Why biodiversity bonds could have a record year
This type of debt is gaining traction as countries and firms are pushed to do more to protect nature and investors see potential in the asset class
BONDS incorporating biodiversity loss prevention and nature protection objectives account for almost a third of all debt issued this year with an environmental, social and governance (ESG) label.
In 2015, such bonds made up just 3 per cent of total issues. At this pace, the year’s total could come close to a record US$300 billion.
The surge is no aberration. A rapidly developing policy and regulatory framework now requires countries and companies to do more to protect nature, and plug an estimated biodiversity finance gap of US$700 billion a year.
For a growing number of investors, meanwhile, biodiversity restoration is seen as a potentially more cost-effective way to tackle global warming and meet net-zero goals.
Credit ratings agency Fitch said in a recent study that nature-positive portfolios are growing in popularity.
There is, then, every reason to believe that biodiversity bonds will account for an ever larger share of the US$6.5 trillion ESG bond universe.
A NEWSLETTER FOR YOU
Friday, 12.30 pm
ESG Insights
An exclusive weekly report on the latest environmental, social and governance issues.
Gaining prominence
Sovereigns and supranational institutions have been spearheading the development of biodiversity-related capital. The European Union and the World Bank were among the first to issue such debt.
They collectively account for around two-thirds of all biodiversity-related ESG debt issuance to date, according to the Institute of International Finance (IIF).
Corporate borrowers are also entering the fray in response to regulations and reporting standards requiring companies to consider biodiversity protection as part of their net-zero planning.
SEE ALSO
Two types of corporate biodiversity bonds have been in the ascendancy.
The first is the use of proceeds (UOP) bond, which raises money for sustainability projects.
Issuance of such bonds has grown in the past few years even as other types of ESG debt have flagged amid fears of a lack of transparency.
Among the most popular UOP nature bonds have been those that fund terrestrial and aquatic biodiversity conservation objectives – both recognised as an eligible UOP category by the International Capital Market Association.
These represent some 16 per cent of all new biodiversity bonds issued in 2023, up from 5 per cent in 2020, according to Fitch.
Among the issuers was Chilean pulp and paper company CMPC – which issued UOP bonds for sustainable forest and water management, and the restoration of native forests.
Finnish forestry company Stora Enso issued green bonds with proceeds earmarked for sustainable forest and water management, as well as pollution control, among others.
The Bank of China recently issued two biodiversity bonds with net proceeds allocated to biodiversity conservation projects as well as environmentally sustainable management of living natural resources and land-use projects.
The second type of biodiversity bond popular among corporate issuers is the sustainability-linked bond (SLB). The distinguishing feature of SLBs is a change of terms – such as coupons – should the issuer fail to meet performance objectives.
Brazilian pulp and paper company Klabin recently sold an SLB maturing in 2030, with 2025 as the trigger for the pricing of the next interest rate.
The company’s 2030 goals include:
- Reintroducing two species that are proven to be extinct in a certain habitat, and promoting the population reinforcement of four threatened species. The SLB’s coupon increases by 6.25 basis points if the target is not met.
- Cutting water consumption equal to or below 3.68 cubic metres per ton of production, representing a reduction of 16.7 per cent from 2018. The SLB’s coupon increases by 12.5 basis points if the target is not met.
Biodiversity hot spots
Corporate biodiversity bonds have been popular among issuers based in emerging markets. They have accounted for nearly two-thirds of all biodiversity-related corporate bond issues.
Asian-based borrowers are becoming more active in the market, accounting for nearly 20 per cent of all newly issued bonds. That is nearly as much as the combined amount issued by borrowers based in the United States and the eurozone.
Emerging-market corporate borrowers look likely to make greater use of biodiversity bonds. This is because populations in these countries, which are home to the world’s most diverse ecosystems, are more heavily dependent on nature for their well-being and prosperity – be it through agriculture, fisheries or tourism.
According to estimates from BloombergNEF, all the top 20 funding priorities for global biodiversity protection are located in emerging markets.
Emerging countries are also keen to finance nature-based solutions – considered effective from a cost point of view – for climate adaptation, as they brace themselves for the effects of global warming.
Nature risk and premium
Growing investor demand for biodiversity bonds may also reflect the favourable financial performance of the asset class.
The IIF noted that the median return of biodiversity fixed income funds stood at just over 10 per cent – outpacing conventional peers, which it calculated delivered 6.7 per cent last year.
The analysis chimes with a growing body of academic research that has uncovered the existence of a “biodiversity risk premium” in the fixed income market.
One study, which analysed the credit risk term structures of infrastructure companies, found that companies that manage biodiversity risks had up to 93 basis points better long-term financing conditions.
The difference was greater over longer lending periods – the slope showing one to 10 years was steeper than that for one to five years.
The credit default swap curve, the researchers concluded, indicates that investors perceive those risks as long-term issues in an industry especially vulnerable to a triple planetary crisis of climate change, biodiversity loss and pollution.
Biodiversity becoming material
Biodiversity has yet to become a mainstream investment in the green bond market, with only some 8 per cent of the total raised in the market directly funding nature protection efforts.
In comparison, over 50 per cent of funds are for renewable energy infrastructure.
The use and setting of biodiversity performance targets has significant room to improve as the current framework makes it difficult to quantify and monitor biodiversity gain or loss accurately.
Bodies such as the Taskforce on Nature-related Financial Disclosures and the Finance for Biodiversity Foundation are working with scientists to refine data monitoring and collection processes.
A more standardised biodiversity finance architecture should help investors ramp up their capital commitments for companies with nature restoration projects.
It could be a matter of time before nature-related bonds follow the same path as climate-related ones to become a standard environmental feature in the global sustainable fixed income market.
Sabrina Jacobs is senior client portfolio manager, emerging market fixed income, at Pictet Asset Management, where Philipp Buff is senior investment manager, developed market fixed income
Copyright SPH Media. All rights reserved.
