Green bonds and sustainable bonds are financial instruments that have a significant impact on sustainability and environmental responsibility, bridging the gap between investors and issuers. These bonds are used as investment vehicles to finance environmentally friendly projects and contribute to achieving sustainability goals.
Green Bonds, a specific type of bond, aim to invest in particular environmental objectives and projects. These bonds are issued to fund eco-friendly activities such as green energy projects, energy efficiency initiatives, waste reduction projects, and sustainable agriculture. The returns on green bonds can vary depending on the success of these green projects. Investors view these bonds as an opportunity to contribute to environmental responsibility by investing in environmental goals.
Sustainable Bonds, on the other hand, target both environmental and social sustainability goals. They offer flexibility to invest in a broader range of projects and activities than green bonds. Sustainable bonds can be used to support social responsibility projects such as community development, inequality reduction, and workforce training, in addition to environmentally friendly projects. Through sustainable bonds, investors have the opportunity to invest in both environmental and social impacts
Both types of bonds adhere to principles of transparent reporting and accountability. Issuers regularly disclose the process of achieving environmental or sustainability goals that affect the bond’s return. Additionally, the returns on these bonds can increase or decrease based on the success of the projects and goals.
Green bonds and sustainable bonds are recognized as significant financial instruments to address global issues such as climate change, energy efficiency, and social inequality. They emphasize the commitment and responsibility of both investors and issuers towards a sustainable future. Green bonds and sustainable bonds are increasingly accepted as a way to promote progress in sustainability in financial markets.
In 2022, it was a challenging year for the entire fixed income market, including sustainable bonds. According to data from Environmental Finance, green, social, sustainability, and sustainability-linked (GSSS) bond issuance in 2022 shrank by 15% to $899 billion from the previous year’s record of $1.05 trillion. Sustainable bonds, which became a trillion-dollar market in 2021, saw its more than a decade-long growth come to an abrupt end due to challenges posed by geopolitical conflicts and inflation.
However, 2022 also demonstrated how far the market has progressed and how much further it needs to go. Green bonds, for instance, showcased the enduring appeal of the oldest sustainable bond label. While younger labels experienced issuance declines of over 20%, the 15-year-old green bond label managed to limit issuance shrinkage to just 10%, outperforming the 26% decline in the total fixed income markets.
Furthermore, despite the turmoil of 2022, the sustainable bond market managed to increase its share of global bond markets to over 13.5%, including more than a 15% share in the latter half of the year. This is a remarkable improvement compared to the 12% share reported in 2021 and the less than 7% share in 2020. This achievement demonstrates the strong foundation upon which the remarkable growth of sustainable bonds has been built in recent years.
Despite the challenging macroeconomic backdrop, market experts forecast a rebound in sustainable bond issuance for 2023. While expectations of setting new records may be tempered, the market remains optimistic about the future.
In contrast, Sustainability-linked Bonds (SLBs) were perhaps the biggest disappointment for 2022. In 2021, the market surged to nearly $100 billion in issuance, the first full year following the publication of the Sustainability Linked Bond Principles in 2020. Despite reaching key milestones in 2022, such as attracting Chile and Uruguay as debut sovereign SLB issuers, the market shrank nearly a quarter to $74 billion in 2022. The reasons for this sharp reversal are complex, but rising scrutiny of the ambition and materiality of the targets associated with these potentially transformative transition-focused instruments played a significant role in weighing down issuance.
Yet, as contributions to this report indicate, intensifying scrutiny of how to ensure the credibility of all sustainable bond labels has also come to the fore in 2022, and the market is responding. Despite concerns about ‘greenwashing’ risks, this is an exciting prospect rather than a threatening one for the sustainable bond market in 2023 and beyond. Moreover, 2023 is likely to see a diverse set of market participants shine a spotlight on the importance of the necessary but somewhat nebulous ‘transition’ theme in sustainable bond markets.
In summary, greater focus on defining credible and comprehensive transition plans can help provide confidence in structuring transition instruments like SLBs better and judge all bond issuers on whether their actions contribute to the solution rather than the problem.
Once again, the scale and sophistication of the fixed income markets can play a catalytic role in driving the overall ‘greening’ of the economy. As we move into 2023, it’s essential for all stakeholders to step up for the next phase of the process, making ‘better’ finance even better still.