by Matthew Welch,
Responsible Investment Specialist at DPAM



    • Green bonds are an activity-based debt instrument that move capital towards projects that generate positive environmental impacts. The financial and utilities sectors are overrepresented.
    • Sustainability-linked bonds are a partial answer to the sectorial bias. They are a more flexible forward-looking, performance-based instrument, categorized as a behaviour-based instrument.
    • Social bonds are an activity-based debt instrument with a focus on projects with a social impact. Many players use this financing instrument to counterbalance the negative social consequences caused by the Covid-19 pandemic. Social bond issuances also flourish in 2021.
    • In the current context, sustainable bonds issuances will only go up and we will see an increasing level of quality assurance thanks to upcoming regulations.

The ESG debt market has continued to grow rapidly. 2020 was a stellar year for the ESG debt financing with a growth of 29%. As seen in the graph below, a significant element that facilitated this strong increase can be found in the boost in social bonds. This increase clearly coincided with the widespread expansion of the COVID-19 virus and the related social problems that this virus brought forth, ranging from health & safety issues to an increase in unemployment figures. Nonetheless green bonds still are the largest driver of the current labelled bond market.

Apart from green bonds, what other instruments can be found in the ESG debt market? Sustainability-linked bonds are an example of a newly emerging type of issuance. They have been introduced to the market in 2019 by the utilities company Enel and have gained rapid traction among sustainable investors, poised to increase further. This new type of issuance should not be confused with sustainability bonds, which intentionally mix green and social projects and work with the same mechanism as social or green bonds.


Green bonds can be categorized as activity-based debt instrument, i.e. the proceeds of the bonds are dedicated to clearly delineated projects. This activity-based instrument enables investors to clearly understand how the financing will be allocated towards -in the case of green bonds- solutions to environmental problems such as climate change or biodiversity loss.

The stringent guidelines set up by the International Capital Market Association (ICMA), the so-called Green Bond Principles, ensure maximum transparency towards investors. These principles detail the use of proceeds of the bond, how projects are evaluated and selected in the context of the green bond, how the proceeds are managed and finally the reporting on both the allocation of proceeds and the generated impact.

The long track record of green bonds has clearly shown the added value of this type of instruments to move capital towards projects that generate a positive environmental impact. Nonetheless, the core characteristic of the instrument also faces a small disadvantage.

Due to using a ‘use-of-proceeds’ based approach, the financial and utility sectors are overrepresented in the corporate issuers of these type of bonds. These two sectors often work on a project basis, with project portfolios that are more logically linked to clear sustainability goals and thus easily financed through activity-based instruments.

The figure below represents sustainability corporate bond offerings as from 2013 and demonstrates this bias toward financials and utilities. This subsequently translates to a select type of projects being financed, specifically in the fields of renewable energy and sustainable housing.

Recently we have seen an increased diversification in green bond issuance across sectors, but the sector concentration is still present, and we need a transition in all sectors to face the environmental challenges.

Source: Bloomberg, Morgan Stanley Research

Now it seems that a new financing instrument, sustainability-linked bonds, is an answer to the sectorial bias characterized by the green bond market.


The ICMA describes sustainability-linked bonds (“SLBs”) as any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined ESG objectives. The variable characteristic of the bond is often featuring a step up in coupon rates if the issuer does not reach predefined sustainability targets. The concept is a forward-looking, performance-based instrument, and therefore, in contrast with the green bonds, they can be categorized as a behaviour-based instrument. An instrument where the investor does not know where the funds will be invested but can have a moderate assurance on the impact that the company will generate through predefined sustainable target(s). Letting go of project-based restrictions, enable a wider array of issuers to use this instrument.

It is important to highlight that unlike green and social bonds there is no “earmarking” on the use of proceeds of the bond with specific environmental or social projects. The issuer has full discretion over the use of proceeds. This additional flexibility is both a blessing (broader universe) and a curse (more potential for greenwashing).

Figures of April in the figure below, demonstrate this diversification in corporate issuers thanks to the introduction of sustainability-linked bonds.

Corporate ESG-Labeled Debt by Sector ($bn)

In order to standardize the set-up of this instrument, ICMA also developed voluntary process guidelines for corporates considering a SLB issuance. These principles consist of five core components:

    • The selection of KPI’s that are deemed relevant core and material for the issuer. Moreover, the KPI should be measurable and preferable externally verifiable. An example can be found in H&M’s SLB framework that, among other KPI’s, has identified the share of recycled materials over the total materials used in its commercial goods as a material KPI for its industry.
    • The definition of the sustainability performance targets for the selected KPI’s should be ambitious, i.e. it does not make sense for a company to set the bar low on its sustainable commitments. In order to gauge the ambition level of these targets, they should be compared to a benchmark or peers, go beyond the business as usual trajectory and preferably have a reference to science based scenario’s or international targets, such as the Paris Agreement on Climate Change. Enel uses its greenhouse gas emissions reduction target in its framework, which has been assessed by the SBTi to be aligned with the 1.5°C pathway trajectory.
    • The way the financial or structural characteristics of the bond will change depending on reaching the predetermined targets. As an example, Klabin, a Brazilian paper company, has defined a 12.5 bps coupon step-up if a KPI (water consumption intensity) does not meet its stated target by 2025.
    • The way the issuer will report on its advancements on the relevant KPI’s and ensure full transparency with investors.
    • How the verification of the targets for each KPI takes place at the predetermined timeslots.


The selection of relevant KPI’s and targets might be easier for companies exposed to climate-related themes, such as decarbonisation, where clear-cut processes and targets have been defined to calculate the scope 1, 2 and 3 emissions. For companies facing more social material ESG issues, this set-up of relevant KPI’s and targets might prove more challenging, but not insurmountable.

Given the additional flexibility of these types of instruments and the uncertainty investors face on the proceeds of the bond, investors must thoroughly analyse every issuance in order to prevent sustainability-washing.


A last type of labelled bond to discuss is the social bond. This activity-based debt instrument has a focus on projects with a social impact when it comes to its use of proceeds. Besides this different scope, it can best be compared to the mechanism of green bonds. The surge of this type of instrument, which tripled issuances in 2020 compared to the year prior to a staggering amount of $150 billion, can be associated with the Covid-19 pandemic.

Many players, mainly government agencies, sovereign bodies, and supranational entities use this financing instrument to counterbalance the negative social consequences caused by the Covid-19 pandemic. The proceeds of these bonds are consequently allocated projects to alleviate unemployment figures, increase the access to social housing or expand the access to health services.

Social bond issuances are also flourishing in 2021, with the current issuances nearly matching last year’s figure already! We are confident that this trend will continue to persist and hope that the issuance by corporates (which only represent 17% of market issuances in 2021) will gain traction.


Thanks to the environmental focus of Biden’s infrastructure plan, the rollout of environmental initiatives from the European Union and the proliferation of net-zero emissions goals announced by governments and companies around the world, sustainable bonds issuances will only go up. There will be an increased level of quality assurance thanks to upcoming regulations, such as the recently published green bond standards by the European Commission. On the other hand, asset managers will have an additional level of scrutiny by investors to demonstrate a thorough understanding of the sustainability challenges of issuers when investing in sustainability-linked bonds.


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