By Rosl Veltmeijer, Portfolio Manager at Triodos Investment Management
Investors with a green heart have a growing range of sustainable investment options to choose from - from investments in sustainable energy projects and housing to cultural entrepreneurs and micro-financing. Another important investment option that has made big strides in recent years is impact bonds. But what exactly are they? And how can they help to make the world more sustainable and resolve social issues?
What are impact bonds?
Impact bonds work the same way as regular bonds, except that their proceeds are used to enhance sustainability or make a positive social impact. Impact bonds can be used for all sorts of purposes and in any sector, from social projects that help to reduce inequality or improve care for the elderly to projects that enhance public transport or sustainable energy projects.
You may be more familiar with the term ‘green bonds’. These are bonds that are used exclusively for funding green projects. The first green bonds were issued in 2007 by the European Investment Bank. The growing success of these green bonds widened the horizon for this bond category and led to them also being used to fund social projects. Hence, the term impact bond is now more appropriate.
Why do impact bonds exist?
The transition to a more sustainable world costs money. Take, for example, the European battle against climate change. To move that forward, the European Union (EU) last year presented the European Green Deal. It’s objective: to reduce CO2 emissions in the European Union to zero by 2050. By 2030 these emissions must already have been halved. Achieving this ambition will require an estimated one billion euro's in public and private investments in the next decade. It will be quite a challenge to raise such amounts of money through government subsidies and bank loans alone. Impact bonds may therefore offer an excellent alternative means of raising money for reaching the climate goals.
What are the risks?
The financial risks are similar to those of regular bonds from the same issuer. Both have the same credit rating.
How can I tell if an impact bond leads to positive change?
The so-called ‘Green Bond Principles’ are an important indicator for the further development of impact bonds. These principles were developed in 2014 by twenty global merchant banks and serve as a guideline for issuers of as well as investors in impact bonds. The European Union is now also preparing various guidelines and standards to ensure that impact bonds do actually contribute to positive change. The EU Green Bond Standard, for example, will be aimed at increasing the effectiveness, transparency and credibility of the green bond market. Furthermore, the EU Taxonomy (which could be considered as the ‘Oxford Dictionary of sustainability’) should provide more clarity about what is and what is not sustainable. Triodos Investment Management uses a strict assessment procedure for impact bonds. Transparency is an important criterion; the issuer must publish an allocation and impact report, describing what the money has been used for and what impact has been achieved.
What do impact bonds mean for the future?
The market for impact bonds has ballooned in recent years. Veltmeijer expects this trend to continue. On paper this is a positive trend, because theoretically impact bonds are very powerful weapons in the battle against climate change. But Veltmeijer also sees trends that cause her concern: “A green bond should be an instrument that helps companies to become greener. It should not be used as an excuse: ‘we issue green bonds, so we contribute to a better world.” This argument does of course not hold water if a company takes no further action to make its operations more sustainable. Impact bonds should definitely not be used as a green front for companies that are in fact not sustainable at all."