Banks embrace alternative sustainable bonds as green loan supply diminishes

Banks are exploring innovative sustainable bond structures as they seek to expand their issuance capacity beyond the traditional green bond and capitalize on investor demand.

Financial institutions have been major issuers of green bonds to date, helping them to fund loans for activities such as renewable energy and electric cars while underscoring their own sustainability commitments. The volume of loans that can underpin these bonds is diminishing, however, and regulatory concerns mean other established alternative products, such as sustainability-linked bonds, are unsuitable for banks.

A key challenge for banks is that most of their carbon footprint resides in their lending book, meaning banks do not own the assets that need to transition, said Jacob Michaelsen, head of sustainable finance advisory at Nordea Markets. New financing structures will therefore be needed, he said.

“We need to see innovation in the market, as we did in the first place with the green bond and sustainability-linked loans,” Michaelsen said.

Analysts expect bank issuance of social bonds and instruments linked to transitional activities to grow.

Finland-headquartered Nordea Bank Abp in September 2022 sold a use-of-proceeds bond to finance its sustainability-linked loan portfolio, the first of its kind. Nordea Markets, the bank’s advisory unit, is in conversation with several other financial institutions about issuing a similar structure.

“We’ve received very strong support from investors and generally from the market participants,” Michaelsen said.

While issuers in other industries have adopted the sustainability-linked bond as a means to support their own transition, financial institutions have largely steered clear of this instrument due to regulatory barriers and investor concerns. Nordea’s hybrid bond instead offered a use-of-proceed structure — similar to that of green and social bonds — that issuers, investors and regulators are comfortable with, while the proceeds help to finance polluting companies that are in transition, Michaelsen said.

UK-based lender NatWest Group PLC in March issued a social bond that will finance loans to women-led enterprises, the first gender-focused bond from a European bank. The issuance raised €500 million from an order book of more than €1.75 billion at its peak.

“There was very strong investor demand,” said Scott Forrest, head of NatWest’s treasury debt capital markets. “We had a lot of interest and support because it was something slightly different. We saw a number of names in our order book that we’d not seen before.”

NatWest has seen growing investor interest in social bonds since its first issuance in 2019 as more funds have expanded their mandate to include social investments, Forrest said. This diversification of its investor base is a key benefit of issuing sustainable bonds, Forrest said.