Why 2021 could be a landmark year for sustainable debt

The sustainable bond market hit an all-time high last year, as companies and governments turned to the debt market to fund green or social objectives that would allow them to meet internal sustainability goals and bolster their recovery from the pandemic. Google owner Alphabet, Tesco, Whitbread, H&M and PepsiCo are just some major brands to issue green, social or sustainability bonds in recent months, and the U.K. government is gearing up to launch its maiden green “gilt” this summer in a bid to fund low carbon projects that can help deliver a lower carbon economy, suggesting the market is on track to maintain its impressive run of firm this year.

Now a major new analysis of the sustainable debt market published late last week by the Climate Bonds Initiative (CBI), the not-for-profit initiative responsible for setting criteria and standards for sustainable bond products, has provided further evidence of how the sector is poised for prime time following record levels of sustainable debt issuance in 2020.

The report concludes that despite the considerable disruption caused by the coronavirus crisis, 2020 was still the most “prolific year ever” for green, social and sustainability bonds, instruments it groups together under the banner of “sustainable bonds.” Overall, it calculates that $700 billion of green, social and sustainability bonds were issued in 2020 — almost double the 2019 figure of $358 billion — as businesses and governments turned to investors to finance longer-term recovery plans in the fallout from the ongoing economic and health crisis. 

While green bonds retained their position as the dominant type of borrowing across all categories, and the largest source of outright capital, the market for social and sustainability bonds saw more rapid growth as issuers around the world looked to raise funding to counteract the effects of the pandemic, according to the findings. The sustainability bond market — debt issued with combined social and green imperatives — saw a 2.3 percent increase on 2019, while the social bond market recorded a huge tenfold increase on last year.

Echoing conclusions reached by analysts from investment bank SEB earlier this month, the CBI said it expects annual green investment to hit $1 trillion for the first time this year. “While GSS [green, social and sustainability debt] is in the minority now it is growing rapidly, and fast appealing to a mainstream audience at both institutional and retail levels,” the report notes. “Social and sustainability themes will continue to grow, as economic measures become more focused on rebuilding a fair and more equal society.” 

The return of U.S. climate leadership under the administration of President Joe Biden, the development and harmonization of green taxonomies for sustainable finance and the growing popularity of sovereign bonds among governments committed to net-zero goals or “build back better” economic recovery plans will all contribute to the growth of the market, the CBI said.

CBI CEO Sean Kidney said the key features of the 2020 market had been the “broadening and deepening” of thematic issuances, pointing to the advent of transition bonds and the rapid growth in the sustainability and social markets. “The emergence of a transition label points towards the pathways investors and corporates in basic industries must take towards net zero,” he said. “The rise of social and sustainability issuance indicates welcome market developments towards building resilience and adaptation measures as part of sustainable development.”

The report charts the emergence of the transition bond market, noting that 11 bonds were issued in 2020 to explicitly fund projects or activities designed to help carbon intensive organizations steer a path towards a lower-carbon future. This included Bank of China’s issuance of nearly $780 million of transition bonds in January to support China’s new goal of achieving “carbon neutrality” by 2060 and a string of instruments issued over the past 18 months by Italian gas distribution company Snam to fund “energy transition initiatives.” The nascent market is poised for exponential growth over the coming years as companies, national and subnational governments seek funding to deliver on their climate goals and overhaul their operations to pivot away from high-carbon assets and activities, the report states.

The report concedes that work needs to be done to give lenders more confidence in the transition bond market, noting that the market response thus far has been “mixed” due to concerns around the relevance, reliability and availability of transition pathways proposed by issuers. In recent months, some green or climate bonds have faced criticism from some investors and campaigners, who have alleged that investments labelled as “green” have been used to fund high carbon projects and industries.

However, the CBI said a “consensus-building process” already was underway, pointing to a white paper published last autumn that explored how the transition bond market could be better streamlined and regulated, as well as a handbook released by the International Capital Market Association (ICMA) in December. However, it recommended investors place the rapidly growing segment under “continual scrutiny” to help ensure so-called “transition-washing” does not occur.

Elsewhere, the CBI’s analysis explores “the rise of the sovereign GSS bond club,” noting that 10 new players entered the market this year, bringing the total number to 22. The non-profit predicts this number will snowball over the coming years, arguing that sovereign bonds are a no-brainer for the 110 countries that have committed to achieving some form of “carbon neutrality” by mid-century, as well as for governments that have pledged to deliver a “green recovery” from the pandemic. The U.K. is set to join the league this summer, when it plans to launch its maiden sovereign green bond.

However, while the sustainable bond markets broke records last year, the CBI cautioned that overall debt issued still falls far short of the levels required to deliver the green infrastructure and climate solutions required to build a net-zero emission economy within three decades. “2020 was a demonstration that business-as-usual economic policy is not sufficient to address multiple and sustained shocks of the sort that climate impacts will increasingly drive,” Kidney warned. “The gap between current investment levels and the sustained flow of global capital in trillions towards climate and green solutions is yet to be bridged.”

Indeed, while 2021 is gearing up to be the biggest year for sustainable investment, it is clear the sector is still in its youth. The market has grown rapidly over recent years as climate policy has ratcheted up in ambition and climate risk has become a key issue for investors and financiers. But the cumulative $1.7 trillion of sustainable debt set out in this week’s analysis remains but a small fraction of both the $100 trillion bond market and the $90 trillion the CBI estimates is required between now and 2050 to fund the net-zero transition. The finance sector is increasingly aware of the mobilizing role it must play in delivering a more sustainable economy — witness the numerous net-zero portfolio pledges from key investors in recent months — but it still needs to put its money where its mouth is and redress the imbalance between sustainable and so-called brown investment in the debt market.

Or, as the CBI put it last week: “Reaching an annual $1 trillion in green investment is just the beginning.”