22 February 2021

Trends in sustainable bonds issuance and a look ahead to 2021

Moody's forecasts that sustainable bond issuance will hit a record in 2021. Experts from Moody's ESG Solutions Group and Moody's Investors Service outlined to Environmental Finance the key sustainable finance trends they are keeping an eye on for the year ahead

Matt KuchtyakGlobal issuance of use of proceeds green, social and sustainability (GSS) bonds – collectively referred to as sustainable bonds – hit record volumes in 2020 with $491 billion issued, according to Matt Kuchtyak, assistant vice president, ESG at Moody's Investors Service.

Moody's expects issuance to reach another new record $650 billion in 2021, a 32% increase over last year. This total will be comprised of approximately $375 billion of green bonds, $150 billion of social bonds and $125 billion of sustainability bonds.

The heightened market focus on coronavirus response efforts drove social bond issuance to new heights in 2020 with issuance reaching $141 billion, up from just $17 billion in 2019. Social bonds were heavily concentrated among issuers responding to the pandemic throughout the year.

Sustainability bond volumes also continued to grow, with issuance doubling in 2020 to $79 billion.

"Although some of this growth is attributable to financings related to the pandemic, there has been greater diversity in sustainability bond issuance. We see the broader focus on corporate sustainability as a lasting trend in this segment, which will contribute to our forecast of 58% growth in sustainability bonds in 2021 to $125 billion," says Kuchtyak.

Figure 1: Sustainable bonds to hit record $650 billion in 2021

After the pandemic slowed green bond issuance during the first half of 2020, the segment rallied in the second half of the year, bringing full-year volumes to a new annual record of $270 billion.

Moody's expects this momentum to continue as the economy continues to rebound and issuers increasingly pursue debt financing for environmentally friendly projects.

"As such, we are anticipating green bonds will total around $375 billion for all of 2021, which would represent 39% growth over 2020," he says.

Although the pandemic-related financings that helped propel sustainable bonds volumes will likely wane as 2021 progresses, the pandemic experience has heightened the focus on global environmental and social risks and accelerated many of the trends supporting sustainable finance that were already underway.

"Thus, we see continued growth in sustainable bond volumes in 2021 and beyond, with more issuers turning to these instruments to highlight their sustainability plans, investors increasingly demanding labelled sustainable bonds, banks seeking to green their underwriting and lending practices and governments increasingly aiming to combat climate change."

Energy transition-related activities will also drive growth within these types of instruments, he adds.

"We also expect sustainable bonds to continue to increase as a share of total global issuance as they have in recent years. With this expected growth in sustainable bonds, and expectations that global debt volumes will pull back after the pandemic-fuelled record year, sustainable bonds may represent between 8% and 10% of total global bond issuance in 2021," he says.

Trend one: Increased issuance by governments and agencies

Environmental Finance: Corporates traditionally have been the main issuers GSS bonds – why do you think they were the trailblazers?

Anna Zubets-AndersonAnna Zubets-Anderson, Vice President, ESG analyst at Moody's ESG Solutions Group: Corporates have been the leading sector to issue labelled bonds since the green label first kicked off the market in 2014. This is part of the overall trend of growing focus on business sustainability, which we expect to continue in 2021 and beyond.

In addition to managing their corporate social responsibility reputations, companies must respond to asset owners and managers who are increasingly focused on the impact of environmental, social and governance (ESG) risks on their portfolios. Furthermore, there is a real need to advance strategic and operational resilience. In response to these pressures, issuers are shifting how they measure their performance along the ESG dimensions and how they interact with the capital markets.

Labelled bonds often become an effective and efficient way to start the sustainability dialogue with the market and begin building an internal reporting infrastructure necessary to respond to stakeholders' information needs.

EF: What has driven the rise of governments and agencies as issuers of these bonds? Is it a short-term reaction to the pandemic or a longer-term shift in issuer behaviour?

AZ: Governments and agencies are increasingly issuing labelled bonds to raise capital for sustainable development projects more broadly. These issuers are at the forefront of responding to social and environmental risks presented by climate change, as well as other key challenges of the 21st century, such as ensuring social cohesiveness in the face of growing income inequality.

In this regard, we provided second party opinion (SPO) 'firsts' for a sovereign in The Middle East (Egypt), and the first sustainable development goal (SDG) bond for Mexico. Social bond issuance certainly surged in 2020, as the pandemic highlighted the need to direct funds towards projects with social benefits, however this trend did not start with the pandemic.

Furthermore, since Poland issued the first sovereign green bond in December 2016, more countries have been entering the market. Sovereign GSS issuance grew from $10.7 billion in 2017, to $17.5 billion in 2018 and $21.8 billion in 2019, and reached $40.5 billion in 2020, according to data compiled by Moody's Investors Service and Environmental Finance. We believe that we will continue to see growth in issuance from governments and agencies well beyond the pandemic.

EF: How do you think this will change the landscape for the types of GSS bonds available and the use of proceeds that are being allocated?

AZ: We believe that governments will increasingly issue green bonds to fund climate mitigation and adaptation projects, as they work to combat the effects of climate change and meet their Paris climate agreement commitments.

That said, compared to corporates, these issuers are also more likely to issue labelled bonds that fund programs that are widely diversified, target many different goals and span multiple years. They are likely to cross many eligible categories – climate adaptation, clean water, biodiversity restoration, green transportation, unemployment reduction – to name just a few examples.

Trend two: The rise of sustainability-linked financing

EF: The rise of sustainability-linked bonds (SLBs) has been a key development for green debt issuance. What trends are you seeing in this space?

Benjamin CliquetBenjamin Cliquet, head of sustainable finance business development at Moody's ESG Solutions Group affiliate, V.E: 2020 was the breakout year for sustainability-linked instruments. The publication of the Sustainability-Linked Bond Principles and the rapid growth of the SLB market has placed a spotlight on their potential and attractivity as a sustainable financing approach. Amongst others, we provided pioneering SPOs for JetBlue the first airline to deploy a sustainability-linked loan (SLL), and Schneider's first sustainability-linked convertible bond.

Their cross-sector appeal is a key attribute. Since there is no need to identify specific projects or to ring-fence the proceeds related to these instruments, they are innately more accessible to more types of issuers.

In addition, because SLLs and SLBs do not focus on current absolute performance but rather on the improvement of it, they are also more attractive to issuers that may still be in the early days of their sustainability journey.

Given these attributes, in the mid-term, we can reasonably expect the number of sustainability-linked instruments to match the pace of traditional sustainable bonds and loans. SLLs and SLBs will also likely influence more issuers to improve their sustainability performance and to set quantified targets.

There are two related projections that we would draw attention to. Firstly, these instruments will likely become a key tool for companies with heavy environmental footprints to showcase and finance their climate transition strategy for the coming years. Thus, these issuances will provide an opportunity for external stakeholders to have a view on corporate climate trajectories and their alignment with the Paris Agreement.

Secondly, SLLs and SLBs appear to be complementary to sustainable bonds and loans: while sustainability-linked instruments provide a forward-looking approach of one issuer's strategy, the more traditional use of proceeds model enables them to highlight the concrete investments that will be made to achieve the targets.

EF: What are the risks and the practical challenges of supporting such engagements?

BC: It is not simple for all sectors to identify comparable metrics referring to highly material issues. So, the first challenge is of course for issuers to find the relevant KPI(s) to be included in the mechanism. In addition to this, setting quantified targets for the next five, ten years (or even more), and publicly committing on these, can be considered as both risky and complex. To date, at least in the SLL market, we have seen that banks have used ESG ratings as an easy solution; enabling them to cover a wide range of material sustainability issues in one shot.

Figure 2: Sustainability-linked loan volumes hit record $68 billion in Q4 2020

Trend three: Climate risk and resilience in the bond markets

EF: How does physical climate risk fit into the green bond conversation?

Natalie Ambrosio PreudhommeNatalie Ambrosio Preudhomme, director of communications at Moody's ESG Solutions Group affiliate, Four Twenty Seven: When it comes to floods, storms, and extreme temperatures the past is no longer an accurate representation of what the future may hold. When considering any infrastructure project, it is essential to take into consideration a forward-looking view of climate projections at the planned location of these projects.

This means leveraging the best available science to understand what the asset is likely to experience over the duration of its life cycle, in terms of inundation events, water stress, higher average temperatures and other phenomena, based on its location.

Alongside exposure, it is important to understand a project's sensitivity to these hazards, as a hydropower development would be more vulnerable to water stress for example, than a toll bridge which would be more disrupted by flooding. This is particularly important due to the long-life cycles and large capital investments in infrastructure projects.

Whether or not a bond focuses explicitly on a resilience project, to ensure that it remains operational and allows the issuer to repay its loan, it is important that the planning phase accounts for changes in extreme conditions and factors in the necessary steps to construct infrastructure that is prepared to withstand these conditions.

EF: What part can resilience bonds play here?

NA: Resilience bonds are a recently developed capital market instrument to raise money for adaptation and resilience projects. They are a specific type of green bond, and they require that proceeds must be specified for climate resilience projects. The Climate Bonds Initiative lays out Climate Resilience Principles explaining which activities qualify as resilience activities.

The need for climate-resilient infrastructure presents significant investment opportunity and resilience bonds provide an important vehicle to finance climate adaptation while fitting into the investment strategies of many large institutional investors and providing an attractive investment for those striving to integrate ESG factors into their portfolios.

The first resilience bond was issued by the European Bank for Reconstruction and Development (EBRD) in 2019. It was a five-year bond and was oversubscribed by $200 million showing the appetite for this type of investment. Proving the benefits of resilience is challenging because by definition a successful resilience project is about avoiding impacts on a community or project that may have otherwise occurred during an extreme event.

As more resilience bonds are issued, tracked and reported upon it will be easier for the market to quantify the value of resilience. As the frequency of climate change-driven events increases, it is becoming widely understood that investing to prepare for extreme events pays off significantly, compared to repeatedly repairing and rebuilding after the fact.

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Contact: David Delaney
Email: David.Delaney@moodys.com

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