In 2006, Muhammad Yunus received the Nobel Prize for making microcredit great. It was not the Nobel Prize for Economics, but the Nobel Prize for the most prestigious category: Peace. It made it clear that the Nobel Committee recognized that Impact Investment matters. Lending money to small private businesses can be a way out of poverty for people. Doing good with “business” financing. Today, microcredit is under the microscope because it has grown from a social investment method to a money-making machine.
Borrowing money from investors by private companies is as old as there are banks. There are different forms, the largest and publicly available form being bonds. The total global bond market is estimated by the OECD at USD 600-800 billion in 2018. An interesting development has emerged in recent years: There is a rapidly growing investor interest in impact investing (more on this in article 2 of this series) resulting in companies borrowing money from investors to improve their Environmental, Social and Governance (ESG) performance. It’s called Green Bond or Social Bond and it’s big. In 2019 alone, a value of USD 257.5 billion was spent globally, estimates suggest it will reach over USD 1 trillion by 2020. Truly what we call “marco lending. And different from early microcredit because it is not a social investment but an impact investment with low risk and return.
Development of COVID and Bonds.
There are several types of Impact Bonds. The most common are Green Bonds: a loan to an organization for environmentally beneficial investments. In addition to Green Bonds, there are Social Bonds, Social Impact Bonds, Sustainable Bonds and even Sustainable Development Goals (SDG) Bonds. The common denominator of these types of bonds is to do good and earn a return. The outlook for 2020 shows a sharp increase in the number and value of Green Bonds and a slight increase in Social Bonds, while Sustainable and SDG Bonds are considered smaller.
COVID-19 was a disruptor in many ways. While the growth of Green Bonds continues to grow rapidly, Social Bonds rose to unprecedented heights and are growing in double digits. Many government issuers are trying to finance their social policies with bonds. From the private sector perspective, companies are following with Google (Alphabet) issuing a record $5.75 billion in Sustainable Bonds in August 2020. CFO Ruth Porat quoted from her blog, “Google’s products have improved the lives of people around the world and the proceeds of this Sustainable Bond are intended to do just that.”
Medium-sized companies and their Bonds
Although values are high, the number of Green and Social Bonds is relatively low. In 2019, there were 1,788 Green Bonds from 496 issuers worldwide, according to the Climate Bonds Initiative. An issuer’s credit rating seems to be the key: with a BBB or higher rating, this type of financing is suitable for an organization. Large issuers are (semi-)governmental institutions, which have high credit ratings.
But things are changing. Smaller companies are starting to issue Green or Social Bonds of <EUR 10 million. Since large institutional investors are not really interested in bonds <100 million EUR, other investors and financing types are entering the bond markets. It is still small in terms of capital, but the yields are higher (as are the risks). We see this as a positive trend, many medium-sized companies are seeking investments for a sustainable transition. This should be promoted not only for financial growth ambitions, but also for the sustainable transition that impact investment enables.
Polishing a business
Issuing an impact-oriented bond that says you are ‘doing good’ with the funds received, while in execution, driven by the bond, less positive social impact is created. This is referred to as “greenwashing,” “social washing” or “SDG washing. Read more in article 3 of this series. The Dutch Financial Authorities (note: the Netherlands ranks No. 5 in the global Green Bond market) warn about these washing practices in their recent report. As the market grows and does not mature at all, this is what worries all investors and regulators the most. How can you be sure the yield is really “doing good”?
The previously given example of Alphabet’s Sustainability Bond meets the Green Bond Principles 2018 and Social Bond Principles 2020, such standards can answer whether the bonds are really “doing good. The future seems to be defined by the EU Taxonomy, an advanced set of rules and standards that will enable transparency on sustainable finance and will likely be used outside the EU. This will not solve the problem of ‘polishing’. It will only give you soap. Investors and issuers need to use the soap correctly.
Part of transparency is verifying green or social claims. An issuer must prepare, not just on paper, but in reality, for a solid ESG process and use of proceeds. A third party conducts an assessment of ESG processes and use of proceeds. This can be seen as a light version of an external audit. Based on the information provided by the issuer, an assessment of a bond is performed, which gives an investor more assurance that no “polishing” is taking place. All this will lead to the maturing of the Green and Social Bond markets, which is especially necessary for medium-sized companies looking to enter the market.
Source: Deschryver & De Mariz 2020
Why would a company issue Green or Social Bonds?
It seems more hassle to issue a Green or Social bond than a regular bond. An organization must prepare by establishing a strong ESG process, ensure that the proceeds are indeed used for green or social purposes and report on the impact once the bond is out there. Research shows that communicating about the sustainable efforts of both an issuer and an investor leads to a better reputation. And a better reputation leads directly to better company performance in all aspects.
High performing ESG companies outperform their competitors as we have seen in Article 1 of this series. The ESG performance of an organization issuing a Green or Social bond is generally high. This can only lead to a better performing company while doing well with corporate finance.
This article was previously published at: https://www.duurzaam-beleggen.nl/blog/impact-investing-how-corporate-green-and-social-bonds-lead-to-a-high-esg-performance/
About the authors:
Martin de Jong is founder of Empact, impact consultancy and works for (international) clients in the field of Social Strategy, ESG and Impact Valuation. He is former Director of Social Value VodafoneZiggo and Sustainable Business Manager Vodafone PLC. He is a guest lecturer at several universities on sustainable business.
Anne Rademaker is founder of Rademaker Consulting and works with strategic partners (both public and private) to accelerate the transition to a global circular economy. Anne works with Martin for Empact’s ESG & Impact clients. She is a former Senior Consultant at EY with extensive knowledge in Finance, Risk and Process management.