What are Sustainability Bonds?

Finance and sustainable business practices have traditionally been considered to be separate fields. It was common for companies all over the world to participate in activism related to sustainable business practices. However, this activism was more a part of their social responsibility and would not have any impact on their bottom line. This has changed with the advent of sustainable bonds.

Sustainable bonds are a mechanism to combine the social responsibility as well as the financial structure of the company to form one integrated strategy. When the idea of sustainable bonds was first introduced to the market, it was considered to be a fad. However, with the passage of time, green bonds have become quite a rage. Today almost all major multinational companies such as Apple, Pepsi, etc. have issued sustainable bonds.

The largest financial institutions of the world such as JP Morgan Chase as well as Citibank have also been involved in the issuance of sustainable bonds. Also, important governments such as the United States and China have shown an inclination towards the issuance of such bonds. Many experts who keenly observe the areas of bond issuance and track the latest developments have concluded that, in the near future, almost 5% of the bonds which will be issued will be sustainable bonds.

Hence, it is important for every investor to understand what these bonds are and how they impact the overall markets for bond issuance.

What are Sustainable Bonds?

The word sustainable-bonds is composed of two different words i.e. sustainable as well as bonds. The word sustainable is used to refer to the overall impact of the investment whereas bonds are the commonly used means of debt financing. Simply put, sustainable bonds are a specialized type of bond, wherein the issuer makes a voluntary pledge to use the proceeds realized from the bonds issue in projects which do not have a negative impact on society. This means that along with being financially viable, the projects also have to be environmentally and socially viable.

It is important to understand that sustainable bonds do overlap the areas of green bonds and social bonds. However, sustainable bonds are a wider concept.

Difference between Green Bonds and Sustainable Bonds?

Investors who regularly invest in fixed income securities routinely come across terms such as green bonds, social bonds as well as sustainability bonds. These terms seem quite similar. However, it is important to understand the difference between these terms.

Green bonds are meant exclusively for environmental issues. On the other hand, social bonds are meant exclusively for issues that impact the social construct of society. Sustainability bonds can be considered to be hybrid bonds. This means that the objectives of both green bonds, as well as sustainable bonds, can be considered when the proceeds from sustainability bonds are being utilized. This is what makes sustainable bonds more popular. It is easier for issuers to justify the use of the proceeds in the event of an audit. Since issuers have more flexibility, these types of bonds are becoming more popular with the passage of time.

Advantages of Sustainable Bonds

There are several advantages that make sustainable bonds an important source of financing. Some of these advantages have been written below:

  • Can be Offered by More Issuers: Sustainable bonds can be offered by a large number of issuers. Green bonds can only be issued by corporations that are involved extensively in businesses that are related to the environment. On the other hand, sustainable bonds can be issued by just about anyone. Hence, corporations, governments, and financial institutions all across the world have started large-scale issuance of such bonds.

  • Cheaper Source of Funds: It is important to know that in most parts of the world, sustainable bonds are not secured. This means that they are only secured by the good credit of the entity issuing them. Despite being unsecured, these bonds tend to offer lower yields to investors. This is because there are many investors and investment funds in the world that have earmarked a certain amount of funds for sustainable projects. Hence, if a company is undertaking such a project, it can take advantage of cheaper financing.

  • Statutory Requirements: There are many governments across the world that have made it mandatory for their businesses to undertake a certain percentage of their projects only if they are sustainable in the long run. Also, many banks such as European Central Banks have started accepting sustainable bonds as collateral. It is for this reason, that government regulations have led to a dramatic rise in the demand for sustainable debt. As a result, companies are issuing more and more sustainable bonds to satisfy the burgeoning investor demand.

  • Public Image: Lastly, companies that issue sustainable debt are viewed by the general public in a favorable light. They are viewed as corporations that are not just driven by the greed of profits but instead look at the world in a holistic manner. This increase in the favorable public image is another reason why sustainable debt has become popular in the recent past.

The bottom line is that sustainable debt is here to stay. Companies, investors, as well as financial institutions, need to adjust their investment strategies in order to account for the increasing number of sustainable bonds being issued in the market.

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