Investors are increasingly considering not just the return potential of their investments, but also what kind of world their money is helping to build. One way to align financial goals and positive outcomes for people and planet is by investing in green, social and sustainability bonds, write Malika Takhtayeva and Alexandre Coupee.
GSS bonds are designed to support projects that help tackle environmental problems and promote social wellbeing, or a combination of the two. While these bonds can be powerful tools for change, they are only as effective as the transparency bond issuers provide and the actual use to which the issuers put the money raised.
What are green, social and sustainability bonds?
At their core, GSS bonds work like any other bond: an entity – often a government, development bank or company – borrows money and agrees to pay the bondholders back with interest. What makes these bonds stand out is that issuers promise to use the proceeds for specific purposes with impact – financing clean transport, waste reduction projects, affordable housing, etc.
Charting such impact requires a so-called theory of change framework. For investors, this clarifies how their capital is leading to desired social or environmental outcome. Such a map of inputs, activities, outputs and long-term effects helps them decide which bond issue to allocate to, measure the progress of the impact, and ensures accountability.
We have set out detailed theories of change for all green and social bond strategies, including specificities of the projects that are eligible for financing, the outcomes the bonds are expected to achieve and the metrics we use to measure progress towards those goals.
Ensuring funds are used for the stated purpose
Impact investors are increasingly taking into account the Operating Principles for Impact Management (OPIM). These principles, developed by the International Finance Corporation, set out a framework for integrating impact considerations. They emphasise the importance of clearly defining the environmental or social objectives, monitoring how money is allocated and managed, and reporting transparently on the results.
Such a setup allows investors to trace how their money is making a measurable impact. We place great importance on post-issuance reporting. After a bond is issued and the money starts flowing to projects, the issuer must report on how the proceeds have been used and, ideally, what outcomes have been achieved.
A typical report will include:
- A list of funded projects
- The share of proceeds allocated to each
- The amount still to be disbursed
- Where possible, environmental or social impacts such as how many tonnes of carbon emissions were avoided and how many affordable housing units were built.
A review or verification by an independent party adds a layer of confidence for investors.
We have set out details of what we expect in terms of issuer reporting in our Green Bond and Social Bond Methodologies and how we report on our own strategies’ impacts in Understanding how social and sustainability bonds can have real impact.
Greenwashing and poor impact reporting
Despite the good intentions, GSS bonds are not without problems. One of the biggest concerns is greenwashing – when issuers exaggerate or misrepresent the environmental or social benefits of their projects.
For example, we have seen a company claim it is electrifying railways, but the electricity it uses is being produced by burning coal. Another issuer was building renewable energy plants at the expense of biodiversity and human rights.
Such issues can arise partly because reporting standards such as the International Capital Market Association’s (ICMA) guidance are voluntary. While such frameworks and third-party verifications help, they cannot fully prevent inconsistent or misleading claims. We have adopted a bond-by-bond assessment and only consider ICMA-aligned bonds.
Another problem is poor impact reporting: the data that issuers provide is often incomplete or inconsistent across bonds. Without standard measures, investors may struggle to assess which bonds are delivering the greatest impact.
We believe investors need better information to guide their decisions. In The current state of accounting for companies’ and sovereigns’ greenhouse gas emissions, we demonstrate the implications of different carbon accounting approaches. We argue that using absolute emissions provides more transparency and comparability than relying on avoided emissions.
Our role in improving the GSS bond market
We believe investors can be important in ensuring GSS bonds make the impact they are intended to have. For example, we do not invest in these bonds simply because the issuer calls them green, social or sustainable – they have to pass a strict assessment to be eligible for inclusion in our GSS bond strategies.
As said, the post-issuance analysis of the impact of the proceeds and allocation reporting play a key role in our assessment.
We set impact targets that our green and social bond strategies must meet and produce annual impact reports that set out progress towards these targets.. We see this as an important step for improving transparency and credibility in sustainable finance.
Outlook
Given that GSS bonds can play an important role in solving global problems, issuers and investors need to ensure the proceeds are being used as intended and have a positive impact.
While there clearly is scope for improvements, there are difficult challenges to overcome. It is generally much harder to measure and quantify the impact of social bonds than it is for green bonds. It is typically harder to determine whether the positive impact would have occurred if the bond had not been issued.
More stringent impact reporting requirements with a clear definition of the metrics and indicators and methodologies used would be key improvements.
