Thematic bonds - which include green, social, sustainability, and sustainability-linked bonds - are debt instruments, in which the proceeds raised are used for ESG-related activities and investments. The use of thematic bonds among sovereign issuers is likely to increase in the coming years, as countries aim to accelerate the energy transition, preserve nature, and combat climate change.
Dentons' new report, entitled "The Name is Bonds. Thematic Bonds." analyzes recent trends and data surrounding the use of sustainable debt around the world. It provides case studies and examples of how sovereign governments are using such instruments to increase access to financing, while also helping to achieve their ESG goals.
"The use of sustainable debt by sovereign governments, especially in emerging markets, can be a win-win for all involved. On one hand, emerging economies - which often struggle with the cost of maintaining their national debt - can access new sources of finance at reduced interest rates, while also investing in environmental protection and social infrastructure. On the other hand, investors and financial institutions have a strong appetite for sustainable investment as a way to fulfil their own ESG commitments," said David Syed.
Thematic bonds currently represent 5% of the global debt market. Of those, approximately 30% of thematic bonds are issued by sovereign states.
According to the Climate Bonds Initiative, in the last five years, thematic bonds have grown exponentially from just over US$200 billion in 2018 to $858.5 billion in 2022. After a peak in 2021, 2022 was the first year in history when sustainable debt issuances slowed down, but this was in line with the overall downward trend in debt capital markets. In H1 2023, $448 billion worth of sustainable debt was issued.
Ecuador's debt-for-nature swap demonstrates the vast potential of this type of financing for emerging economies. Through the historic transaction, it effectively bought back approximately $1.628 billion of sovereign debt in exchange for new debt of approximately $656 million, while freeing up an additional $323 million to fund its commitments related to the conservation of the Galápagos Islands and their marine ecosystems.
Governments in emerging economies see thematic bonds as a promising means to diversify their investor base, secure alternative sources of financing, and reduce the cost of financing. Likewise, emerging markets are likely to have major investment needs in areas such as energy optimization, education, housing, and nature conservation, and are more likely to be negatively impacted by climate change and natural disasters.
Challenges for thematic bonds include high issuance costs, complex processes, and difficulties in identifying eligible projects, and the lack of clear and consistent governance and reporting requirements, which could lead to greenwashing.
To make thematic bonds more accessible, particularly to governments in emerging economies, the report recommends increased standardization, and a streamlined process to simplify execution and reduce cost. Furthermore, the report highlights the need for improved governance, reporting and standardization, such as the recently published TNFD framework, to provide unified definitions and disclosure standards.
The report is free of charge and available for downloadhere.
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