Overview of Ethical Debt Instruments
Introduction
Debt instruments that provide a coupon as well as a social or environmental return are broadly dubbed as ethical debt instruments. They come in a variety of forms, and innovative new structures are increasingly coming to market.
The major driver of this is investor demand (such as pension funds, insurers and millennials) and issuers keen to tap into this rich pool of investment capital at equal to lower cost than purely financial return focused bonds. Investors increasingly believe that these forms of debt financing better capture long term and existential risks as well as seek to provide non-financial returns.
The most important factors to focus on when evaluating such instruments is whether the issue meets a common set of Social Bond Principles, namely use of proceeds, project or investment selection process, management of funds in accordance with a pre agreed framework that has been evaluated by a third party (e.g. Sustainalytics or CECERO) and aligns with a recognized global or national set of principles (such as the Green Bond Principles, the Social Bond Principles and/or the Sustainability Bond Guidelines) and impact metrics monitoring and reporting.
Green Bonds
By far the largest ethical debt market place at the moment, with USD11.9bn issued to date in 2019 alone. Last year there was USD167.3bn in issuances. This year is forecasted to mobilise USD250bn in issues. The majority of these bond issuances are aligned with the Climate Bonds Initiative to provide environmental integrity. A few are certified by the climate bond standard which is backed by a board of investors that represent USD34tr in AUM.
Essentially the proceeds of the bond must be used in areas that are consistent with the 2-degree Celsius warming limit specified in the Paris Agreement. BNP Paribas is consistently in the top five underwriting league tables for green bonds. Several stock exchanges have a dedicated section allocated to green bonds, such as Oslo, London, Mexico, Luxembourg, Italy, Shanghai, Taipei, Johannesburg and Japan. Interestingly the US, China and France are the largest sources of labelled green bonds.
Issuers range mostly from multi sector to energy or building related. Structures are sophisticated and diverse ranging from covered bonds and asset backed securities to green Schuldschein, green sukuks, mortgage backed securities and medium-term notes. Apart from issuing its first green bond (USD500mn) as early as 2015, HSBC has also issued an equity linked green bond for EUR34mn (2017) that pegs returns to the performance of a basket of ESG compliant listed companies that are measured against 134 KPIs (STOXX Europe ESG Leaders 30 Index). The proceeds are dedicated to projects that improve energy efficiency.
SDG Bonds
SDG bonds are a type of sustainability bond that aligns the projects it finances or refinances with social and / or environmental impact linked to specific SDGs. These may include all the SDGs or only some of them, such as in the case of the ANZ SDG Bond that seeks to contribute to the achievement of nine of the seventeen goals including health, education, sustainable cities and climate action or the HSBC UN SDG Bond that uses proceeds towards projects that achieve one or more of seven specified SDGs including clean water, energy, education and infrastructure.
In both cases the proceeds can also be used on its own operating or capital expenditures as long as it contributes to the achievement of one or more of the nine SDGs identified.
In HSBCs case the bond is majority invested in two of its LEED Gold certified headquarters in the Midlands and in Dubai. The HSBC bond which was launched in 2017 was USD1bn, 3x oversubscribed and matures in 2023. The more recent SDG bond issued by the World Bank links return on investment to the stock performance of thirty listed companies that make up the Solactive Sustainable Development Goals World MV Index. Proceeds will be used to finance their development projects. BNP Paribas arranged the bond while Banque SYZ placed it.
ESG Bonds
ESG is now a mainstream topic steering investment towards it, and this will continue at a steady pace given that Millennials, who put greater emphasis on adopting these values, will become 75% of the work force by 2025. One of the challenges the industry faces however is a lack of standardization making it difficult for investment funds to set a fixed ESG criteria. In addition, the size of ESG bond issues are generally small relative to their conventional peers and are issued by those with no track record thereby making it difficult for large institutional investors to participate. In fact 50% of European investors in a recent report said they did not think there were enough ESG products in the fixed income space. Another influencing factor in the debt capital markets is that whether labelled as a type of sustainability bond or not, 85% of European investors apply ESG criteria to at least investment grade bonds. (RBC Global Asset Management & Cerulli Associates)
Blue Bonds
These are bonds that raise financing for projects that support the sustainable use of ocean resources, inspired by the green bond movement but at a naisant stage. Only one issuer has raised a blue bond so far and that is the Seychelles, an island highly dependent on the ocean for its livelihood. The issue size was a modest USD15m and the coupon is part guaranteed by the World Bank and the Global Environment Facility. Considering the size of the issue only three investors participated: Calvert Impact Capital, Nuveen and Prudential.
Vaccine Bonds
Vaccine bonds were in fact pioneered in 2006 by the International Finance Facility for Immunisation (IFFIm) launched by GAVI (The Vaccine Alliance) and began the movement by the financial sector towards developing a set of principles to hold the socially responsible bonds universe together. Vaccine bonds are directly aligned to SDG 3, which aims to end the preventable death of children under 5 years of age by 2030. GAVI has been able to raise USD5.7bn so far as effective bridge financing until grant providers can step in.
Other Bonds
Other kinds of social & development impact bonds include Tobacco Social Impact Bonds (TSIB), a rhinoceros conservation impact bond, a cocoa and coffee production bond in Peru and a youth unemployment program bond in Serbia. Sometimes referred to as a pay for success model or a social benefit bond, these innovative financial instruments tend to be driven by private investors with an interest to offer upfront capital for a particular and specific social or environmental goal. These investors work with governments, philanthropists and/or aid donors to come up with mutually beneficial structures that reward them if outcomes are met.
Conclusion
Although the green bond marketplace has taken off well over the last few years, it is not enough to fill the USD3 to USD5 trillion annual gap that is required to meet the SDGs. Banks are in a perfect situation to align just part of their broad loan books towards SDGs that are material to them to drive more capital towards the achievement of the SDGs. Certain sectors can be identified as most closely aligned and a framework for tracking and reviewing annually can be put in place based on industry learnings from the green bond issuance space. As a result, banks will not only be able to expand their product offering and client base but also support their clients who wish to similarly begin engaging with and reporting on their contributions to the UN SDGs.
References: ICMA, UN, Dealogic, MSCI, European Commission, Climate Bonds Initiative and HSBC
Ethical Finance Round Table
HSBC is an active lender in the sustainable finance industry globally and a member of The ICMA Green Bond Principles Executive Committee, The Catalytic Finance Initiative, The Equator Principles Association, The WEF Climate Leaders CEO Group, The Climate Bonds Initiative, The Social Bond Guidance Steering Committee, China’s Green Finance Committee, and the Adopted Taskforce on Climate Related Financial Disclosure. It is the founder of the HSBC Centre of Sustainable Finance and the award-winning Climate Change Centre of Excellence and the first sovereign Green Bond arranger (EUR750mn Polish Bond 2016). HSBC will be speaking at the Ethical Finance Roundtable in Edinburgh hosted by GEFI on Feb 27th 2019. To be considered for an invitation, please click here.
