20 February 2023

A return to growth for the sustainable bond market

S&P Global Ratings sees the sustainable bond market roaring back in 2023. Environmental Finance talks to Dennis Sugrue, Lynn Maxwell and Christa Clapp, as her firm CICERO Shades of Green joins the S&P Global family

Environmental Finance: What are S&P's expectations for the sustainable bond market in 2023?

Dennis Sugrue: We expect to see a rebound in issuance. There was a 19% reduction in issuance in 2022, down to around $850 billion. However, we're expecting that volumes this year will recover to the range of $900 billion to $1 trillion – around the mark that was reached in 2021 and resuming the levels of growth that we saw between 2018 and 2021.

Dennis SugrueIt's interesting to note that, for this year, we're expecting only modest growth, of just under 3%, in the overall bond market. This means that we're expecting sustainable bonds to start to take a larger share of the total market – estimated between 14-16%.

We've identified three themes that we think will drive this return to growth. The first is around regulation and transparency initiatives. The second is the need for more investment in climate adaptation and resilience, which we saw coming out of COP27. The third is a recovery in the sustainability-linked bond (SLB) market. That part of the market – which drove a lot of its growth in recent years – saw a contraction in the second half of 2022 compared with the same period in 2021.

It's at an inflection point: we've seen a lot of criticism from investors, academics, and even policymakers over the credibility of this sub-class. If the market can address those concerns, we see the potential for sustainability-linked bond issuance to resume its upward trajectory.

EF: What influence do you think initiatives around regulation, policy, and transparency will have on sustainable bond issuance?

Christa Clapp: We're certainly seeing a lot more scrutiny, from social media, journalists and investors, who are asking more questions about whether various issuances are truly green or sustainable. This is a healthy part of the checks and balances that exist in the market. As investors become more savvy, and ask more questions, that could drive more of the market: it has been the case for years that investor demand for robust, green-labelled products has been higher than supply.

In the medium term, we also see transparency regulation encouraging market growth. In the EU, for example, directives around sustainable finance and corporate disclosure require companies to disclose the extent to which what they are doing is sustainable. That means that they've done their homework – they would be prepared to come to the sustainable bond market if they need debt financing in the future.

The third element we're seeing is national policy. Whether it's encouraging electric vehicles, as Norway, where I'm based, is doing, or making building codes more sustainable, lots of countries are pushing their economies in a greener direction. That will help drive issuance in the sustainable bond market.

EF: What role can the sustainable bond market play in helping to answer the call from COP27 for more investment in adaptation and resilience?

DS: The sustainable bond market has really not been focused on adaptation and resilience as much as climate change mitigation. But, given calls at COP27 for more investment in adaptation, we could see issuers turning to the sustainable bond market to raise financing for adaptation and resilience, bringing new issuance to the market.

Part of the challenge is that adaptation, as a proportion of climate finance, has long been lagging compared with what we see on the mitigation side. UN Environment Programme (UNEP) has estimated we're going to face $140-300 billion in adaptation costs by 2030. We're a long way from financing that.

One issue is with defining the types of projects that are eligible, with a lack of awareness from an issuer perspective on the type of projects that can help with climate change adaptation, and how to structure them in a package that's suitable for investors.

Christa ClappFurther challenges include identifying benefits and cash flows, and the potential for mismatch between those financing projects and those who benefit from them.

CC: The public sector and the multilateral development banks have a really important role to play here. In many cases, local governments are at the forefront of the impacts associated with climate change, like extreme heat waves, precipitation, hurricanes, forest fires, etc. There are rising public costs associated with these disasters, which are often borne by the city or municipality.

An interesting example of a sovereign looking at this area is India, which published its national green bond framework a couple of months ago and which includes an adaptation financing category. It specifically calls out that financial assistance to state and local governments, giving examples of forest fire prevention, water storage, public awareness measures, and early warning systems – so a mix of information, preparedness, and built infrastructure.

We're also seeing some large corporates beginning to pay attention to this area, especially if their supply chains are vulnerable. Some are looking at raising financing for material use and for building in climate resilience, for example by making sure that built infrastructure can handle the increased risk of flooding and heat stress.

EF: There has been a lot of scrutiny of the fast-growing sustainability-linked bond market. What are your expectations for that segment in 2023?

DS: Compared with use-of-proceeds bonds, issuance in the SLB market tends to more closely track trends in the broader bond market: as we noted, we're expecting limited growth there in 2023.

In addition, there are other market pressures on SLB issuance. There are some very big questions being asked of issuers and arrangers. They want to know, for example, that these bonds incorporate ambitious targets, and that they don't contain call dates that allow the issuer to exit without paying penalties for missing targets. Issuers and arrangers will have to look at how they address some of these concerns.

CC: This scrutiny is very much linked to that being applied to corporate net-zero targets. It's in everyone's interests to ensure that companies are setting meaningful targets and following up on them. This should not be a checkbox exercise. Some investors want to see more context around the targets: they want to see a company's KPIs [key performance indicators], the timing of reductions, the use of offsets, and the integrity of those offsets. When it comes to assessing ambition, the devil is in the detail.

DS: All that said, we see the SLB market as offering a path to sustainable financing for a broader set of issuers than that which can access the use-of-proceeds market. To the extent that investor confidence can be restored, the SLB market could resume the levels of growth we've seen in recent years.

EF: How do you see the role of Second Party Opinion (SPO) providers evolving?

Lynn Maxwell: The market is moving into financing new technologies, into new applications like adaptation, and we're increasingly seeing more complex structures, such as securitisations or project financing vehicles. What I'm hearing from investors and lenders is strong demand from SPO providers to provide detailed analysis on these novel technologies and structures.

SPOs mitigate the information asymmetry that arises when an arranger markets a bond. An investor might get 24 or 48 hours to make an investment decision, and that's where a second party opinion can be really useful. The investor will do their own analysis, of course, but there's huge value that an independent SPO can provide in terms of scrutinising these structures and investments.

Bringing CICERO Shades of Green into S&P Global

EF: In December, S&P Global announced the acquisition of SPO pioneer CICERO Shades of Green. What was the motivation for the deal?

LM: Our view has always been that a SPO provides a similar benefit to the sustainable debt markets that a rating brings to credit – it's about bringing analysis, information, and insight to the market, and helping to address information asymmetry. Even before the acquisition of CICERO Shades of Green, S&P has grown this part of our business quite significantly, increasing the number of SPOs we produced from 24 in 2020 to more than 110 in 2022.

Lynn MaxwellWe always had a great deal of respect for the high-quality analysis carried out by CICERO Shades of Green, which was the earliest entrant in the green bond market and an expert in climate and environmental analysis. So, we reached out to them to talk about a partnership, and soon found out we had really strong alignment in terms of our own approach and culture.

The conversation quickly turned towards acquisition.

CC: We were brought in to the World Bank deal to provide the SPO on the first green bond in 2008 because we were completely independent and research-based. Those two elements continue to underpin what we do at Shades of Green, and we found great synergies with S&P that allow us to scale up our potential impact. I've been really impressed with the people and processes at S&P, and that speaks to the integrity and robustness of their analysis.

One of the things that was important for us was to continue to keep our links with our not-for-profit former parent, CICERO Research Foundation. We've formalised that to allow for regular updates on climate science, access to climate researchers, and the possibility of doing joint research.

EF: What synergies have you found between your two companies?

LM: One of the advantages of the acquisition was our ability to overlay the regulatory construct that we have at S&P, where our commercial and analytical functions are clearly separated. This allows our analysts to perform their work completely independently.

There are other areas of complementarity from a commercial perspective. Shades of Green is strong in the Nordic region and in Europe more widely. It is also strong with sovereign clients and other public sector entities, including multilateral institutions. With S&P, we have a much bigger global reach. Before the acquisition, we had approximately 60 sustainability-focused analysts. Adding the CICERO analysts broadens our climate and sustainability knowledge base even further.

EF: What are your plans for the combined business?

LM: At the moment, it's business as usual as we integrate Shades of Green. But we're assessing the different products we have in our two organisations, and we're going into the market to get some feedback on those before we finalise the product mix. We're going to get a sense of the direction that the market is going in and the demands that investors are bringing to us. We feel like we've got the expertise, so now we're making sure we've got the products that investors need.

Dennis Sugrue is senior director sustainable finance, and Lynn Maxwell is regional head (EMEA) commercial and global head of marketing, at S&P Global Ratings. Christa Clapp is managing director sustainable finance at CICERO Shades of Green, now a part of S&P Global.

For more information, see: https://www.spglobal.com/ratings/ en/products-benefits/products/second-party-opinions

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