Greening the economy: ESG investing fuelled by rising tide of green bonds

UK Countryside

With the surging popularity of green bonds in the UK, clearly evidenced by the recent announcement of the Green Gilts scheme, we dive deeper into why capital market investments with an Environmental, Social and Governance (ESG) focus hold enhanced appeal for investors, especially in a COVID-19 context, as well as how guidelines such as ICMA’s can help to maintain the integrity of the market by promoting transparency and preventing greenwashing.

On 1 July, the UK Chancellor of the Exchequer Rishi Sunak announced plans to transform the UK’s financial services industry with the launch of the Government Green Gilts scheme. What this announcement amounts to is a whopping £15bn worth of green bonds to support projects that will help to drive the transition towards the green economy, boost green jobs, and tackle climate change.

In terms of the scheme’s operation on the ground, the green savings bonds will be available through National Savings & Investments (NS&I), offering consumers an opportunity to support green projects while receiving a fixed rate on their savings over a three-year term.

With the pandemic placing companies under scrutiny for decisions that impact their employees, customers and society at large, the rise of ESG investing appears inevitable, and this trend is clearly evidenced by the UK Government’s focus on greening the bond market with this innovative offering. Enhancing the appeal of ESG in capital market transactions are factors such as greater stability, broader opportunities, and long-term rewards that come in the wake of sustainable investing, which explains why investors are willing to pay a premium for a green transaction (or ‘greenium’).

At the outset, green bonds tend to exhibit lower volatility than conventional bonds, making them a more attractive proposition for many investors. Moreover, with the pandemic accelerating the fight against climate change, investing in green bonds can be seen as an active decision by investors to allocate capital in a way that makes a significant difference in climate action. Finally, a company issuing green bonds also sends out the signal that it is at the forefront of a transition towards sustainability, and investors would rightly consider that such sustainable ventures should carry less risk in the future.   

ESG investments flood the bond market…

As investment funds face increasing pressure from investors to select portfolio companies with strong ESG parameters, data from Refinitiv shows that companies in the euro investment-grade corporate bond market, a major source of green funding, have already raised nearly as much through green bonds this year as during the whole of 2020. Meanwhile, banks have already printed more green bonds this year than they sold over the course of the whole of last year.

In terms of actual numbers, on the investment front, data from Morningstar shows that investors poured US$54 bn into bond funds specialising in ESG issues in just the first five months of this year, compared to almost US$68 bn for all of 2020. Coming to green bond issuances, according to data from the Climate Bonds Initiative, US$150 bn of green bonds have already been issued as at the end of May 2021. This surge in green bonds builds on a record year in 2020 which saw US$178 bn worth of green bonds added in the second half, almost double the US$91.6 bn added in the first half of the year.

Finally, the overall assets under management (AuM) in ESG bond funds have tripled over the last three years, even as latest figures show a 14% rise in AuM to US$374 bn between January and May. While other investments have been muted and the AuM of the entire fixed-income fund universe rose only 12% in 2020, that of ESG bond funds surged by as much as 66%.

…but greenwashing concerns remain

Even as the rising tide of demand for green bonds has led to a flood of new fund launches with both companies and governments issuing ESG bonds to cater for increasing investor interest, the growing supply has prompted concerns of so-called greenwashing. This implies that certain bond funds may not be as sustainable as they claim, or that fund managers are finding it a tough task to demonstrate the ESG value-add of such bond funds.

Thus, with greenwashing still posing a pressing concern for investors, frameworks such as the International Capital Market Association’s (ICMA’s) Green Bond Principles take on added importance. Promoting transparency and disclosure in the green bond market, the Green Bond Principles (GBP), established in 2014 and updated as of June 2021, are voluntary process guidelines that advocate for integrity in the development of the green bond market by clarifying the approach for issuance of such bonds.

Moreover, with Europe continuing to lead the way as the world’s largest green bond market, the Sustainable Finance Disclosure Regulation (SFDR) that came into effect this March has imposed more stringent requirements on sustainability-related disclosures for financial institutions to target greenwashing. As such, by making companies more transparent to investors, the SFDR should help give the green bond market a boost.

A sustainable trend

Significantly for the growth of the green bond market, a key development has been the veritable explosion of sovereign green bonds, a far cry from being practically non-existent four years ago. Indeed, with the COVID-19 crisis leading to a renewed focus on climate action from governments, 2020 has seen inaugural green bond issues from Germany and new issues from Italy joining the pool of existing sovereign issuers in 2021. Now, the UK has signalled its intent to enter this exciting space as well. 

All in all, as governments across the world start delivering on promises of a low-carbon economy in the wake of the pandemic, it is becoming increasingly clear that green bonds are here to stay as an integral pillar of the green economy.

How IQ-EQ can help

At IQ-EQ, our team is available to assist with expertise encompassing ESG and Capital Markets transactions as both sectors continue to grow, with the latter particularly fuelled by the continuing rise of green bonds.

Our overarching investor solutions service offering powered by IQ-EQ Cosmos is a cutting-edge reporting tool that offers real-time data on a variety of parameters – including ESG factors – partnered with our genuine expertise. Moreover, with specific focus on ESG reporting, we offer IQ-EQ Compass, an innovative and integrated service offering that simplifies ESG compliance while helping build sustainable value and reputational resilience. Under IQ-EQ Compass, services such as ESG health check, reputational assessment and reporting are supported by a powerful technology dashboard, which enables managers and investors to navigate, monitor and benchmark their ESG KPIs against the leading ESG frameworks globally, including the World Economic Forum ESG metrics.

Finally, we are expanding our Capital Markets service line offering to better support our clients on capital market transactions, with special focus on green bonds. We can also offer the full range of corporate services in the Securitisation, Structured Finance and Debt Capital Markets sectors across all European jurisdictions.