Increasing investor interest in environmental, social and governance, or ESG, investment strategies has prompted a boom in related fixed-income products such as green bonds in recent years, and that trend is expected to continue, analysts with S&P Global Ratings Inc. said in a Sept. 10 report.
The ESG-related fixed-income market has seen a compound annual growth rate of 85% over the past five years and could result in $200 billion in bonds being issued in 2018, the report said. "While ESG has only recently emerged as a force to be contended with in the fixed-income market, we believe it is only likely to grow in prominence over time," the report said.
Investors are interested in ESG because it captures long-term and existential risks that may not be discernible on financial statements, the report said. "Climate change and resource scarcity, workplace productivity and product safety, along with technological advances and changing consumer preferences, are among the ESG-related risk factors that have real credit implications," the report said.
Regulators, particularly in Europe but also in China, are working to better integrate ESG concepts into the financial system as part of broader global climate and sustainable development commitments. And investors have put companies under increasing pressure to outline how they are addressing ESG-related risks and have begun avoiding certain investments based on their ESG preferences, the report noted.
This rise in investor demand has prompted new fixed-income markets dedicated to ESG themes, such as green bonds. The green bond market, in which proceeds are earmarked for projects with specific environmental objectives, is increasingly in-demand, the report said. A social and sustainable bond market has also emerged in which bonds are raised for social projects or for a combination of green and social initiatives.
Some issuers and investors have used the United Nations sustainable development goals, or SDGs, as an overarching ESG framework to align their bonds with positive impact. The UN has estimated about $3 trillion to $5 trillion will be needed annually to achieve the SDGs by 2030, which suggests the SDG market has significant growth potential, according to the report.
"As issuers return to the bond market to refinance debt or raise new capital, fixed income is poised to play an important role in illuminating ESG risks and driving capital toward projects with environmental and societal benefits," the report said. The report added that some challenges still exist to embedding ESG risks into the financial system, including a lack of ESG-related data and a limited understanding of how to best report and use ESG metrics in investment decisions.
S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.