22 February 2019
The need for a sustainable economic model with four pillars
Not only since COP21 or the introduction of Sustainable Development Goals (SDGs), there is a growing perception in the markets of developed nations that our current economic model built on the assumption of plentiful supply measuring success only in economic growth is no longer fit for purpose.
Economic growth is an incomplete indicator of wellbeing. It does not value other essential things like environmental, social and Governance quality. We have to realize that sustainable and economic development are inseparably linked with each other.
Furthermore, when talking about sustainable development we may not limit our view to the environmental perspective only. We have to consider social, Governance and economic impact as well.
Hence, we are in need of a new economic model, a sustainable economic model with four different pillars: economic, environmental, social and governance. That is the reason why DZ BANK has developed already in 2011 a unique EESG analysis and rating methodology to allow sustainable stock and bond picking for example.
Global fixed income market: Game changer to enable the transition into a sustainable future
The road towards this sustainable economy is unthinkable without the participation of the capital markets. According to the UN achieving the SDGs by 2030 for example will require a rough estimate of 5-7 trillion US Dollar annually across sectors and industries. Those financing needs are too vast to go through a “central pot”. Public investment alone is not nearly enough. The sustainable funding gap can only be met by significantly increasing private sector participation with the help of the capital markets. Fortunately, investors have started to recognize the sign of times and sustainable investing is on the rise.
The global fixed income market plays a key role in the transformation process. With an estimated volume of more than 100 trillion US Dollar, the global fixed income market bears huge potential for facilitating the transition to a sustainable future.
From our point of view, one of the most promising investment vehicles to support the transition towards a sustainable economy are Sustainable Bonds. They have the potential to be game changer to enable the transition into a sustainable future helping to close the sustainable financing gap.
2018 – A setback for the global Green Bond market?
Between 2007, the year when the EIB kicked off the market with its first Climate Awareness Bond, and 2017 the global Green Bond market has experienced incredible growth. In November 2017, the new issuance volume has topped the significant 100 billion US Dollar benchmark for the first time.
Although, Green Bond volumes have broken through the 100 billion US Dollar mark in 2018 two months earlier than in the previous year, the market’s growth has slowed significantly compared to the 84% year-on-year increase achieved in 2017. According to preliminary statistics from the Climate Bonds Initiative (CBI) global Green Bond issuance reached 167.3 billion US Dollar in 2018 (DZ BANK forecast: 150-175 billion US Dollar) and surpassed 2017 volume of 162.1 billion US Dollar only by 3%.
Is this a setback for the global Green Bond market being characterized by double to triple digit growth rates in the past and forecasted to top 1 trillion US Dollar by the end of 2020?
From our point of view, there is no need to worry.
On the one hand, 2018 figures reflect decreased issuance in some bond markets, particularly from US Muni issuers. According to the CBI, this is in line with a wider trend in US Muni issuance. The passing of the Tax Cuts and Jobs Acts of 2017 by Congress in December 2017 resulted in major alteration to US tax law, and that has impacted the issuance of refunding bonds in particular.
On the other hand, and this is the key development, there is the trend that “Green goes rainbow”. Issuers are going beyond the pure environmental perspective. Social Bond and ESG bond issuance for example is on the rise. Bonds also act increasingly as a bridge to the 17 SDGs.
“Green goes rainbow”
In our last two annual Sustainable Bond market forecasts, we predicted the trend “Green goes rainbow”, meaning that more and more issuers are going beyond the pure environmental perspective when issuing sustainable bonds.
2018 was an important year for this increasing diversification in the Sustainable Bond market, which has already begun a couple of years ago.
According to the CBI, there was a significant rise in the issuance of ESG, Sustainability and SDG as well as Social Bonds, underscoring increasing label diversification. Preliminary statistics from the CBI show the overall Sustainable Bond market has grown by 13% from 199.3 billion US Dollar in 2017 to 226.1 billion US Dollar in 2018. ESG, Sustainability and SDG Bonds experienced a 114% year-on-year growth to 21 billion US Dollar. Social Bonds rose 37% year-on-year to 14.2 billion US Dollar.
For 2019, we expect this trend to continue. We forecast new issuance in the global Sustainable Bond market to grow by around one third, hence exceeding the 300 billion US Dollar mark. The Green Bond market is expected to grow at least by 20% exceeding the 200 billion US-Dollar mark by the end of this year. New issuance of ESG, Sustainability and SDG Bonds as well as Social Bonds will remain the growth driver of the market and is forecasted to increase by around 75%.
A closer look at the Social Bond market
The Social Bond market aims to enable and develop the key role that debt markets can play in funding projects that address global social challenges. Social Bonds are use of proceeds bonds that raise funds for new and existing projects with positive social outcomes.
Since 2014, the annual issuance volume has grown more than 28x as of 2018.
Although still in its infancy, Social Bonds are one of the main growth drivers of the overall Sustainable Bond market in the coming years. The relatively young market already passed a significant milestone when the Social Bond Principles (SBP), a global framework for issuing Social Bonds, were introduced in 2017.
Like in the Green Bond market, Supranational, Subsovereign and Agencies (SSAs) were the pioneers of the Social Bond Market. Especially multilateral stakeholders like the Council of Europe Development Bank (CEB), where social impact is already at the heart of the mandate, were catalyst in the creation of the segment.
A forerunner in the market and frequent issuer since 2015 is Spanish state-owned bank Instituto de Crédito Oficial (ICO). With a total volume of more than 2 billion euros, ICO is currently the leading issuer of social bonds. ICO’s main role is to promote economic activities that contribute to the growth and development of the country while improving the distribution of wealth, especially sectors identified as a priority due to their social, cultural, innovational or environmental significance. This is the context in which ICO is launching its Social Bonds in order to create or maintain employment in Spain’s most economically disadvantaged regions. To achieve this objective, the funds raised via the Social Bonds will be used to finance SME projects in those regions where income per capita is below the national average and that are not involved in industries considered to have a potential negative social or environmental impact, including alcohol, tobacco, gambling and coal mining.
Another frequent issuer in the Social Bond market is the Nederlandse Waterschapsbank (NWB Bank), one of the largest financial services provider for the public sector in the Netherland, which has issued five so-called Affordable Housing Bonds since 2017. NWB Bank is a large lender to the Dutch SHO’s social housing assets and the proceeds of the bonds are used for financing the social housing sector. In the Netherlands Social Housing Organizations (SHO) provide social and affordable housing to people with low incomes, or other vulnerabilities, that have difficulties to access dwellings on the market.
DZ BANK EESG analysis and rating model
Since 2011, DZ BANK is offering investors an integrated analysis and rating methodology that goes beyond the traditional ESG approach. The economic, environmental, social and governance (“EESG”) research model integrates economics as the fourth dimension of sustainability, hence providing a link between financial and sustainability performance. Compared with the conventional ESG viewpoint, DZ BANK’s EESG method permits a more capital-market oriented analysis. It is based on the principle of materiality and is not solely focused on internal guidelines, rules, processes or corporate strategy. Rather, it includes aspects such as the ecological, social and long-term economic impact of products and services in its evaluation of issuers. In addition, this model takes into account the fact that sustainability is not a rigid concept but a complex, dynamic investment process. Conventional sustainability ratings are often only updated periodically. By contrast, the model used by DZ BANK allows continuous analysis and monitoring of issuers. The EESG model helps sustainability-oriented investors to take rapid decisions on the capital market by reducing the complexity of sustainability to a score/ranking. This enables institutional investors to undertake sustainable stock and bond picking and hence to structure portfolios from a sustainability viewpoint.
In November 2017, BayernLabo was the first German SSA to issue a Social Bond. As a public law institution pertaining to housing, BayernLabo’s primary statutory mandate is to promote housing and urban development in Bavaria. The aim is to (re-)finance subsidised loans from three of BayernLabo’s loan programmes, which are beneficial from a social point of view by providing housing to low-income households. The Bavarian loan programme of low-interest loans for private housing supports especially young families in the construction or purchase of their own living space. The Bavarian modernisation programme and the Municipal subsidized housing programme increase the supply of reasonably priced rental housing. Especially the Bavarian modernisation programme also aims at preserving and restoring the urban function of older residential areas.
We forecast that the Social Bond market will exceed the 20 billion US Dollar mark by the end of 2019. We expect SSAs to remain the guarantor for quality in the market. However, we forecast further diversification especially with regard to financial- and non-financial corporates, a trend which already begun during 2018.
In March 2018, Danone issued its inaugural social bond, hence being the first-ever corporate tapping into the Social Bond market since the publication of the SBPs mid-2017.
In September 2018, DKB, the first German commercial bank, which has issued a green bond, launched its second sustainable refinancing programme for capital market products: a Social Bond programme. This made DKB the first bank in Germany to have launched both a Green and Social Bond programme.
Given the fact that there was no Social Bond issuance from the German non-financial corporate sector so far (the only two non-financial corporate sustainable benchmark transactions from Innogy in 2017 and EnBW in 2018 were Green Bonds) we are also confident that we might see the first Social Bond from a German corporate issuer in the course of this years.
We also expect further geographical diversification in 2019, a trend, which already gained momentum during 2018.
In July 2018, state-run Industrial Bank of Korea (IBK) made a successful debut in Social Bond market. In November 2018, Korea Housing Finance Corporation (KHFC) issued the first social covered bond in Asia. In January 2019, Bank of America became the first U.S bank to issue a social bond.
The increasing mapping of financing objectives against the SDGs also bears a huge potential for the qualitative and quantitative development of the Social Bond market. According to the International Capital Market Association (ICMA) 13 out of the 17 SDGs have been identified as being relevant to the SBPs.