Labelled green, social and sustainability (GSS) issuance is still a tiny component of the overall government sector bond market. Climate Bonds Initiative (CBI) reports total sovereign GSS issuance of just less than US$100 billion equivalent in 2021, about one-thirtieth of OECD estimates of marketable debt issuance by its members.

On the other hand, the number of sovereign GSS issuers continues to grow. CBI data reveal that there had been around 40 such issuers by the end of 2021, with issuance volume concentrated in Europe but plenty of activity coming from emerging markets, too.

Labelled bonds give investors that are just starting their journey with environmental, social and governance (ESG) integration in the sovereign sector a straightforward way of expressing their preferences.

“We are talking about a setting in which we have a group of investors that will increasingly be observing risks and climate related commitments, but do not have an action set to align with the risk assessment. In this context, I think sovereign labelled finance will continue to be popular,” argues Zoe Whitton, managing director at Pollination Group.

But even investors that are more progressed with ESG integration and are focused on whole-of-country assessment say GSS bonds have a value. Generally, the emphasis in this case is on what preparing GSS issuance says about a country – and what the country says about itself in its issuance plans – rather than a specific desire to own the labelled product.

“The value of labelled issuance depends on the credibility and sincerity of the projects, and the link to a country that is actually tilting toward a sustainable pathway,” says Mitch Reznick, head of sustainable fixed income at Federated Hermes. “If a country like Australia issued a green bond as a part of shifting its trajectory toward decarbonisation of assets, this is absolutely a credible use of green finance.”

In this context, he adds: “The key aspect is the framework governing the security itself. This is where we start, and it has to be strong – because it invests its credibility in all securities issued under it. We view green bonds as a measure of the sustainability credentials of the issuer itself, not just the transaction.”

Mexico provides a good example here. It issued a US$2.2 billion UN Sustainable Development Goal (SDG) bond in August this year. Before doing so, it went through the process of building a framework that matched its budget to the SDGs, thus providing transparency about what the bonds would be financing.

Reznick suggests Australia may be in the perfect position for green-bond issuance because it has ‘brown’ industries and therefore tilting its funding direction can have the most immediate impact. Such a bond would have to be an important piece of a larger decarbonisation strategy and framework, and an Australian green bond issued before the change of government in May 2022 would have been more difficult to understand, Reznick adds. Accountability would still be very important despite the change.

Ryan Myerberg, partner, portfolio manager and co-head of global taxable fixed income at Brown Advisory, says he is “incredibly excited” about the growth of sovereign GSS issuance but echoes the view that these bonds should form part of a clearly expressed and holistic strategy.

“With labelled bonds it is really important not only to be comfortable with the issue itself but to understand how the bonds fit into an overarching strategy or policy priorities,” he explains. “We need to understand the issuer itself, and its trajectory – what it is trying to accomplish.”

Ardea Investment Management principal and portfolio manager, interest rate strategies and macroeconomics, Tamar Hamlyn, is a sovereign GSS advocate but is realistic about pricing. The ‘greenium’ means, economically, that labelled issuance could be viewed as a form of price differentiation – matching price to customers based on their preferences, Hamlyn suggests.

It is a logical step for a sovereign to optimise its overall funding profile by offering a range of instruments. “Labelled green bonds or other types of certified product are very beneficial from a market acceptance perspective and they carry the right incentives in the sense of encouraging governments to realise they have assets they could fund at a cheaper rate,” Hamlyn says.

In the fullness of time, if governments package all their green assets and fund them through green programmes, all else being equal the quality and attractiveness of the remaining pool of assets will be reduced.

Hamlyn continues: “We shouldn’t kid ourselves that issuing green bonds is creating some sort of miraculous net positive improvement in overall risk profile. Unless we take steps to lower the overall risk activities of the government issuer in question, we are not actually addressing the underlying risks – we are just splitting them up differently.”

Over time, it may be that the weighted average yield a government has to pay across its “squeaky clean” green assets and its dirty brown assets is actually the same as it is paying now, Hamlyn suggests.

“This is certainly how things should progress: if there is no change in net risk the market should charge the same overall average funding cost. But I don’t think it will become clear until we have seen a much larger portion of overall issuance become green, because we are not at the point where the pools are substantially differentiated just yet.”