VP Bank : Rapidly growing market for bonds with an impact

Investor awareness of sustainability has grown exponentially in the past five years. The major rating agencies have taken note of this development and are satisfying the need for more in-depth insight by appraising issuers according to environmental, social and governance (ESG) criteria. With that information in hand, many investors also stipulate specific exclusionary criteria. Depending on the degree to which these factors are accounted for in the portfolio, its structure need not differ significantly from the way it was before.

For some investors, this process may be sufficient - but perhaps not for others who are resolutely focused on sustainability yet want their investments to generate concrete, measurable and sustainable benefits to society and the environment. The aim of these investors is to bring about change at companies. This is a difficult quest in the stock markets since companies normally do not pursue just one sustainability objective. But the situation is different when it comes to the issuers of fixed-income securities. In this area, a steadily growing array of new solutions is being designed explicitly to fund and realise sustainable projects. In the following, we introduce you to this universe and describe how green, social and sustainability bonds work.

"ESG" versus "impact"

Bond prospectuses not only address matters such as collateral and seniority ranking, but also the intended use of the proceeds. The latter, a clearly defined purpose clause, represents the heart of impact bonds, as it specifies that the money raised from such issues will be used solely for the funding of sustainable projects.

Depending on the nature of the various projects, different market segments with their own designation have emerged, for instance "green bonds" that are devoted to renewable energy sources. Most issuers of these bonds voluntarily adhere to the governance and reporting practices prescribed by bodies such as the International Capital Markets Association (ICMA). Nonetheless, investors need to ascertain whether the project objective(s) described in the offering prospectus are in line with their personal investment philosophy.

From an investor's point of view, the question naturally arises as to what would have happened without their investment? Would a company with an otherwise good ESG rating have acted in the same way after issuing a traditional bond as opposed to an impact bond? The so-called "additionality principle" applies here: impact investments not only effect something; they also provide the impetus for it. It follows that impact investors provide the fuel for sustainable change.

Yield still plays a role

The returns that can be expected from impact bonds range from the going market yield on traditional bonds, to what in effect is roughly equivalent to an asset-diminishing donation. So it should come as no surprise that investments made with a financial goal in mind, but which at the same time take environmental, social and governance (ESG) criteria into account, are particularly popular among investors.

Earning a reasonable yield and "doing good" are not necessarily mutually exclusive aspirations. However, the more intently an investor focuses on the actual impact (i.e. the goal), the more the related investment takes on the character of financial aid or even a charitable donation. It follows that the blended approach - i.e. making an impact without sacrificing yield - is currently the primary driver of growth in this market.

Categorisation of ESG/impact bonds