An introduction to the GSS+ bond market for sustainability projects

May 16, 2023
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In 2008, the World Bank issued the first “green bond” to support the financing of projects addressing climate change.

In 2008, the World Bank issued the first “green bond” to support the financing of projects addressing climate change. Such bonds belong to a category called “thematic bonds” which are fixed-income securities to raise funds for activities related to a specific theme, for example, green, social, gender or sustainability. At the COP 27 meeting in Sharm El-Sheikh, Egypt in late 2022, the Independent High-Level Expert Group on Climate Finance (IHLEG) report called for external funding of at least $1 trillion annually for climate mitigation and energy transition in emerging countries. Thematic bonds is a financial instrument that public and private entities can leverage to mobilize resources for climate action.

Funding raised by the thematic bonds have different use requirements. Green, social and sustainability bonds (GSS) are “use-of-proceeds” bonds, meaning that the funding raised are earmarked for specific projects designed to generate the intended impacts. Sustainability-linked bonds, on the other hand, associate the funding to the commitment of the issuer to meeting predefined sustainability performance indicators. Sustainability bonds may be issued by entities of different characteristics, including sovereigns (countries), subnational issuers (e.g., municipals or public corporations), or private sector corporations. In 2017, the Massachusetts Bay Transportation Authority (MBTA) issued the first tax-exempt sustainability bonds in the US, motivated by the potential lower borrowing cost compared to conventional bonds.

The thematic bond market has expanded rapidly in recent years. In 2015, the total amount of annual issuance is 60 billion USD, and by 2021, this has grown to over 1.1 trillion USD (note: 2022 was a relatively muted year for thematic bonds since the annual issuance fell below the 2021 level). Green bonds account for over 60% of the total amount, and issuance by emerging markets account for only about 15% of the total. Corporations and financials account for a large percentage of thematic bond issuers, while the amount of bonds issued by sovereigns account for only about 11% of total issuance, although the interest is growing among sovereigns. According to ICMA’s Sustainability Bonds Database, as of April 2023, there are over 800 issuers of green bonds, about 140 issuers of social bonds, 250 issuers of sustainability bonds, and 90 issuers of sustainability-linked bonds.

The World Bank conducted two surveys in early 2022 to gauge the interest of sovereign bond issuance in emerging markets. 75% of the surveyed countries are considering and preparing for thematic bond transactions in the near future, with the primary reason being the diversification of the investor base while the main deterrent is the costs and institutional capacity associated with issuing a thematic bond since these instruments require setting up governance processes that are different from conventional bonds. The investors agree with the sovereigns that these thematic bonds provide signals of a country’s commitment to climate goals and can also motivate other non-sovereign issuers. Clients who have a preference for thematic bonds may also be willing to pay a premium for these securities. The standardisation of taxonomies and regulations have helped to enhance the credibility of the market.

Sovereign thematic bonds seem to enjoy popularity from investors and have a market premium compared to conventional bonds. The sovereign green bonds issued by Egypt, Mexico, Serbia and Hungry all had a negative new issue concession of high single digit basis points at launch. Colombia issued a thematic bond and a conventional bond with the same features at the same time, and its 9.5-year sovereign green bond priced 7 basis points lower than conventional bonds at its launch and 15 basis points in its reopening one month later. Sovereign issuers also report strong demand from investors, providing them the opportunity to diversify and expand their investor base. In January 2023, several sovereign issues have already taken place by Hong Kong, Slovenia, Ireland, India and the Philippines.


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