Future Trends in Sustainable Bank Bonds: Identifying Growth Barriers and Expanding Environmental Objectives

Only €18bn in EUR sustainable bank bonds fall due in 2024

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Identification of new assets (+)

There are also boundaries to the further growth potential via the identification of new sustainable assets or first-time issuers. Following the substantial issuance in previous years, more banks are reaching the limits of their available sustainable assets. Some banks also assign parts of their sustainable portfolios to deposit or commercial paper alternatives. These loans are then unavailable for sustainable bond market funding. Nonetheless, we continue to see banks financing new sustainable loan types – including, for instance, via separately established social bond frameworks in addition to their existing green bond frameworks. This will remain supportive to sustainable issuance.

 

Evolution of the green and social portfolio versus supply of Germany's largest issuer of sustainable bonds

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Financing of other environmental objectives (+)

Green bank bonds continue to (re)finance mostly loans for the purpose of climate change mitigation. However, they could also more often start funding other environmental objectives, such as climate change adaptation. Think of loans related to the implementation of physical and non-physical solutions to reduce physical climate risks as identified through climate risk and vulnerability assessments (CRVA).

In June 2023, the European Commission also published the Environmental Delegated Act. This sets the technical screening criteria for the remaining four environmental objectives of the EU Taxonomy, i.e., sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems. This may open further opportunities for the issuance of green bonds.

Sustainability-linked issuance (+)

Sustainability-linked bond supply is still more a corporates than a financials phenomenon. In 2023, one of the major Nordic banks issued its first EUR use of proceeds bond financing a portfolio of sustainability-linked loans (SLL) to companies with sufficiently ambitious climate change mitigation goals. Apart from that, there was no sustainability-linked issuance directly via sustainability-linked bonds (SLB), nor indirectly through the use of proceeds instruments financing sustainability-linked loans.

Use of proceeds SLL bonds have the advantage in that they do not have coupon step-up features linked to any sustainability KPIs at the level of the bond. These KPIs and interest rate step-up/step-down features are set at the level of the sustainability-linked loans financed by the bonds. There are therefore no coupon characteristics at the level of the bond that could be seen as an incentive for early redemption. The latter has made it difficult for banks to issue senior or subordinated bonds in SLB format eligible for a bank’s minimum requirement for own funds and eligible liabilities (MREL).

We believe that sustainability-linked issuance could develop more in the bank bond segment. Particularly against the backdrop of the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDD) requiring (non-)financial companies to disclose their transition plans.