability that, in reality, have minimal climate impact. For example, the operator of China’s Three Gorges Dam issued $840 million in Green Bonds to be used for backing wind power projects in Europe. At a surface level, these bonds seem like a sustainable way to raise money and divert it to climate conscious projects. Looking deeper however, the Three Gorges Dam has been continuously cited as a source of water pollution and as damaging for the surrounding ecosystems. Regardless, investors rushed to buy bonds at face-value and overlooked the possible deeper environmental harms they may cause. This process, known as “green washing,” has become a common practice among green bond issuers and is hurting the credibility of such investments. Another instance of greenwashing took place when the Chinese government issued Green Bonds to finance coal-efficiency projects that find ways to burn fossil fuels more effectively. Similarly, a Madrid-based oil and gas company named Repsol issued a set of “Green Bonds” that were used for making their oil refineries more efficient. Although technically still working towards energy efficiency, these projects are not helping the environment to the extent that issuers will often claim.

This issue, realistically, is inherent within any method of raising money to be used for a good cause. An illustrative example would be the donations people make to charities. There have been numerous instances in which international aid funded by domestic donations to charity goes directly to the elites in developing countries, while those in need remain disadvantaged. Although the donors still get the mental ease of believing that they helped solve a problem, their money is actually used to fund state-sponsored companies run by these wealthy individuals. Therefore, individuals already at the higher levels of society are able to leverage their wealth to continue making money, while those most in need continue to suffer. These misguided donations traditionally solve either the wrong problem, or no problem at all.

Given this history with donations and Green Bonds, large financial institutions are wary of classifying every green bond under the same umbrella. Instead, climate agencies and proponents of green bond programs are taking steps to classify the levels of impact that a green bond may have to help inform potential investors. Key examples of this are the Green Bond Principles that were approved by the International Capital Market Association in 2014, the Cicero Shades of Green program, and the European Union’s Green Bond Standard. All of these programs are steps in the right direction for standardizing Green Bonds and are resulting in more focused investments that are creating substantial impact. Like with many other forms of impact investments, creating clear metrics for quantifying the impact achieved is crucial in validating the idea of impact investing for traditional investors. The same holds true for Green Bonds. For them to fully find a place in the securities portfolios of investors worldwide, accurately classifying the projects they will be used for, and the expected impact from them, will be necessary.

Already, the impact from more organized and accurately described Green Bonds is being realized in domestic and international markets. In Mexico and Peru, 24,400 rural households are being powered by solar voltaic systems financed by World Bank Green Bonds. In the Dominican Republic, Tunisia, and Indonesia, 442,650 hectares of land were given new, rehabilitated or restored irrigation services through the same mechanism. Following guidelines set by independent organizations is proving to be effective in directing funds in a more impactful manner.

If Green Bond descriptions and uses can be internationally standardized, there are vast benefits that may be realized from their implementation. For the issuers of the bonds, Green Bonds provide influxes of cash for projects that may traditionally receive lower investments because of their lower profit margins. Moreover, pioneering sustainability projects is a key marketing tool for companies and will allow them to attract more media attention. Implementing Green Bonds will help shine a light on sustainable initiatives and, hopefully, bring them mainstream even more. For investors, standardized Green Bonds will lead to a more nuanced ability to invest in values over profits. Green Bonds will be essential for impact investing as they provide the unique ability for an investor to support a specific cause and, thereafter, find a specific project working to better that cause. For that reason, monitoring the development and formalization of the Green Bond market will be a key action item for any sustainable economist.


QUESTIONQuestions by:
The Socially Inspired Investor Digest

ANSWERInterview with:
Heather Lang – Executive Director at Sustainable Finance Solutions and Sustainalytics.

QUESTIONTell us more about Sustainalytics

ANSWERSustainalytics is a leading environmental, social and governance research and rating firm and we use the acronym ESG throughout. Our clients are among the largest global institutional investors, banks and corporations, and our principal business is really to support our investor clients in incorporating ESG insights into their investment decision making. We have over 25 years of experience in the industry, so in that sense, we’ve really evolved. We participated in the industry’s evolution from niche to mainstream.

QUESTIONAre there bonds that are directly involved in helping us recover from the impact of the coronavirus?

ANSWERYes. Social bonds have really emerged as an important instrument for allocating capital to some of the impacts of Covid-19 and those tend to focus on two key areas. The first is health care and the second is socio-economic impact. For healthcare we might see subsidization of pharmaceuticals for treatment of Covid-19 or research and development for potential vaccines, to name a couple of examples.

QUESTIONTell us a little bit more about green bonds and what types of projects are involved in that?

ANSWERGreen bonds are distinguished from plain vanilla bonds. There are three main areas and one is green buildings. Here we would be looking at companies that would be looking to finance or refinance LEED certified buildings, for example, that meet best practices for energy efficiency. Transport could include investing in a green transit system, or changing fleet from diesel to electric vehicles, or electric trains. The third category, of course, renewables would involve seeing any investments in projects that would support increased use of renewable energies, including solar, wind, biomass and hydroelectric, for example.

ANSWERSo those three categories accounted for about 80 percent of 2019 issuance, and Green bonds constitute the largest segment of the sustainable finance market, accounting for about 260 billion in 2019. But it’s also worth noting that there are other related instruments under the sustainable finance umbrella. Those include social and sustainability bonds, along with green loans and sustainability linked loans. Social bonds though they have a smaller market share, they directly target disadvantaged groups in accessing healthcare, education, affordable housing, gender equality, to name a few; whereas sustainability bonds include both environmental and social projects. And while green bonds really are the market driver, we have seen an uptick in social and sustainability bonds in recent years and particularly a noteworthy uptick in social bonds in the context of the pandemic.

QUESTIONWhat kind of examples are you talking about with Social Bonds? Where is that money going?

ANSWERIt’s largely being targeted towards vulnerable or disadvantaged groups in a variety of contacts, making accessible housing, healthcare, education and transport. Often there’s also an overlap in the sustainability bonds. For example, you invest in transport both on the environmental side and on the accessibility side, to make sure that it’s more available to disadvantaged groups. There’s a lot of focus there under the under the social bonds on small to midsize enterprises and helping them to be more resilient.

QUESTIONOn the subject of Green Bonds, how are U.S. companies participating?

ANSWERBoth financial and non-financial corporates represent about 45 percent of green bond issuance in 2019, and these are large corporates that we know such as, Apple, Starbucks and Pfizer. Financial institutions have played a leading role in this space, both in terms of issuing, and underwriting green bonds. However, we’ve also seen a lot of different sectors come into the green bond space in recent years. There is a lot more diversification now to include tech, telecom and food retail, alongside other traditional issuers like utilities providers and real estate companies as well as corporates.

QUESTIONAre green bonds utilized globally?

ANSWERWe have worked with sovereign insurers over the years and in the last couple of years, Luxembourg, Netherlands, Fiji, Korea; also-sub sovereigns and municipalities. Additionally, development banks have played an important role in the green bond market, especially in the early years, with the World Bank being the first to issue a green bond back in 2008.

QUESTIONSo, government entities are involved in some of these, too?

ANSWERYes, absolutely.

QUESTIONHow do non-government organizations (NGOs) use bonds for social purposes?

ANSWERThey arenot as common as other types of issuers; however, we have seen an increasing amount of nonprofit issuers in the last year or so. A couple of them that Sustainalytics have worked with include the Conservation Fund, the Low-Income investment fund and Century Housing. We’ve also seen recent issuances from a handful of foundations and most notably, including the Ford Foundation, which recently issued its first-time social bond. In doing so, the foundation was able to leverage investment to double its grant making from about half a billion to over a billion, to help stabilize the financial needs for organizations that might otherwise see a funding decrease, due to Covid-19, an associated economic impact.

QUESTIONAre there bonds that are directly involved in helping us recover from the impact of the coronavirus?

ANSWERSocial bonds have really emerged as an important instrument for allocating capital to some of the impacts of Covid-19 and those tend to focus on two key areas. The first is health care and the second is socio-economic impact. For healthcare we might see subsidization of pharmaceuticals for treatment of Covid-19 or research and development for potential vaccines, to name a couple of examples. For socio-economic impact, we’d be looking at loans for small to midsize enterprises at risks, projects to prevent or alleviate unemployment and other financial supports for vulnerable populations.

QUESTIONTell us about how Green Bonds work. Who decides where that money goes?

ANSWERThe project selection for Green Bonds is often a combined effort between sustainability and finance teams and depending on the assets to be financed, they can either choose one or multiple categories. It’s worth noting that there are a set of globally identified guidelines by the International Capital Markets Association and these are called the green bond principles. There are four specific categories that all companies need to align with.

  • The proceeds have to finance or refinance green projects.
  • There needs to be a clear and transparent process for determining project eligibility and any potential material risks.
  • All of the proceeds need to be managed in a separate subaccount or sub portfolio.
  • There’s an expectation from investors that there would be regular reporting, usually on an annual basis on allocations as well as key performance indicators.

QUESTIONAre there some tax advantages to getting the green bonds and investing?

ANSWERThere are several types of tax incentives for investor, there are tax credit bonds through which investors receive tax credits instead of interest payments. That way, issuers don’t have to pay interest on their green bond issuance. There are also tax-exempt bonds where bond investors don’t have to pay income tax on interest from the green bonds they hold and that’s most common in the U.S. muni market.

QUESTIONTell us about Sustainalytics relationship with Morningstar

ANSWERI’m pleased to announce that Sustainalytics was fully acquired by Morningstar, and that’s after partnering with them for a number of years on sustainable indices and ratings. This collaboration will really support the expansion of ESG more to individual investors, advisors and wealth managers around the world. On the sustainable finance side, which is the team that I’m leading up, we are also the leading global reviewer of green bond frameworks. We work with issuers and underwriters to accelerate capital allocation to sustainable solutions.

For more information go to: Sustainable Finance Solutions at Sustainalytics.