Sustainability bonds can be loosely defined as bonds where the proceeds will be exclusively applied to finance or re-finance environmentally friendly and social projects. In an increasingly capitalistic world, where the rich-poor divide and social inequality are ever increasing, many organisations are turning to sustainable bonds to attempt to bridge this gap, and successfully raise capital with social welfare in mind as opposed to pure profit.

Indeed the sustainability bond market tripled last year, and in the last few weeks several issues by high-profile companies have come to market. As investors demand corporates take more responsibility for social action, these bonds will be a key tool in implementing their ESG objectives.

This past March, at the height of the first wave of coronavirus infections, Pfizer issued its first sustainability bond worth $1.25 billion, maturing in 2030. The company explicitly linked the bonds to managing the company’s environmental initiatives and improved patient access to pharmaceuticals and vaccines.
Novartis, another pharmaceutical company, recently raised a €1.85 billion sustainability bond, and will make higher interest payments if it does not hit goals for expanding access to drugs in developing countries. That came hot on the heels of a $750 million emissions-linked issue from Suzano, a Brazilian pulp and paper firm. 

The sustainable bond market is in its infancy, but discussion about them has grown exponentially and the time seems finally right for them to go mainstream. Over the last three months, the issue was discussed in US corporate documents 86 per cent more than during the same period last year. In Europe, discussion jumped 52 per cent, albeit this growth has been from a very small base.

There is also an increased amount of ESG pressure on supply chains. Following an exclusion by an asset manager, and growing international pressure, the world’s largest meatpacker, JBS, will adopt blockchain technology to ensure the provenance of its cattle. The Brazilian company will require its suppliers to use a digital ledger to ensure that cattle are not reared on illegally deforested Amazon land. 

Recently, Volkswagen’s Traton commercial truck subsidiary signed a sustainability-linked revolving credit facility worth €3.75 billion in July. The embedded sustainability rules set financial incentives to improve the company’s sustainability ESG score.

In the US, Alphabet issued $5.75 billion in sustainability bonds last month as part of a larger $10 billion debt offering. This was the largest sustainability or green bond offering in the market's relatively short history. The company said the offering was oversubscribed and proceeds will go toward making the company’s data centres more energy efficient, purchasing clean energy, and promoting clean transportation in Google's Bay Area shuttles.

The diversity of firms in these examples reflect trends in the market. While the early days of ESG bonds were limited to utility firms, financials, mortgages, and the government, the last four years have been different. Now, firms in sectors including consumer and communications have begun to issue. The bonds are also becoming more accepted across a broader array of countries.

Pricing comparisons with vanilla corporate bonds are not straightforward. The relatively small market for sustainability bonds makes it difficult to control for issuer, maturity, rank etc. However, to the extent that sustainability bonds have cross-default clauses with an issuer’s vanilla bonds, we can expect the inherent credit risk to be relatively similar to these bonds. That implies investors do not see a significant difference between ESG bonds and the regular sort from the point of view of risk or demand. 

Disclaimer: This article was written by Simon Psaila, investment manager at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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