creating impact through the bond portfolio

In recent years, French insurers have deployed significant resources to integrate sustainable and responsible investment approaches into their portfolio. In terms of their general assets, they have adopted sustainable investment policies and many of them now consider so-called “ESG” (Environment, Social, Governance) criteria in their investment choices, in addition to traditional financial analysis. Sustainable strategies have also made their debut in unit-linked insurance offers and, a sign of growing interest among policyholders, represent an increasingly large share of inflows. On the liability side, insurers, whose core business is to insure risks, obviously have a particular interest in understanding how sustainability risks could affect their financial obligations.

The importance of sustainable investment today in the strategic priorities of insurers reflects an awareness among the latter: the integration of sustainability factors into investment strategies offers more comprehensive risk management and helps to identification of potential new investment opportunities. This structuring change is also driven by various regulatory measures, in particular by the “Sustainable Finance Disclosure Regulation” (SFDR) and the European taxonomy of sustainable activities.

Today, faced with the urgency of these challenges, more and more insurers want to go beyond the integration of ESG dimensions and add so-called “impact” strategies to their sustainable investment systems. Indeed, impact strategies go beyond taking into account ESG risks and opportunities: impact investing is carried out with explicit objectives of positive and measurable environmental or social effects.

Impact and bond instruments: a new field of action

In its early days, sustainable investing, including impact strategies, was often associated with equity investments, both listed and unlisted. Today, applications in bond portfolios are just as widespread, and are of particular interest to insurers whose general assets are largely invested in debt products. Furthermore, the bond market is the largest asset class, providing a reliable source of capital for the implementation of sustainable development goals. Relatively little new financing comes from equity issues. As “owners,” equity investors seek to be gatekeepers to all activities in which the company is involved. Bond investors can choose to finance all or part of a borrower’s expansion through specific projects.

Here, thanks to the asset class of sustainability bonds, a new field of action opens up for insurers who want to combine the potential for financial return with a positive effect on the environment and society. Sustainability bonds finance specific sustainable investments within a company. These investments are made with the aim of generating positive, transparent, measurable environmental or social benefits, as well as long-term financial returns.

The sustainability bond asset class consists of several segments: Green bonds finance environmental projects. Social bonds support projects that have social objectives. These aim in particular to respond to issues that have become increasingly evident during the pandemic, such as health and education. A third segment is made up of bonds that finance both environmental and social impact projects (sustainable bonds). These first three categories of bonds relate to projects that contribute to the United Nations Sustainable Development Goals by financing companies’ efforts in favor of the climate, essential services, sustainable infrastructure, socio-economic progress or empowerment. Revenues are allocated to specific environmental or social assets with clearly defined impact measures through key performance indicators.

Finally, a fourth category is that of so-called “sustainability-linked bonds” (SLBs). The latter condition the interest rate on the achievement of sustainability objectives: if these objectives, measured by predefined key performance indicators, are not achieved, the borrower must pay a higher interest rate. For example, a utility company could use its production-based carbon emissions as a key performance indicator to measure its alignment with the climate goals of the Paris Agreement.

Social bonds: concrete answers to tangible problems

The social bond market is not yet as mature and diverse as the green bond market, but is one of the fastest growing segments of sustainability bonds.

Among the first social bonds are the International Finance Corporation’s “Banking on Women” bond in 2013 and the “Inclusive Business” bond in 2014. Following the publication of the Social Bond Principles by the International Capital Market Association in 2016, the first players in this new wave were public financial institutions, such as supranational organisations, government bodies and local authorities.

While some people mistakenly thought, especially when they first appeared, that investing in social bonds was at the expense of returns, the return/risk ratio of a social bond actually corresponds to that of a classic bond in the same transmitter. The social impact of the bond is an independent non-financial added value.

In recent years, social bonds have experienced very impressive growth and their investor base has diversified. Thus, between 2019 and 2021, this market increases from around 10 billion annual issues to more than 150 billion dollars. This growth is partly explained by the capacity of social bonds to finance solutions to face some of the major current challenges, such as gender inequality, or measures to support the economy during the pandemic. Indeed, the COVID-19 pandemic has highlighted the importance of social factors and their potential impact on asset values. Social risks, from employee well-being to relations with local communities, directly or indirectly impact a particularly wide range of issuers.

Insurers are therefore increasingly taking these social issues into account in their investment decisions. Social bonds allow them to go even further: they offer an effective means of responding directly to these issues by financing specific projects. These instruments are thus a fundamental element of the achievement of the 2030 Agenda of the United Nations Sustainable Development Goals. The multitude of solutions that they can finance make them a major player in social change. This can be for example: low-cost housing, essential infrastructure and services, job creation, food security, etc.

Beyond the current tangible problems related to the consequences of the pandemic, the attractiveness of the social bond market for insurers is supported by several underlying trends: social bonds are now widely used for large sustainable projects in the public sector . More and more companies want to reduce the social risks that impact their activities. Finally, the EU social taxonomy should help provide a regulatory framework that will make social bonds even more attractive. These kinds of new rules, when enacted, will no doubt help further support the social goals of sustainability.

Implementing bond impact strategies: the importance of cutting-edge expertise

Social bonds, like sustainability bonds in general, offer an eloquent example of the role that finance can play in directing investments towards specific sustainability objectives compatible with an attractive level of return. For insurers, the growth of this asset class opens up an interesting field of action for integrating impact strategies into their bond portfolios.

However, investing in this area is not without difficulty and requires solid expertise to analyze in depth the issuers, the bonds and the sustainable projects they aim to finance. Indeed, there are still no universal standards in this area and sovereign issuers are not subject to standards relating to the declaration of the results of their sustainable projects. This means that the key information relating to these bonds can be heterogeneous and that teams of specialists are essential to operate an optimal selection within the investment universe.

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