The gradual rise in impact bond issuance, since the first corporate impact bond in 2013, to more than US$1 trillion outstanding in May 20201, marks an important development for fixed income investors. No longer are these instruments seen simply as a niche, seed-stage asset class, but rather a viable addition to portfolios in their own right.
What are impact bonds?
Impact bonds are issuances where proceeds raised are dedicated solely to projects that will meet environmental or social criteria. The three most common types are:
- Green bonds: the proceeds are exclusively applied to eligible green projects.
- Social bonds: the proceeds are exclusively applied to eligible social projects.
- Sustainable bonds: the proceeds are exclusively applied to an intentional combination of both green and social projects.
As demand continues to increase, this has led to the evolution of further subsets of impact bonds. For example, growth in the sustainable bonds area has given rise to formation of new thematic impact bonds. These include blue bonds, which have a focus on marine and ocean-based projects, and gender bonds that strive for gender equality and opportunities. 2019 also saw the emergence of transition bonds, which seek to help environmentally friendly companies support the transition to a low carbon economy. Rhino bonds have also come to the market, showing the extent of the rise in more sophisticated impact bond issuance as investors continue to demand more positive impact from their investments.
The classification of a bond as green, social, or sustainable is determined by the issuer based on its primary objectives for the underlying projects. However, there are some commonly used frameworks and standards that provide issuers with information on reporting, verification and bond frameworks. (See below.)
The main impact bond types (USD$ bn)
Source: Bloomberg. Data as at 30 June 2020.
The four drivers of growth
There are four key drivers of the expedited growth rate we have seen in the issuance of impact bonds:
- Shifting attitudes – As the investor landscape shifts evermore toward encompassing millennials and gen-z, investors are increasingly seeking out companies that consider their environmental and societal impact.
- Demonstrating commitment to achieve positive environmental and societal impacts – Businesses recognise the importance of supporting local communities and environments. Impact bonds are an increasingly popular way for corporate, multi-national and sovereign issuers to demonstrate their commitment to achieving their sustainability strategies and to wider efforts such as the Paris Climate Agreement and UN Sustainable Development Goals.
- Regulatory pressure – In some sectors, such as utilities, regulation has threatened their business models; without changes they face uncertain futures. For example, commitments to phase out coal power requires a replacement technology. Automobile manufacturers are investing in electric vehicles due to the widespread ban of diesel and petrol companies over the next 20 years .
- Ease of issuance – It is easier than ever before to come to market with an impact bond. There is more advice and support for issuers (such as on the ICMA website) and investors are increasingly asking for impact investments.
The underlying force is investor demand, driving governments and corporates alike to deliver on the premise of impactful investing.
Issuance is accelerating, led by green bonds
Green bonds dominate the impact bond issuance market. More than US$871.7bn2 has been raised in green bond issuance since 2007, when the European Investment Bank issued its inaugural impact bond. The vast majority of this growth in green bond issuance came following their rise to prominence in 2013 with corporate issuance from EDF and Bank of America spurring more than 500 other entities to issue green bonds since then.
Social and sustainable bonds in particular have been following green bonds’ trajectory and steadily increasing their market share, with social bond issuance in the first half of 2020 more than double the total amount issued in 2019.
Since the emergence of COVID-19, we have seen an uptick in COVID-19 related social bonds, where supranationals, sovereigns and agencies seem to be leading the way. Within the corporate landscape, Pfizer is one of the few to join this part of the impact bond market so far, with their recent record US$1.25bn issuance of a sustainability bond having specific elements of the proceeds to be directed towards COVID-19 social projects. Read the white paper to view examples of this type of issuance.
The growth of impact bond types (USD$ bn)
Source: Bloomberg. Data as at 30 June 2020
Investor susceptibility to impact washing expands alongside the insurgence of impact bond issuance
In large parts of the impact bond market there are lower levels of disclosure, which is a significant enabler of ‘impact washing’ – an issuer falsely claiming to be impact-focused, with potentially little or superficial demonstration of positive impact. This, in turn, creates challenges around comparability in the issuance of, and reporting on, so-called impact bonds.
While there are some commonly used frameworks and standards, such as the International Capital Market Association’s (ICMA) Green Bond Principles, these are not a prerequisite for issuance – and only cover a portion of the universe. Likewise, a lack of consistent reporting renders it difficult for investors to identify whether bond proceeds are used as initially marketed or are simply impact in-name-only.
Help for investors
To manage sustainability objectives for our clients, Insight analyses impact bonds using our proprietary framework. We have found some misalignment in how these instruments are defined, posing issues of integrity in measuring objectives for investors. As the universe expands, these issues are likely to only be further compounded.
Out of the 200 impact bonds we have rated since 2017, it has been concerning to see that just 33% have met all our requirements to be classified as a genuine impact bond3. Conversely, 18% received a red score meaning they did not pass the criteria, with the remaining 49% rated amber, indicating weaknesses in their adherence to impact classification measures. Please see our latest RI and FI quarterly summary for some examples. The table below gives more detail.
Greater collaboration between issuers and investors ahead of new impact bond issuance should support more market standardisation which will be genuinely relevant for investors. Growing alignment with the ICMA principles combined with third party-verifications will help prevent unintended impact washing.
In the meantime though, until more formal frameworks are enforced, it will be vital for investors to exercise appropriate due diligence to avoid falling victim to the rising risk of impact washing.
Traffic light assessment breakdown split by bond type
Source: Insight Investment. Data as at 30 June 2020.
1,2Source: Bloomberg. As at 30 June, 2020.
3Source: Insight Investment. As at 30 June 2020.