Green and social bonds: what s at stake for investors?

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1 Green and social bonds: what s at stake for investors? Written on 29/09/2014 Hervé Guez, Director of Responsible Investment Research Emmanuelle Ostiari, SRI analyst Marc Briand, Head of Fixed Income Chris Wigley, Senior Portfolio manager EXECUTIVE SUMMARY As the market for green and social bonds takes off, attracting ever more attention from the financial community and from agents engaged in promoting the development of a more sustainable economy, we intend to revisit some larger questions that this market raises. How far along have we come in the market s development? What controversies does it provoke? What is valuable about this market and how should we be thinking about its future development? I. Green and social bonds have carved out a place for themselves in the fixed-income market Indeed, by the end of August 2014, the total issuance for the year was close to USD 20 billion, 1.6 times that of 2013, which was itself more or less a threefold increase compared to the birth of this market in A green or social bond is one that, in addition to its usual characteristics (maturity, coupon, etc) is designed to finance projects that offer environmental and/or social benefits. A market experiencing vigorous growth in many directions The year 2013 was full of questions raised by the rising tide of green and social bonds or sustainability bonds. Was the market witnessing an exceptionally good year or the start of a sustained trend? This autumn, as the harvest gets underway, 2014 promises to be an excellent year and appears to confirm that green and social bonds are here to stay, creating a new sub class within fixed income. The market for green and social bonds has more than tripled in a few short years Obviously, despite this impressive growth, green and social bonds represent only a minute part of all bonds issued at the moment (less than 1% of the bond market). Nonetheless, qualitative indicators beyond this sustained growth encourage us to believe that the trend is likely to continue. 1

2 Figure 1. Total number and value of sustainability bond issues greater than USD 200 million, as at 31 August 2014 Source: Mirova / Natixis Global Market Research, First, 2014 was the year that corporate issuers arrived in full force. Whereas the market had previously been completely dominated by supranational organizations, development banks and international agencies, corporate issuances, which first appeared in 2013, grew from 17% to reach nearly 50% of the global volume of bonds issued at the end of August, Figure 2. Distribution of sustainability bonds greater than USD 200 M by issuer type as at 31 August 2014 Source: Mirova / Natixis Global Market Research,

3 Another interesting feature of the market s growth has been the noticeable increase in social bonds. This remains a narrow market segment, however, the last few months bear witness to a significant inroad made by bond issues with a social impact. While 2014 was a year for tremendous growth in the green bond market, there remain several steps if this success is to continue It is fair to say that the market for green and social bonds achieved a number of breakthroughs in 2014, however, the chapter is by no means closed, and, beyond increasing volume, there are several steps needed for this market to realize its potential. As we see it, there are four significant challenges ahead: i) ensuring more corporate bonds with a broader variety of ratings (BBB and HY issuers); ii) attracting more North-American and Asian issuers; iii) fostering activity by sovereign issuers, and iv) growing the number of issues by current issuers in order to produce meaningful issuer yield curves. consisting of agencies and supranational organizations, and the second corporate bonds). Well aware of this momentum, service providers are also developing dedicated products and services. Hard on the heels of S&P Dow Jones, MSCI and Barclays have announced the launch of their own Green bond indices. Meanwhile, extrafinancial ratings agencies are beginning to offer specialized services to supply second opinions. The Green Bond Principles (GBP), created with the intention of structuring the market, come on top of these many microeconomic aspects. Since clearly a green bond ought not to be classified as such on the say-so of its issuer, so the market needs a framework if it is to develop over time, and four banks 1 jointly published the GBP in January of Since then, the governance of this initiative has been broadened and strengthened. In terms of reinforcement, it will now come under the aegis of the ICMA (International Capital Markets Association). Its greater breadth takes the form of an executive committee drawn from three groups: banks, issuers and investors, with six members from each. The GBP now stand at 62 members in all, with several institutions (NGOs, service providers) granted the status of observers. Figure 3. Breakdown of GBP members by category The market takes shape The number of new issues remains the most visible indicator for measuring the size and momentum of a bond market. But it is worth remarking on how the market structure is evolving and contributing to a growing sense that green and social bonds are here to stay as an asset class in their own right. Looking first at the microeconomic level, the number of dedicated structuring and originating teams has increased. In Europe, this market was initially the exclusive realm of teams such as the SEB (Skandinaviska Enskilda Banken) and Crédit Agricole CIB, Merrill Lynch, etc. Today, BNP and HSBC have announced that they will be earmarking resources dedicated to this asset class. Such investments in human resources constitute a particularly strong signal. Investors, for their part, are also getting organized. In addition to Mirova, which, having been an important early supporter of green bonds in its fixed income funds, recently announced the creation of an open fund devoted to green bonds, Zurich Insurance has also positioned itself as a leading player with two portfolios of 1 billion each in green bonds (the first Source: Mirova / ICMA, Bank of America Merrill Lynch, Citigroup, Crédit Agricole CIB, J.P. Morgan Chase & Co.

4 The GBP aim to provide guidelines for what constitute the elements needed before a bond issuance can be considered Green, with the dual goal of helping issuers design their green bonds and assisting investors in evaluating the environmental impact achieved by such bonds. Rather than precisely defining the environmental impact sought, the GBP focus on the governance criteria a bond needs to use in order meet the definition of a green bond. This framework is structured around: - The types of credit instruments that can be considered green. In theory, the framework accommodates any type of bond; practically, however, most issuance has involved senior unsecured bonds. - The characteristics of the security, meaning: 1) a description of the use of proceeds that makes clear, as part of the bond s legal documentation, the types of projects eligible for funding, 2 2) an evaluation and selection process that applies to projects meeting the bond s eligibility criteria (examination and decision procedures, measures for determining impact, documentation required for verifying projects eligibility); 3) management of funds, including a dedicated portfolio or internal audit process for tracking funds, and an external auditor who confirms the veracity of the information reported; 4) disclosure, in the form of a dedicated annual report, of the projects and/or impact produced consequent to the bond issue, using quantitative and/or qualitative performance indicators; - The type of assurances such bonds should offer, such as an independent expert s second opinion regarding criteria for project eligibility and, more importantly, a third opinion, with this one being from an independent audit firm. This framework, designed to provide green bonds with a structure that will guarantee their credibility is supported by all members; however, implementation of these recommendations remains voluntary at this time, and the level of adherence to these guidelines varies considerably, including among GBP member organizations. Common sense suggests that this flexibility is warranted by the embryonic nature of the market, where players may have very different levels of maturity; thus pragmatism advises that we let time do its work, and regularly revise these principles indeed, a drafting committee, on which Mirova sits, has just been named within the executive board without doing anything to radically upset the market s momentum. But beyond the issue of adherence to the principles enumerated above, there are three concerns that remain all but absent from the GBP: - Defining what green is, and what is green. Here, given the complexity of the issue and lack of consensus on the matter, we do not expect much progress from the GBP in the immediate future. - What exactly can green bonds fund? Can external growth be financed using green bonds? Should issuers operating solely in the domain of renewable energy be subject to fewer requirements? And so on While it is difficult to secure a consensus on such issues, we believe that the GBP are in a position to offer guidance. - Lastly, the desired quality of reporting remains somewhat hazy, even if outlines have been sketched. Here again, progress could be made through the GBP. The credibility of this new market will depend on its capacity to reinforce its standards 2 Here, the GBP propose a non-exhaustive list of environmental categories, including renewable energy, energy efficiency, waste management, sustainable soil management, protection for biodiversity, clean transport and management of drinking water. It is clear to see that the credibility of this new market will depend on its capacity to offer satisfactory responses to these questions. It is equally clear, in light of current debates on the subject, that a broad consensus on these topics is not likely in the immediate future. Nonetheless, we believe that in order for a consensus to appear, debate there must be, and that

5 participants need to take a stance on these issues, even though this means adjusting their positions as their experience increases and the market evolves; only then can a consensus coalesce around shared principles, ideally taking shape as a label. II. Mirova s current position Concerning these three central questions, namely, how to assess the green qualities of projects, the possible objects of allocation, and the desirable quality of reporting, Mirova offers the following analysis. activity itself represents a significant risk to sustainable development. 2. A review of ESG risks to determine each actor s responsiveness to the ESG issues raised by the way they do business. This evaluation is made on a three-point scale: Positive, Neutral, or Risk. Figure 4. Indicative matrix of the elaboration of the Mirova Sustainability Opinions A methodology for evaluation consistent with Mirova s overall approach to measuring the environmental and/or social contribution of an investment For Mirova, Responsible Investment aims to achieve economic, social and environmental performance by directing savings towards the entities, initiatives, and projects that contribute to sustainable development. We are convinced that extra-financial dimensions constitute a crucial component of any investment strategy that aims to create value. Consequently, Mirova seeks first and foremost to identify entities or projects designed to seize opportunities associated with the transition of our economy toward a more sustainable society, while ensuring that potential environmental, social and governance (ESG) risks are taken into account. This philosophy is implemented as a two-tiered ESG evaluation: 1. A review of opportunities designed to determine how well an activity (product service, project etc.) meets the challenges of sustainable development. The level of exposure is calculated in terms of the environmental or social benefits an activity presents in comparison to a business as usual scenario, and is expressed using a four-point scale: high exposure, significant exposure, low or no exposure and negative exposure. Negative exposure occurs, for instance, when the nature of the = Source: Mirova, 2014 This matrix (Figure 4) provides a five-point scale (Figure 5) that runs from Committed down to Negative and forms the basis for Mirova s sustainability opinions. A methodology for evaluation with two distinct levels: one to identify sustainable development opportunities and another to assess ESG risks

6 Schéma 5. Opinions Développement Durable Mirova Source : Mirova, 2014 This methodology is applied, with suitable adjustments, for each of the asset classes Mirova manages, including equities, fixed-income securities and infrastructure. Applied to green bonds, this evaluation framework would ideally analyse the underlying projects, making no exclusions a priori as to issuers, except as concerns those in flagrant violation of the fundamental principles of the Global Compact and OECD s Guiding Principles. 3 In practice, the current levels of documentation for green and social bond issues do indeed allow us to analyse the environmental and/or social benefits of underlying projects using our in-house grid (presented below). However, the information provided at this time does not make it possible for us to judge how the environmental and/or social risks associated with underlying projects are handled. In the absence of data specific to the project, the risk review segment of the analysis will rely on information concerning the issuer s management of risk. Thus our evaluation of green and social bonds has two components: on the one hand the anticipated contributions to sustainable development from underlying projects, and on the other a review of ESG risks, primarily those of the issuer. 3 OECD Guidelines for Multinational Enterprises. Environmental and/or social benefits ensuing from the use of proceeds Evaluating the environmental and/or social benefits associated with the projects underlying green bonds obviously requires transparency as to the use of funding and clear, verifiable, criteria for determining projects eligibility to receive financing. Once an issuer publishes information about a project, the first task is to review how well its intended goal meets the challenges of sustainable development. The analysis of a project s contribution must address the following concerns: - Which sustainable development issues does the project offer solutions to? - Will this project have a significant impact on the sustainable development issue it aims to address? - Does the project really go beyond business as usual practices? The intent here is to determine to what extent underlying projects offer sustainable development solutions. Mirova s opportunities grid considers six challenges: climate change, resources, pollution, biodiversity, health, and development. Each project may address one or several of these basic sustainable development challenges.

7 Figure 6. Examples of «sustainability opportunities» by sector Energy Mobility Buildings and cities Resources Consumption Healthcare Finance ICT Climate Change Resource Pollution Biodiversity Health Development Renewable energy (solar, wind, hydraulic, biomass, geothermal energy) Energy efficiency (in industrial processes) Access to energy for the most disadvantaged population Technologies of CO2 emissions reduction (ex: carbon capture and storage) Green Mobility (electric, hybrid, fuel cell electric vehicle, lightweighting, low rolling resistance, solutions to reduce pollution relative to mobility such as Nox, Sox, PM10, oceans acidification, etc.) Alternative mobility to road/air transportation (ex : rail transportation, maritime, bicycles, metro, train, carsharing) Access to mobility for the most disadvantaged population (development of transportation means) Eco-efficiency of buildings Sustainable infrastructures and cities (design, construction, environmental services) Social infrastructure (health, education, etc) Access to housing for the most disadvantaged population Sustainable agriculture and forests (improvement of agricultural productivity with reduced environmental impacts, bio-based economy) Water security (water supply and sanitation, agricultural and industrial water-use efficiency, universal access to drinking water) Other resources productivity (waste reduction and recycling, etc) Offers of specific products improving quality of life for all (food, hygiene, etc) Eco-products / eco-services Healthy products Access to healthcare for the most disadvantaged population Unmet medical needs Autonomy and quality of life (ex : home care) Access to financing solutions for the most disadvantaged population Green investments (ex :financing of renewable energy projects) Enabling sustainable benefits (smart technologies, access to health) Green ICT Access to ICT for the most disadvantaged population Source : Mirova, 2014

8 For each bond, all the projects identified are reviewed in light of these six issues. To be considered a green or social bond, the underlying projects must meet the following conditions: - Have at least one Significant Exposure rating for one of the issues, that is, offer demonstrably improved practices that exceed business as usual, as well as a positive impact in the area under consideration. - Not exhibit negative exposure to any of the six issues. We hope to enrich this basic framework for analysis as our knowledge and expertise of the standards and best practices prevailing in each sector progresses. A continuous learning and adjustment process is crucial if this new financial vehicle is to establish credibility as having genuine environmental and social value. Green bonds have ESG risks too! Every project, every activity, however beneficial it may be with respect to the challenges of sustainable development, carries with it negative social and environmental externalities that vary over the course of its life cycle (supply chain, development, construction, operations, end-of-life). As we see it, responsible investors should be taking these risks into account. Where green and social bonds are concerned, current documentation practices, unlike those prevailing in the area of infrastructure finance, do not make it possible to determine as precisely how environmental and social risks associated with underlying projects are handled. For lack of this information, we rely on available data on the issuer s handling of these risks. On the assumption that if an issuer is responsible about controlling for potentially negative social and environmental externalities in its activities overall, there is a strong chance that the projects underlying its green bond will be at least as well managed as the balance of its activities. Nonetheless, some best practices stand out. We could point to the EDF s green bond, which finances only projects that respect a specific set of criteria established by Vigeo in order to guarantee the responsible management of projects. These include taking into account health and security issues affecting employees, management of relationships with suppliers. In this way, beyond the intent of the underlying projects (renewable energy), which contribute to the energy transition, the issuer provides investors with assurances that social and environmental externalities are taken into account. However, this level of detail remains a rarity for the moment. Also, there remains, beyond concerns regarding how environmentally or socially beneficial a project is, the question of what kind of projects may be financed. Use of proceeds From investor s point of view, the function of this market is to provide an opportunity to contribute to the ecological transition, by providing the capital necessary to the development of business models offering social or environmental benefits. Such rational altruism seeks to ensure that our model of development becomes sustainable by transforming its core, convinced that this is the only way to guarantee long term returns and, thus, to stabilize long term liabilities. From this perspective, there is, beyond the green or social quality of the underlying project, an additional question, which is the nature of the project; and this, it seems, presents itself in somewhat different terms for a creditor than it would for an equity holder. When one purchases shares in a business concern, it requires one to take a global approach to social and environmental analysis. After all, one becomes the owner of indivisible portions of the company and responsible for both its assets and its liabilities. A creditor is often in a somewhat different position. When an issuer uses the market to raise debt capital for general corporate purposes its creditors are in the same position as shareholders: there is no alternative but to consider the environmental and social qualities of the issuer in their entirety. Such an approach inevitably results in placing offlimits certain companies present in the equities and bond markets. Regardless of the methodology employed assessment is inevitably based on comparison, and almost every SRI approach entails some exclusion, whether this is done ex ante or ex post, on a sector basis or based on normative criteria. The great strength of the green bond concept is to tie investment to specific underlying projects. Thus, no company is left out in the cold, as long as it has a viable project for transformation to offer the market. The counterpart to this inclusiveness is a stringent demand for clarity as to the use of proceeds to finance investments that induce the promised transformation. And, as we know, capital markets are quite simply organized to ensure that debt instruments are as fungible as possible. Green and social bonds are at odds with this attitude, since their function is to bind together financing and investment. One might summarize the rational of this market as follows: using green debt to finance green or social assets. The corollary of this principle is that there cannot be more green or social bonds than there are 8

9 green or social assets on the issuer s balance sheet, meaning that such bonds may not be used to cover operational losses, share buybacks, or to refinance existing debt, even if such losses, shares or debt were to belong to green or social companies. The great strength of the green bond concept is to tie investment to specific underlying projects. This consideration of asset/debt relations is also interesting insofar as it applies also to the financing of green or social debt that can be securitized. While practically non-existent at this juncture, we expect a bright future for this market in the coming years. Financing the ecological transition also means financing the investments of consumers, especially assets like homes and vehicles, which are often the leading items of both their household budgets and carbon footprints! Consequently, there is every reason to expect financial solutions, such as mechanisms to refinance debt associated with energy-efficient renovations, a major environmental concern if ever there was one. Clarity of the dedicated reporting scheme The most controversial issue is probably the possible financing of green goodwill using green debt. For instance, is it acceptable to use green bonds to finance the acquisition of a renewable energy manufacturer? Issuers are tempted to answer in the affirmative. From their point of view, a euro, whether allocated to organic or external growth, involves much the same process: what difference is there between investing in the construction of a wind farm and buying one that s already built? Only the question of financial profitability, based on a firm s internal technical competencies will determine the best choice. However, it is perfectly clear that for society at large the difference is considerable. In the one case new capacity is created, while in the other, there is simply a change in capital ownership. In one case it is possible to objectively identify gains compared to a reference scenario, while in the other there is no change in the scenario underway. For this reason we do not believe that green debt should be used to back green goodwill. This does not close all doors to the possibility of refinancing green assets as part of external growth: however, only unamortized green assets can be backed by green debt, not goodwill, which is merely a financial return collected by the original capital investors, and not a new investment. One might object that the acquisition price in fact reflects the new value of these assets, and therefore goodwill should be eligible for refinancing under principles that combine backing green assets and debt. To this, we respond that i) from a theoretical perspective, goodwill is a residual ensuing from an acquisition, thus cannot be attributed to an asset ex ante, and ii) in practical terms there has been no end to the number of cases in which goodwill has suffered accelerated or sudden impairment because it failed to demonstrate ex-post justification. Even the greatest mastery of these elements, from the quality of environmental or social components, to the traceability of projects funding, is to no avail if lacking a high degree of transparency and gestures of commitment on the part of issuers, and this at several levels. - Eligibility criteria: transparency as to the evaluation of projects environmental and/or social quality, consultation with independent experts and third party assurance of veracity. - Traceability as to use of proceeds - Reporting on outcomes: regular updates (at least annual) on the projects actually financed with proceeds, including the capital allocated to each; qualitative and quantitative performance indicators for measuring the real impact of investments with respect to sustainable development goals (for instance, tonnes of CO 2 avoided by a green bond, number of individuals gaining access to a health service for a social bond etc.), and third party assessment confirming the veracity of information provided. To take an example, Nordic Investment Bank (NIB) publishes a complete list of each and every project financed through its green bonds, and updates this inventory every time a project is added. Information provided includes the goal of the project, its 9

10 duration and the companies participating. A separate list tracks the CO 2 emissions avoided yearly thanks to these bond issues. This level of transparency concerning project funding, which still rare today, is essential for maintaining the value-added of sustainability bonds for investors, which resides in the measure of impact that they offer. Each of these elements contributes to the establishment of a credible market, and is thus championed by Mirova in all our exchanges with issuers, although they are not qualifying features per se in our analysis process at this time. This is a requirement whose stringency will evolve alongside our experience and observation of best practices. These requirements are not, in fact cumulative, and are assessed globally. We recognize that reporting elements of this type can be onerous and time consuming to set up for issuers. In order to lighten this load to a strict minimum at issue, we encourage companies to move toward an integrated reporting model (cf. the Integrated Reporting Initiative, to which Mirova is also deeply committed). Such a model would make it possible to fairly easily provide, as an appendix to the report, a detailed description of green or social assets and liabilities. If issuers committed to ensuring that such liabilities do not exceed assets, investors would doubtlessly be significantly less demanding concerning segregated accounting, second opinions and ex ante descriptions of projects, as secure in their certitude that all significant information would be available ex post as part of the audited and certified annual report. III. What makes this market attractive? To be sure, contributing to a more sustainable economy ought to be a sufficient goal in and of itself. After all, without a sustainable economy we are constantly facing the risk of a Collapse, to borrow the title of Jared Diamond s work, which would, de facto, result in severe losses for all economic agents. By investing in and for a sustainable economy we help to ensure long term prosperity for all, something that ought to be worth a few short-term opportunity costs by way of a tradeoff. Absolutely. However, we believe that the outcome of this short versus long-term cost/benefit calculation can and should be reinforced by creating a market infrastructure based on a win-win approach. This is possible because the economy is not a zero-sum game (even, or rather especially, when the time dimension comes into play), which is just as well, because however mistaken and dangerous it is to design a market theory based entirely on greed, it is delusional, and likely just as dangerous, to try an found it on altruism alone. Human nature being what it is, it is better to design incentives that attempt to reconcile and overcome our contradictory tendencies, rather than ignore them. But before we come back to the mechanisms that might allow us to resolve these contractions, let us consider what interests this market holds for its two principal participants: issuers and investors. The market s appeal from an investor standpoint To date, the green and social bond market seems to offer nothing but upside from an investor perspective. Issuers have more or less entirely abandoned the idea of structured products with variable coupons contingent on environmental or social goals, and have largely floated vanilla instruments on the market. Returns are determined by the overall credit rating of the issuer. Thus investors receive the same rate of return, for a given issuer, whether the bond is green or social or neither. This explains why these issues have met with such great success; outside the space of SRI investors, conventional investors also subscribe on the basis of ordinary risk/return calculations. While especially high levels of demand at issuance can sometimes create a slightly less attractive spread than traditional bonds exhibit, its effect is generally minimal, with little impact on their overall yield. Thus we are currently witnessing the development of a market that offers investors environmental and social benefits without sacrificing financial returns. To an issuer-by-issuer analysis, it is worthwhile to add an overview of the market as a whole. The underlying question remains: if, as an investor, I allocate part of my holdings to this new asset class consisting of green and social bonds, what is likely to change about the overall return I can expect from the bond markets? The following snapshot, which we offer here in response to this question, dates from 15 September, and is presented by way of example only. In addition to changes in general market conditions, we have already made clear that the market for sustainability bonds is rapidly evolving, and that we should expect the snapshot we might take a year from now to look extremely different. These precautionary statements notwithstanding, it is interesting to compare the financial characteristics of the current supply of green and social bond issues greater than 10

11 USD 200 million with those of traditional indices. The result shows a very marginally lower return for green and social bonds (1.46%) as compared to the iboxx Overall index (1.54%), due to an average maturity that is significantly lower (5.38 years versus 6.96 years). Figure 7. Financial characteristics of the iboxx Overall compared to green and social bonds The portion of this market issued by development banks and agencies shows characteristics similar to the iboxx Supra, which is to say, much like the returns offered by AAA issuers in terms of credit rating. This is unsurprising, given the significant overlap among these issuers at the moment. More interesting is the non-financial corporate component of green and social bonds. We arrive at an average rating of A in terms of credit rating, and thus a relatively favourable financial profile compared to the comparable iboxx ratings class, as corporate green bonds have a high proportion of utilities that are relatively highly rated. Their yield is significantly higher, as compensation for a longer average maturity. This longer horizon is likely influenced by the duration of the underlying projects the credit serves to finance. Figure 9. Financial characteristics of iboxx Corporates index and the corporate portion of green and social bonds Source: Mirova / Natixis Global Market Research, The financial characteristics of green and social bonds are somewhat different from those of a broad based investment grade bond index. The dissimilarities can be attributed to the current profile of the sustainability bond market, populated almost entirely by development banks, agencies, and only very recently, corporations. Figure 8. Comparative profile of securities in the iboxx Overall vs. green and social bonds Source: Mirova / Natixis Global Market Research, For an investor, the green and social bond market does indeed have a distinctive issuer profile, though this is changing daily, but offers financial characteristics that are very similar to those exhibited by the bond market as a whole. The appeal from an issuer standpoint Because the issuance of green or social bonds does not currently reduce financing costs, it may seem surprising that issuers would commit to the substantial constraints associated with such bonds in terms of internal organization, reporting and consulting simply to raise funds they could have obtained on the conventional market by offering similar yields, without all the hassle. Source: Mirova / Natixis Global Market Research, If not financial motives, what does drive issuers? First of all, beyond the mere image aspect, issuing bonds with environmental or social characteristics sends a signal regarding commitment to sustainability that is more concrete than publishing a sustainable development report. Of course, it would not do for these specialized issues to let us ignore the other kinds. To this effect, there might be a way to 11

12 encourage development banks to adopt a methodology whereby they only issue sustainability bonds, which would be consistent with their mission. The second motive, while not strictly financial, involves a calculated effort on the part of issuers not to cut themselves off from certain investors. SRI investors employ environmental and social standards, and thus sustainability bonds are a way of attracting investment to fund specific projects that a company would not have been eligible for with a general corporate purpose issue. Thus, while certain investors do not wish to finance nuclear power or fossil fuels, issuers with a presence in these sectors may still be able to reach out to them by offering such investors an opportunity to finance only the company s development of renewable energy. Some observers have criticised green bonds for this very reason, saying they might become a means for certain players to secure SRI financing that they would otherwise not be eligible for. We disagree. First of all, the reasoning doesn t apply to equity funds, for which project finance is irrelevant. Secondly, because if green and social bonds work for these issuers as for any other, this will eventually translate in the market as a difference in financing costs. Capital that can be raised from the entire pool of investors becomes less costly than financing that can draw on only a subset of them. If so, the market will have accomplished its fundamental role: it will assign a price (indirectly and not directly as does a Carbon Exchange) to social and environmental benefits. By reducing the cost of financing green and social projects, this process will lower the profitability required of them as compared to other types, thereby contributing to the development of a sustainable economy. Rather than fret about possible negative effects, socially responsible investors should be doing everything they can to support the healthy development of this market; the more it grows, the greater its positive impact on the financing costs for projects of social and environmental benefit will be. where possible, the social and/or environmental benefits resulting from the underlying projects. Issuers, on the other hand, may be reluctant to incur large additional reporting costs. True, the market appears to have found an equilibrium point at the moment: brand image benefits for both parties, financing costs that are identical or even slightly lower, along with reporting costs that are manageable for issuers, while investors receive yields around those of conventional bonds. This equilibrium makes us comfortable assuming that the market will continue to grow. However, it is not impossible that this growth may produce large spreads when green or social bonds are issued, or that the bond curve may come to favour issuers of this type of bond. We are by no means there yet. But it is possible, right now, to design a market infrastructure that would allow us to overcome this easily anticipated obstacle and accelerate the market s development. Since, green and social bonds contribute to the general interest by reducing systemic risks such as climate change, it seems appropriate that regulations, notably the Solvency Directive, move to treat them more favourably. By aligning the interests of society, those of corporations developing green or social projects, and those of socially responsible investors, new regulatory mechanisms would help to create a market infrastructure strongly tipped in favour of green and social bonds, and thus toward a multiplications of the investments they finance. Of course, such a programme cannot be envisaged without significant strengthening of market standards for the evaluation of environmental and social benefits; this could ultimately lead to a recognized label. Is there a need for investments in transformation? Are there financing issues at hand? If established on firm footing, the green and social bond market can become an essential tool for financing the energy transition; and for this reason we predict that both its future and our own look brighter every day. Moving towards a win-win situation To place issuers and investors head to head is to invite a confrontation between contradictory attitudes. Issuers are hoping for their green or social projects to be financed at a lesser cost than other kinds, whereas investors are looking to hold out for comparable returns. Meanwhile, investors make considerable demands in terms of reporting in order to forestall the risk of weak issuance through due diligence procedures. The most demanding among them ask issuers to quantify, 12

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