Sharp perspective is needed in selecting ESG-labeled bonds that are truly sustainable

“There has been a definite shift towards formalizing the way investors assess the entire ESG bond market over the past year or two, in line with a heightened awareness of the risks of greenwashing,” says Gino Beteta Vejarano, Green Bond Analyst at Robeco.

In practice, this has encouraged more investors – asset owners and asset managers – to set up in-house ESG-bond screening processes to mitigate these greenwashing risks. There is also recognition that this screening needs to be more rigorous than a simple check against the international guidelines and principles that apply to this category of the bond market.

Peter Kwaak, portfolio manager of RobecoSAM Global Green Bonds, says that, while these international green bond and ESG bond principles are a handy guide for issuers when they structure an ESG bond, investors need to apply deeper analysis. “For us as an asset manager, it's very important to have our own view on green bonds, for example, and to apply our principles and ideas on whether bonds genuinely align with sustainable values and have a positive impact on the environment or society.”

To this end, Robeco has developed a five-step selection framework for each of the ESG-labeled bond categories. The aim of these frameworks is to ensure that only bonds that adhere to internationally accepted standards, and that Robeco trusts to have an impact, are eligible for inclusion in our strategies.

The five-step framework is broadly similar for each category of the ESG bond family.

In the first three steps, the bond documentation is evaluated with the aim of assessing, firstly, whether there is indeed alignment with principles or industry standards relating to the labeled ESG objective; secondly, to examine what the stipulated allocation of proceeds is or whether the pre-determined sustainability targets are material, and thirdly to scrutinize the impact reporting.

The last two steps require an analysis of the bond-issuing entity, to consider the issuer’s sustainability strategy and to evaluate the issuer’s conduct.

For green, social, and sustainability bonds, the bond must pass each of the five steps in order to become eligible for inclusion in Robeco’s strategies.

Once the universe of eligible ESG-labeled bonds is determined, a fundamental analysis is applied, which is part of the disciplined and repeatable investment process used by the Robeco Credits team.

To investors, verifying the credentials of ESG-labeled bonds is not only about addressing concerns around greenwashing. It is also a matter of ensuring that capital allocation aligns with asset owners’ and asset managers’ values and longer-term objectives.

“If we consider ESG bonds to be an important mechanism to channel financial resources to tackle climate or environmental issues, we as investors need to act responsibly and make sure that these selected green bonds are indeed financing truly green projects,” says Beteta Vejarano. “And we also need to make sure we avoid those projects or green bonds that do not generate any positive impact on the environment or on society. I believe this is our duty.”

The efficiency achieved through targeted allocation of capital is especially relevant in situations where ESG bonds empower investors to tackle large and seemingly overwhelming issues. “In emerging markets and in a region such as Asia, where one accepts that there are many issues to be addressed, it makes sense to follow a funding route that ringfences the use of proceeds. This frees one from the problem of needing to fix the whole company or the whole country,” says Thu Ha Chow, Portfolio Manager for Robeco Sustainable Asian Bonds. “It enables investors to isolate the returns, the risk, and the impact. As long as the structures are right, we can safeguard our investments.”

While the market in ESG bonds is still dominated by green bonds, it’s clear that social and sustainability bonds are gaining traction, while sustainability-linked bonds are still in the early stages of investor acceptance. “Social bonds gained a lot of attention in 2020, and the market expanded rapidly as debt was issued to alleviate the impact of the Covid-19 crisis on households and companies,” says Beteta Vejarano. There has been a shift since then towards funding to support economic recovery. Interestingly, most of this funding has had a green theme, with companies and countries aiming to ‘greenify’ their productive capacity, and many using green bonds to achieve this.

Initially, the issuance of social bonds was hampered by questions around the definition of what constitutes social impact. “While it has always been relatively easy to define green projects, it’s more complicated when it comes to defining and measuring a project with social impact,” says Chow. “But we’re making progress. For example, I’ve just evaluated a social bond whose proceeds are earmarked for housing. Here the use of proceeds is in line with the EU social taxonomy objective of ‘adequate living standards and well-being’ and is therefore consistent with social impact.”