Sustainable bonds offer the opportunity to diversify and achieve possible outperformance
ESG bonds have recently gained significant prominence in the global investment universe. Over the past two to three years, these investments have been significantly boosted by a lively public debate. Sustainability has become an integral part of many areas of daily life. And why shouldn’t this be the case in bond markets?
This encouraging growth was driven by both parties. Issuers offered a diverse range of products. Investors seem to be increasingly demanding it. These securities offer the opportunity to diversify and may have the potential for outperformance over time. They can offer attractive opportunities for bond investors.
1/ The supply of sustainable investments continues to grow
1.1 Sustainable bonds: a great success story on the primary market
Strong activity in the global primary market in 2023…
ESG bonds are fixed-income securities whose proceeds are used to finance or refinance environmental or social projects or activities, or a combination of both. Issuance of these bonds reached an impressive volume again in 2023, largely driven by record sales of green bonds, according to data compiled by Citigroup.[1] The issuance of so-called use of proceeds bonds (i.e. green, social, sustainable and sustainability-linked bonds) totaled $895 billion in 2023, a significant increase of around 8 % compared to the same period last year. This figure, however, does not constitute a record. The previous one took place in 2021, when emissions reached just under $1 trillion. One of the segments where records were set in 2023 was corporate and government green bonds, which soared to $571 billion, well above 2022 and 2021 volumes ($486 billion and $516 billion, respectively).
…continues into early 2024
This impressive performance of ESG bonds in the primary market continued in the first three months of 2024. According to Bloomberg data, green bonds worth $202.5 billion were issued in the world, the highest figure ever recorded. With a 60% share of total ESG bond issues in the first quarter, green bonds have left other segments far behind. Social bonds represented the second largest level of issuance in the first quarter, with USD 63.9 billion, or 19% of the total, followed closely by sustainable bonds with USD 60.2 billion, or 18% of the total. At $11.8 billion (3.5% of total volume in the first quarter), sales of sustainability-linked bonds remained low.[2]
Dynamic development of the ESG bond market
Sources: Citi Global Sustainable Debt Capital Markets, DWS Investment GmbH as of 03/22/24
European IG and high yield corporate bonds are particularly strong
The trend in euro-denominated European corporate ESG bonds in the Investment Grade (IG) and High Yield (HY) segments has been particularly strong, according to Bank of America calculations.[3] In the first three months of the year, ESG bonds with a volume of around €46 billion were issued in the IG segment – only around €1 billion less than in the first quarter of 2023 , the strongest first quarter to date, and already equivalent to around 33% of the total sustainable IG bond issuance in 2023. In the high yield segment, we already represent around 43% of last year’s total volume , with issues of 6 billion euros in the first quarter.
A review of the stock also clearly shows that the role of ESG bonds is becoming increasingly important. Today, 16% of the ICE BofA Euro Corporate Index is made up of these securities, compared to around 11% for the corresponding high-yield index. For the full year 2023, ESG corporate bonds represented just over 28% of the sector’s total supply, with green bonds accounting for just over 75% of sustainable issuance.[3]
Given the increasing investments being made in the energy transportation sector, we believe that sustainable investing will become extremely important in the years to come. For a more distant future, they represent a potential factor of differentiation, if the problem is pursued with the necessary vigor. Green bond issuance will likely become active even in sectors that have seen little or no green bond issuance so far.
1.2 What is the framework for sustainable bond issues?
ICMA Green, Social, Sustainable and Sustainability-Related Principles
The market for sustainable bond investments has grown in recent years. As a result, it is becoming increasingly difficult for investors to identify which products actually fall into this category and which suppliers and issuers simply want to jump on the bandwagon without actually meeting high environmental standards. Statutory rules and regulations for ESG obligations have been adopted by the EU but are not yet effectively established. This is why we currently use standards established by private initiatives, such as the Green Bond Principles (GBP) of the International Capital Market Association (ICMA).
The GBP is a set of voluntary guidelines and principles, intended to provide investors with a certain degree of security. The GBPs are closely linked to the ICMA Social Bond Principles (SBP), Sustainability Bond Guidelines (SBG) and Sustainability Linked Bond Principles (SLBP). According to the ICMA website: “The Principles are a set of voluntary frameworks whose stated mission and vision is to promote the role that global debt capital markets can play in financing progress towards environmental sustainability and social. The Principles describe best practices when issuing bonds in the service of society. and/or for environmental purposes through global guidelines and recommendations that promote transparency and disclosure, thereby supporting market integrity. The Principles also raise awareness among financial market participants of the importance of environmental and social impact, with the ultimate aim of attracting more capital. support sustainable development. »[4]
In the EU, the taxonomy sets the basic framework, while the “Green Bond Standard” specifies the criteria
In the European Union, the so-called EU taxonomy constitutes the basic framework for classifying green or sustainable economic activities. The EU taxonomy, which came into force in July 2020, creates clear rules and framework conditions for the concept of sustainability, defining when a company operates in a sustainable or environmentally friendly way.[5] In our opinion, this framework constitutes an important and above all necessary step to channel capital flows towards sustainable investments and support companies in their initiatives to become more environmentally friendly.
In order to make investing in sustainable assets safer, “Regulation (EU) 2023/2631” of the European Parliament and of the Council on European Green Bonds (EUGBV) was published on November 30, 2023. It defines a framework for action at EU level. market standard for “green” bonds: the European Green Bond Standard (EUGBS).[6] A bond complying with this standard must meet specific conditions linked to environmental sustainability criteria. The EUGBS also specifies how external auditors, national financial supervisory authorities and the European Securities and Markets Authority ensure that issuers comply with these requirements. Of course, issuers can always decide for themselves whether or not they want to issue their bonds as EU Green Bonds (EuGB). It is also still possible to comply with other available sustainability standards, such as ICMA’s GBP. However, if an issuer decides to issue its bonds in the form of EuGB, the EUGBS must be strictly complied with.[7] As the competent supervisory authority, BaFin, the German federal financial supervisory authority, monitors whether issuers of European green bonds comply with transparency and information requirements. BaFin also checks whether the required documents have been verified beforehand by external auditors.
Rating agencies are also getting involved in the ESG movement
A lot has improved for investors in sustainable products in recent years. A certain number of uncertainties have at least been mitigated by the different frameworks and regulations. Rating agencies also play an important role in valuing sustainable assets and it is not just large, well-known agencies that feel obliged to respond to investors’ growing demand for relevant information. A number of specialist agencies have also been created. In the case of ESG bonds, so-called second-party opinions, which are external verifications of an investment’s compliance with sustainability standards, constitute an essential part of the external assessment of the quality of the security.
