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Impact bonds
What’s behind the
exploding growth
in green and social
bonds markets?
Impact Bonds
Impact bonds have emerged from relative obscurity just a
few years ago to become a rapidly growing asset class today.
But what are green and social bonds, and what could the future
hold for the growth of the market?
The recent growth in the ESG investment market is best
highlighted by the Responsible Investment Association
Australasia (RIAA), who reported a 24% increase in “core
responsible investment” assets under management for 2014
compared to 2013. RIAA also found that 50% of total assets
under management in Australia are now held by funds with
environmental, social and governance (ESG) factors integrated
into their investment selection process.
Figure 1 |Kg[aYdAehY[l:gf\ÕfYf[af_hjg[]kk1
Private
investors
Traditionally, this type of investment has been based on
channeling funds into equities that don’t do harm. What
is now emerging is growth in impact bonds that seek to
do “good,” that is channeling investment to purpose-driven
endeavors that have social or environmental outcomes
as a core function of the activity.
Private
money
Target
population
| Impact bonds
Public
money
Recognizing the need for integrity, the green bond market
has seen the development of the Green Bond Principles (GBP)
and the Climate Bond Initiative (CBI), which have established
requirements to be met by green bonds. Both the GBP and the
CBI view assurance as a key element in unlocking the additional
“ethical” value of green bonds and assuring their long-term
integrity.
The social and wider impact investing bond market is yet
to develop a similar set of requirements that can be applied
universally, due to the complexity and range of social and
environmental outcomes. As the G8 Social Investment
Taskforce in 2014 pointed out, although some methods (such
as SROI), guidelines (such as UN Global Compact, Integrated
Reporting Framework) and optional standards (IRIS Metrics,
Global Impact Investing Ratings System [GIIRS]), can form
a technical basis for performance, no required standard or
formalized reporting and disclosure regime exists. The market
akhj]k]fldq\]n]dghaf_ZYk]\gfZgf\kh][aÕ[gml[ge]kYf\
performance approaches to provide investors with comfort
over the integrity of the bond.
1
1
Government
Service
provider
What are impact bonds?
Impact bonds are debt instruments, most
commonly referred to as green or social
bonds, which associate the proceeds of
a bond issue to environmental or social
Y[lanala]k$[j]Ylaf_jaf_%^]f[]\\]ZlÕfYf[]
for green and social investments. Impact
bonds can take a number of forms — self
issued, corporate, project, plus more exotic
hybrids — but their common theme remains
the focused use of funds raised by the bond
Y_YafklY\]Õf]\k]lg^_j]]fgjkg[aYd
outcomes. The impact bond market is still
in its infancy, and will need to overcome
some challenges facing the sector to
become a major source of debt capital.
For ESG investors, a key issue will be the
integrity of impact bonds, both at issue
and over the tenure of the bond.
Social
Z]f]Ôl
bond user
J Liebman (2011). Kg[aYdAehY[l:gf\k29hjgeakaf_f]oÕfYf[af_eg\]dlg
accelerate social innovation and improve government performance. Center for
American Progress)
Risk and return
In addition to generating positive outcomes for society and the
]fnajgfe]fl$aehY[lZgf\k`Yn]YlljY[l]\ka_faÕ[Yfl\]eYf\
from private investors.
So far, most large corporate green bond issuances have had
recourse to the bond issuer, meaning they are issued at the
credit rate of the issuer and offer a similar return to standard
corporate debt. This structure has been popular as it attracts
institutional investors looking for investment grade bonds.
The reason investors like to invest in green bonds is they
are seen as superior to similar risk and return “non-green” debt
products as they have the extra “ethical value” that is sought
by ESG investors. Issuers of green bonds have reported the
Z]f]Õlkg^YlljY[laf_f]o=K?afn]klgjkl`Yl\an]jka^qYf\
expand their funding sources. Issuers also use green bonds
to promote their own ESG actions.
The social bond market has attracted investment through
higher risk/return characteristics, which can be bespoke
given the relatively small issue size compared to green bonds.
9kljgf_]pYehd]g^l`akak9mkljYdaYÌkÕjklkg[aYdaehY[lZgf\
‘Newpin’, backed by the New South Wales government, which
generated an interest rate of 7.5% in 2014, well above the
average of 2.9% for medium-term returns.2 Under the Newpin
bond, the government provides payments based on the
proportion of children participating in the program that are
restored to their families, which then impacts investor returns.
Afl`]Õjklq]Yjg^l`]Zgf\l`]F]ohafhjg_jYe`Y\Y
60% restoration rate, which under the bond’s terms delivers
a 7.5% return. Going forward, a 65% restoration rate will
deliver a 12% return, and a 70% rate will see a 15% return.
2
Of course, as with any investment, impact bonds carry a
degree of risk. Since investor return is intrinsically linked to the
success of the program, investors must place their trust in the
effectiveness of the service provider. With the Newpin bond,
afn]klgjkYj]_mYjYfl]]\Yeafaeme-j]lmjf^gjl`]Õjkl
three years, however if the restoration rate is below 55% in
subsequent years the interest rate is nil. Because social bonds
Yj]Yj]dYlan]dqf]oÕfYf[aYdafkljme]fl$l`]j]akfgljY[c
record with which to make informed decisions, and similarly
little credit history for the service providers. The present scope
of social bonds is also limited by the metrics on which
performance is based. The outcome metric, its measurement,
Yf\n]jaÕ[Ylagf$^gjehYjlg^l`]Zgf\afkljme]fl&L`]YZadalq
to demonstrate that the outcome has been achieved is a crucial
factor in outcomes based payments. Furthermore, investors
are required to put their faith in the fact that the government
department that signed the initial contract will honour their
commitment many years down the line (generally a low risk
except if dealing with some regional Government bodies).
There is also growing acceptance that the outcomes that many
green or social bonds deliver may be valued higher in the
future. For example, the potential upside associated with
carbon abatement technologies should the policy environment
shift globally, may make investing in green bonds attractive
for longer term investors.
Shane Oliver, ‘What return can you expect in this market?’, ASX Investment
and Finance Newsletter, June 2015, http://www.asx.com.au/education/
investor-update-newsletter/201506-what-return-can-you-expect-in-thismarket.htm.
Impact bonds |
2
Growth of the impact bond market
Green bond market
More than US$35 billion in green bonds were issued worldwide
in 2014, a growth rate of approximately 300% from 2013.
This year’s issuances look set to equal the 2014 record with
issuances of approximately US$25 billion so far (as of
September 2015).
To-date, international and supranational entities such as the
World Bank have dominated the green bond market, and
[gflafm]lg\]egfkljYl]ka_faÕ[Yfl_jgol`afZgl`ngdme]Yf\
issuance size. However, the most exciting element of this
growth is the explosion of issuances from corporate entities,
o`a[``Ykd]\lgf]oÕfYf[af_kljm[lmj]ke]]laf_f]]\kg^l`]
issuers and investors.
Figure 2 | Volume of green bonds issued since 2007
Volume of green bonds issued (US$ billion)
30
Recent corporate green bond issuances have been heavily
oversubscribed, with many bonds increasing their size due
to high demand. This high demand may represent the extra
“ethical” value investors receive from green bonds compared
to their traditional counterparts. Such oversubscriptions have
resulted in investors driving the growth for “green” investment
options.
Table 1 | Examples of corporate issued green bonds
40
35
Akkm]jkg^_j]]fZgf\k`Yn]j]hgjl]\logeYafZ]f]Õlkgn]j
traditional bonds: attracting new investors and supporting
issuer’s ESG objectives. Green bonds have so far been issued
at similar prices to corporate debt of the same tenor
(investment period) and investment grade, suggesting that
afn]klgjkYj]q]llgYddg[Yl]Ykh][aÕ[=K?nYdm]lg_j]]f
bonds. However, further maturity of the green bond asset class
may see green bonds issued at a discount to traditional bonds,
as investors recognize the tangible ESG value of green bonds
over standard bond issues.
Other
Issuer
Size /
Currency
Coupon
and Tenor
Sector
:]f]Ôlk
GDF Suez
EUR2.5
billion
1.375% —
6 year
(Two
tranches)
2.375% —
12 year
Energy
]^Õ[a]f[q
and
renewable
energy
64% of issue taken
by socially responsible
investors
Berkshire
Hathaway
US$1.0
billion
5.375% —
22 year
New solar
plant
Bond size increased
from $770m due to
demand
Toyota
US$1.75
billion
0.19% —
5 year
Transport
Attracted traditional
and new investors and
allows more people to
lease “green” cars
Financials
Corporate non-Õnancial
Municipalities/ cities
25
Supranationals
20
15
10
Bond size increased
from $1b due to demand
5
ANZ
0
2007
3
Aim to increase growth
in renewable energy
Yf\]f]j_q]^Õ[a]f[q
sectors and meet
corporate ESG targets
| Impact bonds
2008
2009
2010
2011
2012
2013
2014
AU$0.6
billion
3.25% —
5 year
Renewable
energy,
commercial
buildings
125% oversubscribed
Achieved goal of
afn]klgj\an]jkaÕ[Ylagf$
attracting new investors
Social bond market
The social bond market is in an earlier development stage
l`Yfl`]_j]]fZgf\eYjc]lYf\[mjj]fldqka_faÕ[YfldqkeYdd]j
in size, however it is also displaying rapid growth. The key
difference from the green bond market is that all issuances
so far for social bonds have a government party involved,
Ykl`]qYj]Yc]qÕfYf[aYdklYc]`gd\]jafl`]ljYfkY[lagf&
One limitation on the market progression of social bonds
is the current absence of formal schedules of outcome value
to government that could be used as a universal basis for
h]j^gjeYf[]Yf\af[j]Yk]ljYfkY[lagf]^Õ[a]f[a]k^gjf]o
bond issuances.
Development of outcomes measurement frameworks that
balance commercial and social returns and subsequently
enable the valuation of these outcomes for both public and
private sector participants is crucial for the ongoing success
g^l`ak]e]j_af_afn]kle]fleYjc]l&:mad\af_[gfÕ\]f[]afl`]
value of the outcomes of the bond issuance whilst maintaining
alkÖ]paZadalqak[gehd]p$Yf\hYjla]kaf\]h]f\]fllgl`]
transaction will likely need to be involved to ensure
transparency.
Figure 3 | Social Impact Bond development over time3
Figure 4 | Active Social Impact Bonds by sector4
40
3
35
4
UK
US
30
18
Australia
Germany
25
Netherlands
13
Belgium
Canada
20
Social welfare
Employment
Criminal justice
Education
Portugal
15
10
5
Sep 14
Dec 14
Jun 14
Mar 14
Sep 13
Dec 13
Jun 13
Mar 13
Sep 12
Dec 12
Jun 12
Mar 12
Sep 11
Dec 11
Jun 11
Mar 11
Sep 10
Dec 10
Jun 10
Mar 10
0
3
The Potential and Limitations of Impact Bonds’, Global Economy and
Development at Brookings, http://www.brookings.edu/~/media/Research/
Files/Reports/2015/07/social-impact-bonds-potential-limitations/ImpactBondsweb.pdf?la=en
4
‘The Potential and Limitations of Impact Bonds’, Global Economy and
Development at Brookings, http://www.brookings.edu/~/media/Research/
Files/Reports/2015/07/social-impact-bonds-potential-limitations/ImpactBondsweb.pdf?la=en
Impact bonds |
4
Payment by Outcomes —
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Impact bonds are being issued under a new innovative form
of payment, known as Payment by Outcomes, Payment for
J]kmdlkgjHYqe]fl^gjKm[[]kk&L`ake]l`g\g^ÕfYf[af_
involves a bond issuer entering in to a contract with private
investors or donors that supply the project’s up-front costs,
the private investors then hold a separate contract with the
government that pays out only on the successful delivery
of social or environmental outcomes. A methodology for
measuring the environmental or social outcomes is agreed
upon between the parties before the contract is entered
and the measurement process is often carried out by an
af\]h]f\]fll`aj\hYjlqlgYnga\Yfq[gfÖa[lg^afl]j]kl&
Other examples of Payment by Outcome bonds:
L`ak^gjeg^ÕfYf[af_akaf[j]Ykaf_dqg^afl]j]kllg
_gn]jfe]flko`gYj]YZd]lgk`a^llgoYj\kÕfYf[af_gml[ge]k
jYl`]jl`Yfafhmlk&Afl`akoYql`]qZ]f]Õl^jgeegnaf_l`]
ÕfYf[af_jakcg^hjgb][lklgl`]afn]klgjYf\k]jna[]hjgna\]j
partnership, thus reducing public money spent on achieving
the desired social or environmental outcomes. Theoretically
this reduction in government expenditure across a portfolio
of activity would be greater than the overall payments to
private investors.
9f]pYehd]g^YHYqe]flZqGml[ge]kÕfYf[af_kljm[lmj]
is the Emissions Reduction Fund set up by the Australian
Government. This is currently Australia’s key climate change
mitigation mechanism, which funds the purchase of
greenhouse gas emissions abatement only after it has been
achieved through a reverse auction process. This style of
structure means the government avoids investing in climate
change mitigation projects that don’t achieve their expected
outcomes and the reverse auction mechanism ensures the
government pays the lowest cost available for the abatement
they purchase.
Bond name
Country and year issued Entities involved
Social outcome
Tenor and return
Benevolent Society
Kg[aYd:]f]Õl:gf\
Australia — 2013
Unhealthy family
environments for
children
The bond launched with AU$10 million from investors.
NSW State Government
Outcome funder
CBA and Westpac
Investors
Special Purpose
EntityBond issuer
Benevolent Society
Implementation of
the project
Duo for a Job
Belgium — 2014
Actiris (Brussels-Capital
Region Employment
G^Õ[]!
Outcome funder
Kois Invest
Investor
Kios Invest
Bond issuer
Duo for a Job
Implementation
of the project
5
| Impact bonds
Funding goes towards
Resilient Families, an
intensive family support
program designed to
keep children and their
families safe and avoid
entry to out of home
care.
The bond is structured with two tranches with different
jakcYf\j]lmjfhjgÕd]k2;dYkkH [YhalYdhjgl][l]\!Yf\
Class E (subject to 100% loss of principle if performance
improvement is less than 5%).
If the performance improvement is >40%, Class P interest
return = 10%
Class E interest return = 30%
Unemployment
Investment of EUR234,000 from the investor.
Participants are matched
with local retirees who
ogjc]\afl`]Õ]d\g^
the participants interest,
and who offer advice for
6 months and put them
in contact with suitable
employers.
If reemployment rate is between 0-10% payment gradually
increases from 0-100% of initial investment.
If improvement is beyond 10% investors incrementally
earn higher interest up to 6%.
The future
As we move closer towards our planetary boundaries
(e.g. global greenhouse gas emissions limits and social inequality)
environmental and social issues will become increasingly
prominent, requiring more urgent action from governments,
investors and corporates. This increase in ESG awareness is
driving demand for innovative solutions to these problems,
including green and social bonds.
Increased awareness of these issues is best highlighted
in the actions being taken by governments, investors and
corporates in the lead up to the Paris COP21 in December
2015. The world’s largest investors have made pledges
to reduce the greenhouse gas emissions intensity of their
investments, in some cases excluding investments in whole
sectors such as thermal coal mining. Governments have
pledged country level greenhouse gas emissions reduction
targets and corporates have formed coalitions to promote
pricing greenhouse gas emissions. The combination of these
Y[lagfkoaddka_faÕ[Yfldqaf[j]Yk]l`]\]eYf\^gj_j]]f
projects that address the issue of climate change and
should lead to continued growth in the green bond market.
Another area of potential growth comes from the key
difference in the current structure of green and social bonds.
Past growth in the green bond market has largely been driven
by corporate issuances offering similar returns to similar
corporate debt. Recent growth in the social bond market
has been driven by the Payment by Outcome funding model
which involves a government body paying investors for the
level of success of the project. If these different structures
are applied to the other bond market, new areas of growth
may be unlocked.
These bonds represent reduced costs for social welfare
programs and lower levels of risk for government, while
offering investors potentially above average returns and clear
repayment thresholds. Most importantly they provide a new
and potentially large source of funding for service providers
to tackle important social and environmental issues.
In the green bond space, governments and corporates spend
large amounts of money on environmental aid as well as
social aid, meaning the green bond market could expand into
Payment for Outcome structures which would provide an
additional revenue stream to green bond structures. In turn
this could open up the possibility of green bonds being issued
at a higher rate of return than similar debt products, which
would immediately attract huge demand.
In the social bond space, one area of anticipated growth
is in International Aid and Development Assistance, where
US$140 billion of aid is invested globally every year. In an
era where donors are looking for innovation in aid, they are
increasingly looking to business as a partner in development
to help achieve outcomes like jobs for the poor. The scope and
structure of the new Sustainable Development Goals provide
the prospect for a universal approach to outcomes payments
for all international donors and potential investor projects
in an emerging social bond market. Payment for Outcome
kljm[lmj]k[gmd\]phYf\Z]qgf\_gn]jfe]flÕfYf[]\hjgb][lk
to address social problems where corporates or philanthropists
currently spend money to improve their social license to
operate. For example, the Coca Cola Foundation has spent
over US$650 million addressing social issues. The Foundation
is currently focusing on female empowerment, access to water
and well-being. It is likely that the social bond market could
then see the same kind of growth from corporate issuances
that the green bond market witnessed in 2013 — 2015.
Impact bonds |
6
Contacts
Mathew Nelson
9kaY%HY[aÕ[EYfY_af_HYjlf]j$;daeYl];`Yf_]Yf\KmklYafYZadalqK]jna[]k
Tel: +61 3 9288 8121
[email protected]
Krishna Sadashiv
9K=9FD]Y\]j$;daeYl];`Yf_]Yf\KmklYafYZadalqK]jna[]k
Tel: +65 6309 8813
[email protected]
Dr. Matthew Bell
G[]YfaYD]Y\]j$;daeYl];`Yf_]Yf\KmklYafYZadalqK]jna[]k
Tel: +61 2 9248 4216
[email protected]
Ivan Tong
;`afYD]Y\]j$;daeYl];`Yf_]Yf\KmklYafYZadalqK]jna[]k
EY | Assurance | Tax | Transactions | Advisory
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