How the energy industry can tap into the momentum of social bonds

AC Energy investment

European Union has issued its first social bonds, generating an impressive order book of 233 billion euros to boost employability and fight the negative impact that Covid-19 has had on our societies.

The offer was oversubscribed 14 times over, demonstrating how the market is underserved with a low supply of sustainable debt.

With these bonds most likely being the biggest debt sale ever, investors are waking up to the reality that there are immense opportunities for social bond frameworks. But if there’s a high demand for companies and borrowers that serve a social purpose, what could this mean for the energy industry? After all, green energy has proven a good investment as well, not just environmentally, but economically too.

By taking advantage of the current social bonds momentum, the European green energy sector could significantly strengthen its position. Here’s why.

Offer needs to match demand

First, why did the world’s largest social bonds offering see such high demand? For one, being issued by the EU, it carried the bloc’s premium AAA credit rating, making the bonds highly reliable. Being the EU’s first joint debt offering since it agreed to a pandemic recovery deal, the bonds were also highly awaited. But the fact that they were socially oriented is no less important.

The mass success also makes us realize that the EU could have sold not 17 billion euros of social bonds, but over some 200 billion directly. With low supply, there’s always the risk that investors could take their debt appetite elsewhere, no matter how green or sustainable their intentions might be. So, if the demand for bonds is out there, the offer needs to follow. For governments, this is a sign that private investors are more than ready to explore alternative bonds – including those benefiting the environment.

A green bond is a fixed-income instrument designed specifically to support specific climate-related or environmental projects. While the green bond market only makes up around 4% of the global bond market, it’s not because there’s a lack of interest. On the contrary, it’s not uncommon for capital providers to experience frustration due to the lack of “green papers”. And investors who aim for a specific part of their portfolio to be green can struggle to meet this goal. That’s why it’s key for both governments and green debt issuers to step up and meet the demand.

Drive trust through commitment to taxonomies

Green bonds are no different from conventional bonds; the only unique characteristic is the specification that the proceeds are invested in projects that generate environmental benefits. Moody’s recent projection says that the total issuance of green bonds worldwide could grow to between $175 billion and $225 billion by the end of 2020.

However, while the first green bonds were issued by the World Bank back in 2009, mobilizing capital to advance sustainable solutions has traditionally been difficult. The assets were considered new and bankers lacked familiarity with how to underwrite them or assess their risk, some of the assets weren’t considered investment-grade, and the categorization of green investments wasn’t widely recognized or understood.

In the current EU’s social bond framework, transparency is a significant differentiator, with the targeted use of proceeds clearly defined, along with measurable impact reporting. Any green bonds should therefore provide a similar level of trust. Among other things, this can be ensured by showing a clear commitment to alignment with the EU taxonomy on sustainable finance – rules ensuring that investments do not prop up pollution.

For example, the UK government recently announced that it would issue its first green bonds to fund investment in tackling the climate crisis and post-pandemic recovery. The bonds will finance projects aimed at energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, clean transportation, clean water, and much more.

In addition to these bonds, the UK will also seek to implement a green taxonomy that would provide a common framework for determining which activities can be defined as environmentally sustainable, building on the EU’s on-going efforts. There will also be a new UK Green Technical Advisory Group to ensure the approach is fit for purpose for the UK market. This will help institutions to robustly classify what they mean by green to help both firms and investors.

Not social, not green – but sustainable? 

Social bonds were first issued in 2006 with the aim of increasing vaccine supplies in the world’s most disadvantaged countries. Up until recently, the social bonds market remained considerably smaller than the green bond market, with issues amounting to $13 billion in 2019.

However, this year saw the tables turn. With the Covid-19 pandemic, the rise of eco-friendly debt has slowed down, and the focus has turned toward urgent social issues such as employment and healthcare. As pushing for green bonds might be more difficult in the current climate, there’s a prospective solution on the horizon. Instead of social or green bonds specifically, how about introducing common sustainable bonds?

Luxembourg has, in fact, recently taken this path and managed to raise over 1.5 billion euros. The debts present a blend of both green bonds to finance environmental projects and social bonds with socially beneficial outcomes. The proceeds will be divided equally between these two. This is the perfect solution that brings environmental goals back to the forefront and ensures that both short-term and long-term societal goals are met.

The European Union has a unique opportunity to incorporate both social and green bonds into its recovery packages. In order to pave the way for more green bonds, the issuers need to go beyond expanding the offer and championing transparency. By finding the right balance between social and green, sustainable bonds could not only build a path toward a better future but attract a broader investor base at the same time.

By Radoslav Stompf, CEO of FUERGY