A bright future for GSS Covered Bonds

"Green will remain the top product amongst GSS issuances” was one conclusion during a panel discussion about “ESG – the investor perspective” at this year’s Euromoney covered bond conference in Vienna.

The key learnings and take-aways included:

GSS and SL issuance – market statistics reveal a mixed picture

  • Approximately $980 billion GSS and SL bonds were issued in 2021, an increase of 77% compared to 2020. So far, 2022 has seen roughly a $452 billion issuance of sustainable bonds – less than the $647 billion volume in the first eight months of 2021.
  • 58% of the GSS and SL bond issuance this year has been green, totalling c.$260 billion, while social bonds totalled $56 billion and sustainability bonds $93 billion. Meanwhile, sustainability-linked bond (SLB) issuance remains small, with issuers raising c.$43 billion.
  • Global Financial Institutions (FI) GSS/S issuance has fallen by 7%, but significantly less than the corporate supply with 28% – increasing diversification concerns from investors.
  • Looking at GSS and SL issuance in EUR in relation to overall EUR bond issuance, sustainable bonds in any format total between 15-25% each week, and in some weeks reaching nearly 30%. Looking at USD bond issuance, GSS and SL bonds contribute 5-10%.
  • The Euro has extended its dominance in GSS and SL issuance, now with 50% of all issuances in EUR, followed by the USD (30%) and GBP (3%).

Sustainable bonds issuance by FIs: green bonds dominate

  • Green bonds remain the most dominant format for FIs, representing over two thirds of the total issuance – an increase on 2021. The remainder is evenly split between social and sustainability bonds, and a small tail of SL issuance.
  • While social bond issuance continues to be popular in the banking sector, it has subsided since its peak in 2020.
  • GSS covered issuance now accounts for around a fifth of total GSS issuance – predominantly in the EUR market. Sustainable covered bonds have also achieved improved greeniums due to high demand.

Investor trends: natural capital and biodiversity have become major themes alongside climate

  • As seen during the COVID-19 pandemic, holdings in ESG fixed income instruments are more robust to crises which has again been proven since the outbreak of the Ukraine war. While towards the end of August, ESG funds had seen significant outflows, they regained their holdings in September.
  • Whilst climate remains a priority, natural capital and biodiversity have become major themes which have been called out by many investors, including BlackRock, in its key priorities for 2022.
  • More broadly, investors favour investing in GSS bonds which demonstrate ‘additionality’ – often shown by limiting the ‘refinancing’ element of the net proceeds, and rather for those to go into new projects.

Sustainable investing: MiFID II initiates discussions with retail investors about sustainability preferences

The growth in the GSS and SLB market is not only driven by institutional investor demand but also by private investors: MiFID II, the EU framework for investor protection, has brought up – as part of updating customer profiles – conversations between banks and private investors about their sustainability preferences. This has led to a boost in private investor demand for GSS and SLB investment products, in line with $55.9 billion of new inflows into ESG/SRI funds, according to EPFR.

Green versus social: the established versus the ‘unknown’

The panellists agreed that green issuances represent by far the most attractive product in the GSS and SLB bond markets, with the EU Taxonomy considerably helping to ensure investors that the green bond label reflects what’s ‘in the tin’. Unlike green, social bonds will have to prove that they weren’t just a pandemic phenomenon – despite established social bond categories, such as social bonds for care homes, hospitals or housing associations. While an EU Social Taxonomy could help establish social bonds and help with defining what social impact looks like and can be measured, it seems that investors’ appetite is more in favour of a combination of green and social.

The UN SDGs: a highly effective way to showcase impact

While developed for the developing world and for countries rather than corporates, the panellists agreed that the UN Sustainable Development Goals (SDGs), which most GSS issuers incorporate into their GSS frameworks, are highly effective for issuers and investors alike to highlight the (17) areas where GSS and SLB debt will help make positive impact.

GSS covered bonds: the future looks bright

With better pricing, a wider breadth of investors and a considerably higher oversubscription rate, there are very tangible benefits for GSS covered bonds. Also, as with other GSS bonds, GSS covered bonds do perform better during crises compared with their conventional counterparts due to consistently strong demand. And the future looks bright: GSS covered bonds are now being issued in a wider range of currencies, while the market also celebrated some ‘firsts’ such as the first-ever sterling covered bonds in social format and the first social covered bond in the mortgage banks market in Sterling Overnight Interbank Average Rate (SONIA) format (lead managed by NatWest Markets).

Greenwashing: need for even more regulation, especially around ESG ratings

While currently at the crossroads where regulations and guidance through reporting standards such as Sustainable Finance Disclosure Regulation (SFDR) or the newly-established International Sustainability Standards Board (ISSB) will help to mitigate greenwashing, the panellists were adamant that further regulation is required to increase transparency in the market, pointing to ESG ratings and second-party opinion providers which deliver very different, non-comparable analysis. As a result, investors still rely on their own research. However, some of these developments will take time to fully embed into the systems and disclosures, as well as focusing on the materiality of the outcomes to ensure that impact is effective and efficient.

Greeniums: pricing is not everything for investors

While issuers may well be attracted to the GSS market because of greeniums, the investor representatives on the panel pointed out that looking at the risk of an issuance is more important than its pricing. The experts also agreed that issuers can usually only achieve greeniums if they are coming to the markets as one of the first ones in their sectors. Furthermore, with some products, such as GSS covered bonds, greeniums will be very small due to the existing tight spreads.  

Sustainability-linked bonds from FI issuers: a product with big potential

The panel agreed that SLBs in general tell a strong story, and – through the use of penalties – further highlight the issuer’s commitment to achieve positive impact. In addition, the use of key performance indicators (KPIs) makes SLBs more accessible for a wider range of issuers. If the KPIs show sufficient rigour and robustness, SL bonds could see strong adoption and growth. To close off the discussion, the panel focused on sustainable linked bonds issued by financial institutions and their complexity given the limited ability to report Scope 3 emissions for universal bank portfolios for a number of years to come, restrictions to incorporate KPI-linked ratchets into ‘minimum requirement for own funds and eligible liabilities’ (MREL) or capital instruments and the 5% step-up limitation of the initial margin outlined by International Financial Reporting Standard 9’s Solely Payments of Principal and Interest (SPPI) test.

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