Commentary

Opportunities in a Maturing Market

Agathe Foussard, Fixed Income Portfolio Manager, Mirova, considers recent trends in sustainable bond investments.

Launched in 2008, the sustainable bond market, particularly Green Bonds, grew continuously… until 2022, when the most dramatic interest rate increases in 40 years brought this expansion to a halt. In 2023, issuance struggled to regain momentum. Despite two promising first quarters, the end of the year, and particularly the third quarter, proved more complex, with issuers lacking visibility over the future path of interest rates.

So, should one conclude that 2023 was a disappointment? It is not as simple as that, since there are various factors that shed a different light on the year’s performance when analysed closely.

Firstly, the green bond format is consolidating its lead. We are delighted to see green bonds back on the rise, not only as a proportion of the total amount of labelled debt, but also in absolute terms, with the total amount issued up by 10% compared with 2022. We attribute this increase to sovereign issuers, who, as usual, preferred the green format to others. Governments continue to abandon the social format, with Chile and Colombia the only issuers on purely social impact programmes last year.

Does this mean social bonds are in terminal decline? Perhaps. Social bonds appeared in 2017 but really started to expand in 2020 with US$150 billion in issuances all over the world versus US$17 billion in 2019. They were prioritised over the Covid crisis, when governments, agencies and supranationals had to support employment measures provided by major economies.

After a second year of strong expansion in 2021, the market suddenly slowed down in 2022, by -38%. Part of the drop can be attributed to the market context of rising rates in addition to the global decrease in the amounts issued within the fixed income market overall, but this slowdown was worse for social bonds than for other formats (-15% on average).

We are convinced that the environmental transition cannot be done without addressing social issues, but sustainable bonds offer issuers a more flexible vehicle to finance social projects while combining them with larger, more liquid environmental ones.

Sovereigns taking the lead

Sovereigns were the main contributors to growth in the green bond market for 2023. They issued US$161 billion in green bonds, the highest level ever, a 50% increase on 2022.

Corporate issuers, on the other hand, disappointed as they issued ‘just’ US$238 billion, 10% less than the previous year. They spurned sustainable formats as well as sustainability-linked bonds (SLBs), although certain sectors with less experience of the green, social and sustainability bond (GSSB) market stood out, such as communications, consumer discretionary and industrials whose penetration rates rose.

In green bonds, we used to see a balanced allocation between corporate and government/quasi government issuances, even though we recently observed an increase in the share of government issuances. Indeed, the large increase in green issuances from sovereigns helped the total market to expand compared with 2022.

For some corporate issuers, the need to identify green assets will weigh on the market expansion, so we should observe a higher proportion of sovereign issuances versus those from corporates in the coming years. But this trend should slow down again once the EU taxonomy is implemented with the release of many data at corporate level.

In geographical terms, EMEA remains the most heavily represented zone, while the APAC region’s level of issuance has remained flat for the past three years, at around US$280 billion, and the Americas saw its issuance of labelled debt fall significantly in 2023, to US$144 billion versus US$224 billion in 2021. Turning to currencies, the euro and the US dollar, while they continue to dominate the market, together accounted for only 63% of total issuance, compared with 80% in 2020. Meanwhile, the yuan accounted for 10% of the total in 2023.

Shortening maturities

One last trend we are observing is the shortening of maturities. After 2019, the Global Green Bond index saw a sharp increase in duration relative to a conventional index, following the arrival on the GSSB market of sovereign issues with maturities exceeding 20 years. However, since 2022, and the rising interest rates imposed by central banks to combat inflation, issuers that favoured very long maturities to take advantage of exceptionally low rates have had to review their strategy and seek financing on shorter or intermediate maturities.

This, combined with the need to accelerate energy transition and finance projects with shorter time horizons, has returned the Global Green Bond index to duration levels closer to those of a conventional universe. And lastly, insofar as rising interest rates exert mechanical downward pressure on durations, today’s bond market has a lower average duration than before.

Further, we’d expect the primary bond market to benefit from greater visibility on interest rates trajectories and lower volatility. We forecast the GSSB market to expand yet again by around 5-10% compared with 2023, also driven by the need to accelerate transition to a low-carbon world.

Green bonds are likely to remain the favourite of issuers, particularly sovereigns. Furthermore, real estate projects could end up bouncing back once rates started to decrease, feeding banks’ balance sheets, hence the asset pool available for green programmes.

Which new GSSB issuers joined the market in 2023?

Sovereigns were the life of the party in 2023, and no fewer than eight new issuers joined, mainly from emerging countries: Brazil and Cyprus issued sustainability-linked bonds, while India, Israel and Turkey opted for green issues.

Meanwhile, we listed about 120 new corporate issuers. Among them, a notable amount of green bonds issued by automotive firms such as Stellantis, Valeo, LG Energy Solutions and Autoliv.

Mirova’s ESG Research teams particularly appreciate the green bond issued by East Japan Railway and that issued by packaging firm DS Smith, among others. 2023 also witnessed the entry of several Central European banks on the sustainable bond market, including Banca Transilvania and Bank Pekao.

New players were less common in the social bonds market, however a mention is due to the Natwest issue, in which 100% of Use of Proceeds will finance SMEs run and/or owned by women.

However, once again last year, we had to turn down many programmes, primarily due to unambitious decarbonisation strategies on the part of the companies issuing them. We are thinking in particular of issuers in the areas of fast fashion, mass retail and gas utilities.

Responsible investment opportunities have also arisen in the conventional universe. Indeed, of the 15 or so first-time issuers we identified in 2023 in the euro universe, two thirds were eligible for Mirova’s investment universe. Among the new issuers that we deemed as having a strong positive impact is Veralto, the Danaher spin-off set up last September, which specialises in water and food quality control systems, as well as treatment systems with a positive impact on biodiversity.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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