ESG Transformation of the Fixed Income Market (2024)

Investor Demand on the Rise

Sustainability considerations have moved from being an “nice to have” option to becoming crucial to an increasing proportion of investors, reflecting new regulatory requirements and changing societal expectations - particularly in Europe.88% of our surveyed investors say they will further increase their allocation to GSS bonds in the next 24 months.

The main barriers to further growth from investor's demand identified in our survey - a lack of liquidity in secondary markets and fears of "green-washing" due to inconsistent standards around the use of GSS proceeds and weak reporting - are likely to be addressed by additional market growth, increasing standardisation and tightening regulation, particularly through the new European Green Bond Standard.With GSS bonds securing a risk/return balance similar to that of conventional bonds, while also fulfilling rising ESG preferences, investor appetite for this instrument will continue to carry the market to new records.

Uptake of GSS Bond Issuance

Our analysis suggests a major acceleration in issuance by new and existing players in both the public and private sectors, drawn by reputational benefits and access to a broad and committed investor base. The main challenge will remain the identification of a pool of compliant assets that can be eligible for GSS bond issuance, and the expertise needed to go through the issuance process.

Within the public sector, which has up until now dominated GSS issuance, we have projected continued rapid growth in European supranational issuance, largely based on announced EU and EIB plans regarding GSS bond issuance up to 2026. We have also looked at the expenditure composition of the national EU member state budgets, estimating the potential percentage taxonomy- or sustainability- aligned expenditures, and derived from this a trajectory for sovereign GSS bond issuance. This analysis suggests further steady growth in public sector GSS issuance in the coming years which will reach EUR 712bn by 2026 – up from EUR 266bn in 2021.

On the private sector side, we expect private sector issuance – particularly from the non-financial corporate sector – to gain importance in terms of GSS bonds new issuance in the coming years increasing from 46.5% in 2021 to 49.1% in 2026.GSS bonds may be particularly attractive to CFOs as a transition financing tool as they are well designed to attract external financing for the specific purpose of sustainable or transition projects in organisations that also have non-sustainable business activities.

Key Market Developments

• Despite a great run from Social and Sustainability bonds, Green bonds will continue driving the market.
• Energy, Building and Transport to guide the EU sustainability transformation.
• As Covid-19 fades away, medium to small bonds are expected to gain back some market share.
• Currency diversification will continue to decrease as the Euro increases its dominance.
• Sustainable securitised products show signs of promising development, even though the amount of compliant underlying assets can pose a limit to this growth.
• Sustainability linked bonds (SLBs) claim their seat at the big table after a staggering first half of 2021. That being said, SLBs remain significantly different from GSS “use of proceeds” bonds as they are not earmarked for specific projects underpinned by recognised sustainability standards, but are instead linked to corporate wide sustainability targets on which the coupons are set. There remains to be seen how EU and international regulatory developments will affect the development of this product.