The next chapter for the ESG bond market

Channels: ESG, Green Bonds

After dramatic growth in the ESG bond market in 2021, BBVA sees issuers further embedding ESG into their financing strategies and grappling with an evolving regulatory context. Angel Tejada, Michael Gaynor and Álvaro Sánchez talk to Environmental Finance

Environmental Finance: What do you see as behind strong growth in the sustainable debt markets in 2021?

Michael GaynorMichael Gaynor: The principal driver of growth in the market last year was COVID, much as it was in 2020. We were somewhat surprised that the volume of COVID-related issuance on the social side of the market continued to persist as strongly as it did, given that, among the investor base, a lot of attention continues to be on the green side of things.

Similarly, there was continued popularity among issuers for sustainability bonds that can be issued for either green or social purposes. For the issuer, this provides an awful lot of flexibility in terms of how they can use the proceeds. However, from an investor standpoint, especially for a dedicated green investor, it can muddy the waters somewhat.

Meanwhile, the volume of issuance of sustainability bonds from non-financial corporates was a positive surprise on the primary side of things. There aren't many sectors, outside the banks and SSAs [sovereigns, supranationals and agencies], that can issue pure social financing vehicles. Issuing sustainability bonds gives corporates the flexibility to allocate proceeds towards hitting their SDGs [Sustainable Development Goals] and more of their underlying corporate targets. 

Álvaro Sánchez: From the corporate side, 2021 was the year that sustainability-linked bonds [SLBs] really took off. That's given space to a lot of companies that may not have been perceived as green to enter the market and issue in this sort of format, where the bond is linked to overall corporate sustainability performance, rather than to a specific green or social purpose.

EF: How are issuers approaching the market?

Angel Tejada: Issuers today are very interested in integrating sustainability into their strategy, including their funding strategy. ESG is becoming a topic of interest for the CFO and the CEO, and they are trying to understand what ESG financing solution provides the best option. This will depend on the jurisdiction, the industry they are in and, of course, where they are in terms of the transition to a more sustainable world.

We are certainly seeing dynamics that can justify issuing ESG bonds from a funding perspective, but the willingness to integrate ESG targets with financing and strategy, and to look at it in an integrated way, can also help to engage other stakeholders regarding the issuer's sustainability agenda.

Issuers are also very concerned with avoiding accusations of greenwashing. Issuers and investors are becoming more open to engaging together to discuss potential queries and to work with advisors such as BBVA to provide some guidance to the market as a whole. There is broad understanding of the need for the highest standards of integrity in the market, whether from voluntary guidelines or, in future, from regulation, if we are to build a robust market based on best practice.

EF: What about investor preferences? How are they evolving?

MG: We have seen another leap forward in terms of investor sophistication. The emergence of SLBs as a popular instrument has had a lot to do with it: they helped to catalyse a lot of integration in how more traditional use-of-proceeds green bonds fit into wider corporate strategy. Investors have begun to question what green bonds were actually doing for issuers at the corporate level: were they meaningfully helping to finance corporate decarbonisation, or materially improve another ESG-related metric, or were they, in some cases, just enabling business as usual?

SLBs as an asset class have really piqued the interest of investors because there's a very direct story there in terms of their contribution to overall corporate sustainability. There has been a read-across to use-of-proceeds bonds, in that they want to see that these dedicated financing vehicles are also having that kind of 'second derivative' impact as well.

We're also starting to see investors look to integrate green bond investing with other ESG strategies. For example, an investor may have an exclusionary strategy that blacklists sectors or issuers but, if an issuer is using green bonds to finance a particular activity, that might offer a strong argument to negotiate around that blacklist. So, we're seeing the traditional separation of ESG strategies in the credit space begin to break down, and changing into one holistic, very sophisticated approach.

EF: You mentioned the dramatic growth in the sustainability-linked bond market. What developments are you seeing there?

Angel TejadaAT: Many of the conversations we are having with investors and issuers are around the relationship between standardisation and innovation. For example, most SLBs are focused on step-ups, where the issuer pays a higher coupon if it misses its sustainability performance target. But there is the potential for step-downs that incentivise issuers to set and achieve more ambitious targets. That innovation is going to emerge, sooner or later.

But I think we may well see these kinds of innovations starting in the public sector. Given the limited number of sovereign issuers, their credibility, the large amount of information available about their sustainability policies and the liquidity of that part of the market, investors will be better able to engage with innovation from those issuers. If, on the other hand, we see too much innovation in the corporate space, from smaller, less well-known issuers, I fear that the due diligence expected of investors would be too great.

EF: BBVA was Green Structuring Advisor and Lead Manager for the Kingdom of Spain's first green bond, a €5 billion, 20-year bond, which was placed last September. How did that process go?

AT: It was a long and intense process, as the Kingdom of Spain wanted to build a very rigorous, robust framework, developed through an inter-ministerial working group, ensuring that it was very well prepared ahead of the verification process. For sovereign issuers, this is always a complex project but, in the case of the Kingdom of Spain, they successfully managed to achieve their objectives with excellent coordination and agility. According to the second party opinion provider Vigeo Eiris [VE], Spain's Green Bond Framework meets the highest possible standards and got the highest rating ever given to a European sovereign by VE. Ultimately, the framework was not that difficult for the Kingdom of Spain to put together because it has an ambitious climate framework (with clear climate and environmental policies) that will help the country build a carbon-neutral and resilient economy. Having such an environmental ambition is always one of the most important elements for any green bond issuer.

It's definitely a fantastic development, meaning that Spain now has the possibility, on an ongoing basis, to issue green bonds in future that will lead the green recovery process.

EF: What impacts did COP26 have on the ESG finance markets and do you anticipate continuing positive effects?

AT: Yes, I think COP26 is continuing to have a lot of effects in the ESG bond market. It has proved to be a major step forward in encouraging companies and countries to think about science-based scenarios and methodologies to define and understand their decarbonisation trajectories. Also, for sovereigns, the way they will report on their nationally determined contributions could have very interesting implications for the ESG bond market.

Compared with previous COPs, it was awesome to see at COP26 the engagement of the private sector in working towards methodologies and commitments to reach the 2050 emissions goals.

We expect to see more companies publishing commitments linked to 1.5°C, and more investors demanding this greater ambition. We expect that companies will aim to leverage efforts towards more aggressive commitments, and to issue sustainability-linked bonds or green bonds to finance the capex involved.We also expect the competition to accelerate regarding how companies are going to decarbonise and transition their business towards the net-zero global economy.

EF: Are you concerned that extra burdens imposed by the EU Taxonomy and the forthcoming EU Green Bond Standard will make it harder for issuers to come to market?

AT: Existing issuers of ESG bonds are trying to understand how the EU Taxonomy and the Green Bond Standard will affect them. Some of them are modifying some of the wording in their green bond frameworks to add more content and to ensure their alignment with the EU's forthcoming rules, as well as their alignment with the recent recommendations from ICMA [the International Capital Markets Association].

However, many companies in Europe that are involved in the ESG bond market are already responding to the EU Sustainable Finance Regulation, the EU Non-Financial Disclosure Directive and, from January next year, will have to comply with the Corporate Sustainability Reporting Directive; they are required to report non-financial information and the alignment of their investments and revenues with the EU Taxonomy. Here, it is helpful to have these definitions around green activities and what activities should be funded to enable the decarbonisation of the economy.

In this regard, the EU Taxonomy is likely to be a positive in terms of the future issuance of green bonds. Discussions that are ongoing internally among issuers to understand the debates around the Taxonomy, and the eligibility of assets within their portfolios, will benefit the structuring process for potential use- of-proceeds green bonds. We are going to find better-prepared issuers.

Meanwhile, the market already has clear guidance, recommendations and standardisation from ICMA that provides issuers and investors with best-practice guidelines. For that reason, I don't see the Taxonomy or the Green Bond Standard having a huge impact this year.

EF: Finally, what's next for BBVA in 2022?

AT: For BBVA, our objective is to become a sustainability partner for our clients, to help advise them on how they can best integrate sustainability into their business processes. Specifically, we are allocating resources to ensure that we can offer a sustainable alternative for every financial product we offer – a commitment we achieved in Spain last year.

In the ESG bond market, we are working to get closer to issuers and investors; we think it is particularly important to foster engagement between the two sides of the market. There has not been enough focus in the past on the conversations between them to ensure that, for example, appropriate structures are in place so they can be incorporated into socially responsible investment mandates, bond indexes or can be purchased by any type of institutional investor.

Finally, BBVA will continue to be an active ESG bond issuer to reinforce one of our key strategic priorities: "Helping our clients transition towards a sustainable future".

Angel Tejada is global head of green and sustainable bonds at BBVA, Michael Gaynor is senior analyst – European financials fixed income strategy, and Álvaro Sánchez is senior analyst – credit corporates and ESG strategist.

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