In recent years, the financial markets have experienced growing interest and activity around the issuance of environmental, social and governance (ESG)-focused financial instruments, ie those which take into consideration ESG factors. Prior to the COVID-19 pandemic, there was significant year-on-year growth in green financing, both in conventional debt markets and the Islamic capital markets (ICMs). This was complemented by issuance in social financing, though not nearly at the same levels. For instance, in 2019, prior to the pandemic, conventional green bond issuance topped US$266.5 billion with green Sukuk issuance hitting new levels at US$3.5 billion.[1] Meanwhile, some have estimated 2019’s social bond issuance in the conventional space to be around US$15 billion.
Then, in 2020, as the pandemic took hold, things began to shift. In the first quarter (Q1) and Q2 of 2020, the world began to understand the gravity of the situation in which it found itself. As global conditions deteriorated, the extreme inequality of the pandemic’s impact became apparent. ESG-aware financing (both in the conventional markets and ICMs) refocused toward social bonds and Sukuk. In March 2020, seeing where global priorities then were, the International Capital Markets Association (ICMA) “underlined the relevance of social bonds in addressing the coronavirus pandemic and provided additional guidance for eligible social projects, which could include coronavirus-related healthcare and medical research, vaccine development and medical equipment investments.”[2]
It has been reported that US$32 billion of social and sustainability (those which take into account both green and social considerations) debt instruments were issued in April 2020 alone and “it marked the first month in which social and sustainability bond issuance surpassed green bonds.”[3] In June 2020, S&P Global Ratings predicted that social bonds would make up a significantly larger share of the debt market in 2020 as compared with green finance and that further diversification of social bonds to fund everything from medical equipment, infrastructure and employment support would continue in the months to come.[4]
In the end, 2020 would see the issuance of US$164 billion-worth of social bonds, nearly 10-fold of 2019 numbers.[5] Increased social finance issuances in both conventional markets and ICMs addressed poverty, inequality, SME financing and economic stability. For example, in June 2020 the IsDB issued a US$1.5 billion ‘AAA’‐rated sustainability Sukuk facility as part of its response to the COVID‐19 pandemic, the proceeds of which were “exclusively deployed by IsDB towards social projects under IsDB’s Sustainable Finance Framework, with a focus on ‘access to essential services’ and ‘SME financing and employment generation’”.[6]
For those active in the ethical finance space, it was noticeable that the dialogue in 2020 focused on social bonds and Sukuk. In the midst of this, there were some who did wonder if this would be to the detriment of green issuance in the long term, or if the interest in ESG through the S-lens would bring renewed and increased interest to E-focused financing as well. While the increased focus on social financing did contribute to a dip in green issuance in Q2 2020, an exceptionally strong Q3 in 2020 provided a record-breaking year, with the total amount of global green issuance reaching US$269.5 billion by the end of Q4 2020.[7] These levels have continued, with green origination in Q1 2021 rising by more than 400% year-on-year to US$131.3 billion.[8]
A year later, the dialogue in the ethical finance space now seems to have shifted to an almost exclusively green focus. This could be due to sentiment that there is a need to make up for lost time, or because these are the final four months in the run-up to the UN Climate Change Conference in November and pressure on governments and corporates is mounting to meet 2030 and 2050 commitments.
If the past year has taught us anything, though, it is that the health and well-being of both people and planet are interdependent and inextricably intertwined. Accordingly, when looking at ESG, environmental and social considerations are equally important, and the financial community must look to design financial instruments that address both. The ICMA, a provider of industry guidelines for ESG-focused issuance, has recognized that the way forward must incorporate all factors and that “the transition to a sustainable global economy requires scaling up the financing of investments that provide environmental and social benefits”. As discussed above, debt issued in this way is often referred to as a sustainability bond. The ICMA Sustainability Bond Guidelines (SBG) define a sustainability bond as a bond where the proceeds will be exclusively applied to finance or refinance a combination of both green and social projects. In 2018, with the foundation on the ICMA’s SBGs, the ASEAN Capital Markets Forum published the ASEAN Sustainability Bond Standards, which are also aligned with the core components of both the ASEAN Green Bond Standards and the ASEAN Social Bond Standards.
A recent report by Refinitiv highlighted that sustainability debt issuance was at new highs with around US$286.5 billion issued in Q1 2021.[9] With the volume of conventional sustainability and green issuance reaching unprecedented levels and momentum continuing to increase, the ICMs are also heeding this as a call to action to increase their own activity. A pioneer in this space, Malaysia issued itsr maiden sustainability Sukuk in April 2021. This was the world’s first US dollar sovereign sustainability Sukuk, the proceeds of which will be used for eligible social and green projects aligned to the UN Sustainable Development Goals (SDGs). A Sukuk like this “will enable Malaysia to not only meet its commitments as a responsible nation and signatory to the Paris Agreement, but also further its efforts to advance its people’s socioeconomic well-being. It is also a testament to the government’s efforts in combating climate change as well as accelerating the transition towards a more resilient and inclusive economy, in line with the government’s Shared Prosperity Vision 2030.”[10] To show the scale of interest, the issuance was oversubscribed by 6.4 times which led the Malaysian government to increase the issuance to US$1.3 billion.
As the ICMs focus not only on green and social Sukuk, but also increasingly on sustainability Sukuk, it is important to remember all aspects of ESG. It is easy to think that G means ‘green’ given all of the attention that climate risk and carbon neutrality rightfully get in ESG conversations. However, G stands for governance, a crucial underpinning of environmental and social considerations.
The ‘G’ in ESG pertains to the factors that influence decision-making, the rules or principles defining the rights, responsibilities and expectations between different stakeholders and the mechanism in place to provide a system of checks and balances to align and manage interests of stakeholders. These factors are crucial because they are how corporates or sovereigns manage their existing environmental and social risks and how they will be able to address these risks going forward. Understanding and measuring these factors will be key to the success of green, social and sustainability financing.
The ‘G’ also has a part to play in the green, social and sustainability issuances themselves. With increased scrutiny over ‘greenwashing’ and other potential misleading practices, the governance surrounding the legitimacy of the impact of green, social or sustainability issuance is as important as ever. To keep faith in this market, ICM participants must prioritize compliance with international issuance and project guidelines and recognize the value of second-party opinions confirming that compliance. Investors and other stakeholders are reviewing the entire value chain of a deal or project and issuers must ensure E and S and G considerations are taken into account across the lifecycle of the project. Accordingly, alongside the integration of environmental and social factors, the focus on governance should come from the effective measurement and reporting of:
- impact or expected impact, including the key underlying methodology or assumptions used to determine the impact or expected impact
- key performance indicators (KPIs) and achievement against those KPIs, and
- mapping KPIs against the SDGs and their underlying targets.
By focusing on reducing negative environmental impact while promoting social considerations, ICMs can more efficiently mobilize capital toward responsible and sustainable causes. By increasing their focus not only on the governance of the institution implementing these social and environmental changes, but also on the governance of the issuance itself, ICMs can develop further the trust in these instruments to effect meaningful change and attract global interest to support further issuance to create impact.
- [1] https://openknowledge.worldbank.org/bitstream/handle/10986/34569/Pioneering-the-Green-Sukuk-Three-Years-On.pdf?sequence=1&isAllowed=y
- [2] https://www.spglobal.com/ratings/en/research/articles/200622-a-pandemic-driven-surge-in-social-bond-issuance-shows-the-sustainable-debt-market-is-evolving-11539807
- [3] https://www.spglobal.com/ratings/en/research/articles/200622-a-pandemic-driven-surge-in-social-bond-issuance-shows-the-sustainable-debt-market-is-evolving-11539807
- [4] https://www.spglobal.com/ratings/en/research/articles/200622-a-pandemic-driven-surge-in-social-bond-issuance-shows-the-sustainable-debt-market-is-evolving-11539807
- [5] https://www.refinitiv.com/perspectives/market-insights/sustainable-finance-surges-in-2020/#:~:text=In%202020%2C%20issuance%20of%20social,three%20times%20that%20of%202019
- [6] https://www.isdb.org/news/islamic-development-bank-issues-us-15-billion-debut-sustainability-sukuk-in-response-to-covid-19
- [7] https://www.climatebonds.net/2021/01/record-2695bn-green-issuance-2020-late-surge-sees-pandemic-year-pip-2019-total-3bn
- [8] https://www.refinitiv.com/perspectives/future-of-investing-trading/sustainable-finance-continues-surge-in-q1/
- [9] https://www.refinitiv.com/perspectives/future-of-investing-trading/sustainable-finance-continues-surge-in-q1/
- [10] https://www.mof.gov.my/en/news/press-release/world-s-first-sovereign-u-s-dollar-sustainability-sukuk-issuance-by-the-government-of-malaysia