EdenTree
Blue bond debut expands potential to link impact to financial return
by David Katimbo-Mugwanya, CFA, Head of Fixed Income at Edentree
Recent years have witnessed record growth in the issuance of debt securities that enable investors to achieve positive environmental and/or social impact. With the exception of 2022, which saw Green, Social and Sustainable debt issuance volumes decline in tandem with conventional bond supply, year-on-year growth remains positive. ESG-labelled debt is forecast by S&P to account for 14% of total debt outstanding by the end of 2023. In addition to the growing universe, it is anticipated that a broader cohort of issuers is set to tap the market compared to when the concept first emerged.
The market has also innovated. Whereas green bonds were clear pioneers and targeted several environmental impacts ranging from pollution prevention to renewable energy generation, blue bonds1 – whose focus is on funding projects to conserve marine biodiversity, thereby restoring the Earth’s oceans, have since made a debut. The emergence of outcome-linked bonds more recently, which explicitly link the success of a project’s impact to the return payable on a corresponding debt security, is but another example of innovation within this space.
In this article, we take a brief glimpse at blue bonds and opine on their portfolio suitability.
1 Guidelines for Blue Finance – Guidance for financing the Blue economy, building on the Green Bond Principles…January 2022
Blue bonds – positive impact for oceans and marine life
The International Capital Markets Association (ICMA) defines blue bonds as those that earmark funds exclusively for ocean-friendly projects and critical clean water sources protection.
Like their green predecessors, blue bonds are largely issued in the use-of-proceeds format characterised by ex-ante bond frameworks with clear project selection criteria as well as alignment to the Green Bond Principles.
Where these have been issued by developing countries however, blue bonds may incorporate other more esoteric features including debt-for-nature swaps. The latter introduces an added layer of complexity compared to the largely ‘plain-vanilla’ green bonds and, as a consequence, also alters the securities’ risk profile.
A debt-for-nature swap involves the restructuring of a country’s debt in exchange for its commitment to investing in nature conservation projects. With global debt service costs having risen sharply over the course of 2022, a growing number of nations are said to be contemplating such swaps.
In fact, IMF research has found that 34 of the 59 developing economies most vulnerable to climate change are also at a high risk of fiscal crises.
As such, countries experiencing financial distress are able to obtain a measure of debt relief from creditors seeking to generate positive environmental impact. One such transaction is the Barbados blue bond issued last September.
The Government of Barbados partnered with The Nature Conservancy (TNC) and the Inter-American Development Bank (IADB) to issue a $150 million blue bond that saw the Caribbean nation restructure its debt to more favourable terms while committing funding to marine conservation.
Barbados has set aside $50 million over 15 years to conserve approximately 30% of its ocean by 2030, an approximate area of 55,000 square km. This project aligns with the United Nations’ Global Biodiversity framework and supports the UN Sustainable Development Goals.
In a noteworthy departure from green bonds, whose compliance with issuance frameworks are typically voluntary, Barbados’ marine conservation targets are legally binding. These commitments include the adoption of science-based Marine Spatial Planning to help the nation identify new protected areas and to develop ocean management plans.
Technical assistance provided by TNC also entails the organisation’s participation in the governance of the newly established Barbados’ Environmental Sustainability Fund (a vehicle set up to fund and implement commitments) as well as periodic reporting on conservation milestones.
The evolution of impact investing – the ESG spectrum of capital
Source: EdenTree (2023). Adapted from Bridges Fund Management (2015)
Despite the rapid evolution of the Green, Social and Sustainable debt universe over the last decade, there was also criticism that these debt instruments insufficiently embedded impact into the securities’ risk-return profiles.
This latest iteration of bonds that more directly link risk and return to the positive impact they are able to generate addresses this criticism. Put another way, the blue bond framework enables suitable end-investors to have more ‘skin in the game’.
Where potential market participants sit on the ESG spectrum though (see image below), will be a key determinant of take up and may well influence the ultimate growth of the universe of instruments seeking to deliver enhanced alignment of impact and financial returns.
Achieving the positive impacts that the world so desperately needs therefore, such as the restoration of marine life, could well entail a tolerance for sub-par financial returns that is common among philanthropic endeavours unlike mainstream investors for whom a finance-first approach is more palatable.
