It’s almost impossible to keep up with the latest trends in environmental, social and governance finance. In the debt markets alone, it’s not just “green bonds” anymore but also “social bonds,” “sustainability-linked bonds” and “transition bonds.” Asia might be about to experience a “blue bond” boom. There’s a proposal for “Eden bonds” that would pay investors to keep certain land wild. Understanding the differences between these ethical debt designations literally requires a glossary.
For bond traders who aren’t focused specifically on meeting ESG criteria, it can all feel a bit much. The scrutiny over what truly qualifies as a green bond seems to have improved in recent years, but it’s still imperfect. Meanwhile, in the case of some sustainability-linked debt, the incentives don’t quite align between borrowers and lenders. A Bloomberg QuickTake explains how it works:
By tying debt costs to measurable and verifiable companywide goals, known as key performance indicators, or KPIs. Issuers set targets with timetables and then make extra payments to bondholders if they fail to achieve them. The penalty could be higher coupons during the life of the bond or an additional payment on maturity. Chanel, for instance, agreed to give bondholders an extra 75 basis points when a 2031 bond comes due, if it misses an emissions goal.
In other words, to lock in the maximum return (climate benefits notwithstanding), investors would be tempted to root for these companies to fail to do good so they pay a penalty. Sure, the prospect of a financial gut punch might be necessary to keep executives on track, but it’s nevertheless a somewhat strange position for lenders, especially those that aren’t necessarily willing to forgo extra yield to help the environment.
This dilemma is what makes the first “wildlife bond,” which the World Bank will sell in the middle of this year, such a rare offering. Investors stand to make more money if the initiative succeeds and the population of the endangered black rhinoceros in South Africa grows over the next five years.
Bloomberg News’s Antony Sguazzin reported that the World Bank will bring a five-year, 670 million rand ($45 million) security to market that won’t have annual interest payments but instead will repay investors their original capital plus an extra payout if the black rhino population increases. Their numbers have plummeted to about 5,500 from 65,000 in 1970, with 2,046 black rhinos now in South Africa.
The incentives probably line up because the final payments will be made by the Global Environment Facility, which has received donations from more than 40 countries and obviously has a different mindset than a company like Chanel or even a sovereign nation that wants to fund ESG projects but not necessarily pay more to do so. The GEF, by contrast, is more motivated by getting worthy initiatives up and running and might not mind providing investors interested in its work with a larger return for successful projects.
To be sure, the details are lacking so far, leaving the potential upside on the bonds unknown. A park manager at one of the two sites chosen in South Africa told Sguazzin that the goal is to increase the rhino population by 4% a year. The financing paper describes it like this, which at least on its face suggests a sizable windfall if the rhino population surges:
A KPI, net rhino growth rate, is used to inform the conservation outcome. A secondary set of interim KPIs are utilized for short-term payment triggers, based on the assumption that short-term KPIs influence the ultimate KPI. Based on the conservation outcome (measured by the KPIs), the outcomes-payer pays the impact investor back the original investment plus or minus a percentage relative to conservation outcome.
History suggests the returns offered for meeting the stated goals can be quite large. In one of the more similar deals to these wildlife bonds, the UBS Optimus Foundation in 2015 put up $270,000 to fund what was called the world’s first development impact bond for increasing girls’ school enrollment in India. As a Brookings Institution report noted, the impact bond was judged by student enrollment (20% of the outcome payment) and learning outcomes (80% of the payment). Both targets were met within three years and UBS earned an internal rate of return of 15%, albeit on a somewhat meager sum.
“When working on innovative structures like this one, we start small and hope to learn from the first one and then get successfully larger in an ambition to ultimately scale what works,” Marisa Drew, chief sustainability officer at Credit Suisse Group AG, which is advising on the rhino bonds, told Bloomberg’s Sguazzin. The ESG bond market, meanwhile, is getting bigger in a hurry, with Bloomberg Intelligence estimating that issuance of green, social and sustainability debt may reach $1 trillion this year.
In the race to scale up, initiatives that both reward lenders and do good shouldn’t be left behind, especially if more evidence piles up that they’re likely to achieve their desired outcomes. Brookings put it well: “Impact bonds remain a complex and time-intensive mechanism for contracting services, and decision-makers must ensure that contracting on outcomes, and engaging private investors, are the right options for the problems they are trying to solve.” That was almost three years ago—and yet the first test of a wildlife bond is still months away.
There’s always natural tension between bond investors, who want the highest yields possible, and debt issuers, which want the cheapest borrowing costs. That kind of push and pull is fine when it’s an offering from a company like AT&T Inc., Boeing Co. or Oracle Corp. But maybe when it comes to saving black rhinos, everyone can be on the same team, cheering for this deal’s success.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.