OECD Sovereign Borrowing Outlook 2023

Report

OECD Sovereign Borrowing Outlook

22 May 2023

2. Sovereign sustainable bonds: Issuance trends and practices

Abstract

The sovereign sustainable bond market is evolving, with new issuers and new approaches such as sustainability-linked and transition bonds. The years running up to 2022 saw a marked increase in the pace of sovereign sustainable bond issuance. After declining in 2022, issuance activities in the first four months of 2023 indicate a strong rebound. The long-term future of this market depends on a variety of demand- and supply-side factors, including continuity of strong investor demand and simplification and standardisation across the bond lifecycle, from issuance procedures to impact reporting.

Drawing on a wealth of data sources including a recent survey of issuers, this chapter delves into trends, benefits, and challenges associated with sovereign issuance of sustainable bonds, and presents country practices that can assist sovereign issuers in their efforts to meet those challenges.

2.1. Introduction

This chapter builds upon the discussion on sovereign sustainable bonds from the 2022 Sovereign Borrowing Outlook (SBO) by providing a comprehensive overview of the sovereign sustainable‑bond market, emphasising the latest trends in issuances and the operational aspects of these issuances. The analysis utilises survey data, market data, and debt management offices’ (DMOs) framework, allocation, and impact reports. The structure of this chapter is organised as follows: it begins by analysing the trends in sovereign sustainable bond issuance. It then delves into OECD practices, supplementing the survey-based analysis by examining the framework, allocation, and impact reports of OECD countries. Finally, the last two sections investigate the primary challenges in and the prospects for sovereign sustainable bond issuances.

Key findings

After more than doubling between 2020 and 2021, sovereign sustainable bond issuance decreased by 18% in 2022. This first-ever decline was primarily due to reduced activity from large issuers, and the appreciation of the US dollar, which diminished the value of issuances denominated in other currencies.
The stock of sovereign sustainable bonds now exceeds USD 325 billion globally, with two‑thirds issued by advanced economies (AEs). However, despite recent rapid growth, sovereign sustainable bonds represent a small share of total sovereign bond issuances, averaging 2.2% for AEs and 8.1% for emerging market and developing economies (EMDEs) in 2022.
Majority of sovereign sustainable bonds are euro-denominated and sustainable bonds have longer maturities. The large volume of Eurozone issuances means more than half of the outstanding sustainable bonds are denominated in euros, followed by US dollars, largely from the issuance of EMDEs in international bond markets. Maturities are on average five and two and a half years longer than conventional bonds for AEs and EMDEs, respectively.
Green bonds have maintained their dominance in the sovereign sustainable bond market, accounting for over 75% of sovereign sustainable instruments mainly issued by AEs. New approaches such as sustainable and sustainability-linked bonds, developed to overcome some of the challenges of green bonds, are more popular among EMDEs.
Most sovereign sustainable bond proceeds are directed towards clean transportation, energy efficiency, renewable energy, and sustainable water and wastewater management. However, countries have a wide and varied range of eligible expenditures based on their investment strategies and characteristics.
Sovereign debt managers face major challenges in issuing sustainable bonds, notably administrative burdens in identifying eligible projects and reporting on funds’ use and impact, a lack of internal expertise, and a general lack of eligible projects in budgets, which existing green budgeting practices can help address.
Further progress is required to lift the integration of environmental and social factors in public debt management practices and to promote robust and liquid sustainable bond markets, including through greater standardisation of sustainable products and related taxonomies and impact reporting, expanding eligible expenditures, and sustained growing investor demand for sustainable investing and sustainable products.
A wider adaptation of green budgeting, which is a form of outcome‑based budgeting that evaluates the impact of expenditures and budgetary measures, can further support the issuance of sustainable bonds.

2.2. Recent trends in sovereign sustainable bond issuance

2.2.1. Sovereign sustainable bond issuances declined in 2022 after peaking in 2021

Sustainable bonds refer to an emerging category of financial instruments that have captured the attention of investors. These bonds can be categorised into three primary types. Firstly, based on the use of proceeds, which includes green, social, sustainability, SDG (Sustainable Development Goal), and transition bonds. These instruments are explicitly designated for projects that deliver positive environmental and/or social outcomes. Secondly, based on Key Performance Indicators (KPI), known as sustainability-linked bonds, which tie financial performance to pre‑determined sustainability targets, often through non-binding documentation. Lastly, there are unlabelled bonds, which are deemed ESG-compliant based on a second-party opinion. While these are more common amongst corporate issuers, some sovereign cases may also exist. This chapter will delve into the nuances of sovereign sustainable bonds by exploring these distinct types and their implications for both investors and issuers.

Sustainable bonds have gained ground in the government bond market in recent years on the back of robust market demand and supply. On the demand side, the number of investors who are committed to responsible investment and integrating environmental and social factors into their investment decisions and processes is rapidly increasing (e.g. Norwegian Global Fund, Denmark’s ATP Pension Fund, Swedish National Pension Fund and the California State Teachers’ Retirement System) which, in turn, supports portfolio investments in sustainable securities. On the supply side, the growing issuance momentum was sustained between 2016 and 2021, with a more than tenfold increase in gross amounts in this period. The trend accelerated in the wake of the COVID‑19 pandemic, due to both the sudden increase in borrowing needs prompted by the pandemic, and by governments’ expanding social and climate agenda and efforts to promote sustainable finance markets (OECD, 2022[1]). Hence, the issuance amount reached record levels in 2021, at around USD 129 billion (Figure 2.1 Panel A).

After rising with a growth rate of 115% from 2020 to 2021, the issuance amount declined by 18% to USD 106 billion in 2022 (Figure 2.1 Panel A). While this was the first decline in issuance since the debut of these instruments in 2016, levels are still relatively high, with the amount issued in 2022 almost double that of 2020. The decrease in 2022 in sovereign sustainable bond issuance is also reflected in the relative share of the issuers’ gross borrowings in marketable debt, meaning that the decline in overall government borrowing needs in the same year (see Chapters 1 and 3 for details) does not explain the reduction in labelled issuances. More precisely, after peaking at 2.8% in 2021, the ratio of sovereign sustainable issuance to total issuances declined to 1.9% in 2022 (Figure 2.1 Panel B).

It should be noted that the decrease in sovereign sustainable issuance was more acute for emerging market and developing economies (EMDEs), which issued 26% less in 2022 than in 2021, compared to 14% for advanced economies (AEs). Nevertheless, despite a reduction in the share of EMDEs in global sovereign sustainable bond issuances, as a share of their respective total gross borrowings, EMDEs issued significantly more sovereign sustainable bonds than AEs since 2018 (e.g. 1.5 times more in 2022).

This relative and absolute decrease in sovereign sustainable bond issuances in 2022 can be attributed to three main factors. Firstly, 2021 was an exceptional year as large issuers of sovereign government bonds debuted in this market, such as Italy, Spain and the United Kingdom, which contributed to doubling the amount issued in that year compared to 2020. Secondly, 89% of the issuances were made in currencies other than the US dollar. Given the substantial appreciation of the USD in 2022, issuances in dollars also diminished due to a pure foreign exchange effect. This effect accounts for roughly one‑third of the reduction (i.e. 6 percentage points of the 18% reduction). Lastly, four of the top five issuers (i.e. Chile, France, Italy, and the United Kingdom) reduced their issuances in 2022.1

Figure 2.1. Sovereign sustainable bond issuance trends in advanced and emerging market economies

One factor behind the reduction in the issuances from large issuers of sustainable bonds, comprising both AEs and EMDEs, is the limited size of eligible expenditures; France and Chile, two large issuers, attributed their lower issuance amount in 2022 to this. In France, the envelope of green expenditure for Green Bonds, including public subsidies for renewable energies, was revised downward against the backdrop of a lack of need for subsidies for renewable energy tariffs in 20222 (Agence France Trésor (AFT), 2022[2]).3 In the case of Chile, the country’s borrowing needs are declining, as is the size of its eligible expenditures and room for sustainable bonds, despite a favourable environment with stable investor demand and improved pricing and liquidity conditions for these instruments (Annex A).4

It is worth highlighting that corporate sustainable bond markets have been following a similar trend to sovereign bond markets. In 2016, companies issued USD 74 billion in Sustainable bonds and issuances peaked in 2021 at USD 622 billion, a more than eight‑fold increase over five years. Total issuance fell in 2022 but remained high, at USD 516 billion. However, there is a noteworthy difference between sustainable sovereign and corporate bond markets: sustainable bonds are relatively more commonplace for companies. For instance, the ratio of sustainable bonds to total bond issuances by non-financial corporates was 13% in 2021 and 15% in 2022.

2.2.2. The first four months of 2023 marked a historic high in the amount issued

In the first four months of 2023, the sovereign sustainable bond market witnessed the entry of several new participants. Israel issued USD 2 billion in 10‑year green bonds through an international offering on 25 January. India introduced its debut 10‑year Sovereign Green Bond in January, amounting to INR 80 billion (USD 1 billion), and followed up with a second issuance of the same value in February due to the positive response. In March 2023, Slovenia made its first issuance worth USD 1.25 billion. In addition, Türkiye and Cyprus issued 7‑year and 10‑year sovereign sustainable bonds valued at USD 2.5 billion and USD 1.1 billion, respectively.

From January to 26 April 2023, governments issued sustainable bonds worth approximately USD 60 billion – higher than the issuance in the same period over the past six years. This figure is nearly triple that of 2022 and 60% higher than the previous record set in 2021. The momentum of sustainable bond issuance is anticipated to carry on in the coming years, encompassing both OECD member countries and various emerging market economies. Potential debut issuers within the next 12 months include Greece and Iceland among the OECD members, and Brazil and the United Arab Emirates among EMDEs.

2.2.3. The number of sovereigns issuing sustainable bonds continues to increase

The number of sovereign issuers of sustainable bonds has increased rapidly since the issuances from Poland in 2016 and France in 2017 (followed by Fiji and Nigeria in the same year) (Figure 2.2). Twelve countries debuted issuance in 2020 and a further 16 in 2021, amid increased government borrowing needs due to the COVID‑19 pandemic, which widened the scope for new instruments, as well as governments’ increased willingness to meet their Paris Agreement commitments and UN Sustainable Development Goals. In 2022, ten new countries issued their debut sovereign sustainable bonds, below the number of new issuers in 2021 and 2020.

As of April 2023, 55 countries have already issued such instruments since the first in 2016. Of these, 24 are European, 11 are African, 11 are Asian, four are South American, three are from Central or North America and the remaining two are from Oceania. As a share of the number of countries in each continent, 55% of all European nations already issued a sovereign sustainable bond, followed by 33% in South America, 20% in Africa, 23% in Asia, 14% in Oceania and 13% in Central and North America. It is worth noting that the three largest issuers of sovereign bonds, Japan, the People’s Republic of China (hereafter ‘China’) and the United States, have never issued a sovereign sustainable bond.

Figure 2.2. New sovereign issuers by year of debut issuance

As expected in a growing market, the volume share of issuances made by new issuers (i.e. countries that issued for the first time in a given year) has been decreasing on an annual basis (Figure 2.3). At the same time, sovereign issuers, especially large issuers, are committed to mainstreaming sustainable bond issuance in their annual strategy and sustaining the liquidity of debt securities on both primary and secondary markets. For example, 15 out of the 24 countries that issued sovereign sustainable bonds for the first time in 2020 or before issued in all years following their first issuance, while only nine went for sporadic issuances. As many sovereigns have already issued their first sustainable bond market, future issuances will rely on recurrent issuances instead of on debut issuance. Recurrent issuance of these bonds is important to support the deepening of the market and ensure the entrance of new issuers, influenced by leading examples. In addition, this would create positive spillovers to the private sector, especially by setting up a benchmark for private issuers, and could generate crowding effects (OECD, 2022[1]).

Figure 2.3. Issuer trends: new entrants vs recurrent issuers

2.3. Composition of the outstanding sovereign sustainable bonds

2.3.1. AEs account for the majority of all sovereign sustainable bonds’ stock, with France and Germany accounting for roughly one‑third of it alone

In terms of the USD 326 billion outstanding in sovereign sustainable debt as of 2022, Figure 2.4 shows, in descending order, that France, Germany, the United Kingdom, Italy, the Netherlands, and Belgium are the largest AEs sovereign issuers, accounting for 65% of all the debt stock combined. Chile is the only EMDE that makes up more than 5% of all the sovereign sustainable bond stock, with 8% of the total stock and 30% of all EMDEs stock. In descending order, other EMDEs comprising more than 5% of the EMDE stock are Serbia, Thailand, Mexico, Indonesia, Peru and Hungary. It is worth noting that although OECD EMDEs (a group comprising Chile, Colombia, Costa Rica, Hungary, Mexico, Poland, and Türkiye) account for only 11% of EMDEs’ total outstanding sovereign debt, they make up 47% of all EMDE sovereign sustainable bonds’ outstanding amount. In addition, the European Commission might shortly become the largest player in the sustainable bond market – the European Commission plans to continue funding NextGenerationEU (an instrument designed to help repair the immediate economic and social damage caused by the COVID‑19 pandemic) through the issuance of green bonds, which could amount to EUR 250 billion, or 30% of the programme’s total needs (European Commission, 2023[3]).

Figure 2.4. Country composition of outstanding sovereign sustainable bonds

Naturally, the more debut issuers that join the sovereign sustainable market the more the outstanding amount is distributed across countries. The share made up by EMDEs rose from 8% in 2017 to 35% in 2021 and remained roughly stable in 2022. As a share of their total sovereign marketable debt stock, sustainable bonds account for 1.7% of the outstanding amount issued by AE sovereigns and 3.0% by EMDE sovereigns. In no advanced economy did this share exceed 10%, while for ten EMDEs this value exceeds 30%, including Chile.

2.3.2. The euro remains the preferred currency in sovereign sustainable bond issuances, accounting for half of the issuances in 2022, down from 60% in 2021

In 2022, the euro maintained its position as the primary currency of choice for sovereign sustainable bond issuances, representing over 51% of the total issuance, a decrease from 60% in 2021 (Figure 2.5 Panel A). The proportion of sovereign sustainable bonds denominated in US dollars diminished from 14% to 11% in 2022, while the British pound constituted approximately 11% of the annual issuance in 2022, a decline from 18% in 2021. Other currencies, such as the Canadian dollar, Chilean peso, Colombian peso, Mexican peso, New Zealand dollar, and West African CFA franc, comprised the remaining 26% of the 2022 issuance. The predominance of the euro can be attributed to the considerable number of EU countries issuing such bonds. In fact, 85% of all sustainable bonds issued since 2016 in euros originate from the euro area.

Countries tend to issue a higher proportion of sustainable bonds in foreign currencies than conventional bonds, with 22% of all issuances since 2016 (Figure 2.5 Panel B) being denominated in foreign currencies, compared to a mere 4% for conventional bonds for the same countries within the same period (Figure 2.5 Panel C). When examining country averages (rather than the aggregate), 35% of the total amount issued was denominated in foreign currency, as opposed to 23% for conventional bonds. However, there are significant asymmetries across countries. On the one hand, countries such as Chile, Egypt, Korea, the Philippines, Poland, and Uruguay issued in foreign currency, and tended to benefit from labelled bonds in accessing international capital markets. On the other hand, countries such as Cote d’Ivoire, Senegal, and Uzbekistan issued all their sovereign sustainable bonds in domestic currencies, while an average of 70% of their funding needs were financed through bonds denominated in foreign currency since 2016. Box 2.1 explores the impact of sovereign sustainable bond issuance in the debt portfolio with more detail.

While the euro has been the predominant currency in the sovereign sustainable debt market since 2016, the US dollar is the preferred currency for foreign currency issuances (Figure 2.5 Panel D). Since 2016, the amount of sovereign sustainable bonds issued in USD (USD 42 billion) has been higher than the amount of sovereign sustainable bonds issued in euro as a foreign currency (USD 33 billion). This is mainly explained by the issuance by Chile of 65% of its outstanding sustainable bonds in USD and 32% in euro. Additionally, Asian and South American countries, which have mainly entered this market since 2019, have issued more in US dollars than in euros. Indonesia, Peru, South Korea, and Hong Kong respectively issued 87%, 75%, 65%, and 60% of their sustainable bonds in US dollars. Aside from Benin, all other countries that issued more sustainable bonds denominated in euro as a foreign currency are the countries in Eastern Europe (i.e. Bulgaria, Poland and Serbia).

Figure 2.5. Currency composition of sovereign sustainable issuances

Box 2.1. The impact of sovereign sustainable bonds on countries’ debt portfolios

Sovereign sustainable bonds can change the risks and costs of debt portfolios

Sovereign issuers diversify their debt instruments to fulfil government financial needs while minimising borrowing costs and risks. To accomplish this, DMOs issue various instruments, such as long-term maturities, short-term instruments, floating rate securities, and index-linked securities. These instruments impact the issuer’s strategy differently, with some offering lower costs and higher risks, and others presenting higher costs and lower risks. Furthermore, DMOs aim for a diverse investor base to benefit from a liquid market that enables efficient security trading at lower costs and higher volumes.

In this context, sovereign sustainable bonds can help achieve debt managers’ objectives concerning the diversification of the investor base. As reported by a few DMOs, these bonds attract different investors compared to conventional bonds, diversifying the investor base and potentially altering the cost and risk trade‑off. However, depending on the sustainable bonds’ features, such as maturity, indexation, currency denomination and (floating) coupon, they may also increase debt portfolio risks or costs. Figure 2.6 compares the characteristics of sovereign sustainable bonds with conventional bonds, demonstrating that some countries benefit from issuing these bonds to reduce debt portfolio risks, while others incur additional risks through their issuance.

Figure 2.6. Characteristics of sovereign sustainable bonds VS conventional bonds

Compared to conventional bonds, sovereign sustainable bonds generally have longer maturities, are more frequently denominated in foreign currency, and, when in domestic currency, often have fixed rates

In terms of the number of sovereign sustainable bond lines, EMDEs, on average, have roughly five times the number of bond lines than AEs, resulting in a more diverse range of maturities and instrument types (Figure 2.6 Panel A).

Sovereign sustainable bonds contribute to lengthening the debt portfolio in terms of weighted average term-to-maturity (ATM) (Figure 2.6 Panel B). For AEs, the ATM of labelled bonds is nearly five years longer than conventional bonds, while for EMDEs, the difference is around one and a half years. Of the 50 countries that issued sovereign sustainable bonds until 2022, only in seven AEs and three EMDEs was the ATM of conventional bonds longer than that of labelled bonds.

Sustainable issuances denominated in foreign currency can create debt payment fluctuations in local currencies, if not hedged. Despite the high share of sovereign sustainable issuances denominated in foreign currency in EMDEs, this average conceals the fact that only a few countries issued sovereign sustainable bonds denominated in foreign currency, while the countries that issued in local currency also tend to issue a portion of their labelled bonds in foreign currency. Of the 50 sovereign issuers of sustainable bonds, the share of issuances denominated in foreign currency was higher for labelled bonds compared to conventional bonds in 16 countries.

Regarding domestic currency bonds, sovereign sustainable bonds are predominantly fixed rates for both AEs and EMDEs (Figure 2.6 Panel D). The average share of fixed rates accounts for a significantly higher proportion of gross borrowing in domestic currency. Only four sovereign issuers –Benin, Mexico, Senegal, and Togo –saw the issuance of sustainable bonds reduce the share of fixed rates issued in domestic currencies. Benin, Senegal, and Togo issued short-term sovereign sustainable bonds, while Mexico issued sovereign sustainable bonds with floating rates.

A few countries have managed to reduce their debt portfolio risks by issuing significant amounts of sovereign sustainable bonds in domestic currency with fixed rates

Although labelled issuances are primarily fixed rates and tend to have longer ATMs, their impact on debt portfolios may be minimal if they only account for a small share of gross borrowings. Figure 2.7 examines the effect of sovereign sustainable issuances on debt portfolios by displaying the share of gross borrowings on a country-specific basis and the differences between labelled and conventional issuances concerning foreign currency denomination and instrument type. This analysis yields three notable findings.

First, labelled issuances constitute a considerably lower share of gross borrowings for large issuers than for small ones, implying that labelled issuances have a greater potential to alter the debt portfolios of smaller issuers. Second, some countries, particularly a few from the West African CFA franc monetary union (e.g. Burkina Faso, Guinea Bissau, and Mali), can moderately reduce their debt portfolios’ sensitivity to interest rate risks by issuing a significant amount of labelled bonds in domestic currencies with fixed rates. Third, other countries, such as Benin, Senegal, and Uzbekistan, are moderately increasing their exposure to foreign exchange risk. This demonstrates that the impact of sovereign sustainable bonds on debt portfolios can be substantial and diverse across countries, with a few nations actively mitigating their risks through the issuance of sustainable bonds.

Figure 2.7. Country-specific analysis of the impact of sovereign sustainable issuances on debt portfolios

2.3.3. AEs have predominantly issued green bonds while EMDEs also focus on social and sustainability bonds

Green bonds continue to be the top choice for labelling in the sovereign sustainable bond markets and are expected to remain the most frequently issued new product in the upcoming year. Since 2016, green bonds accounted for over 75% of all sovereign sustainable instruments (Figure 2.8 Panel A), though this share has decreased over time. Looking forward, according to the 2022 OECD Survey on Central Government Marketable Debt and Borrowing, although OECD countries are planning to issue more green bonds compared to sustainability, social, and sustainability-linked bonds, the share of countries planning to issue sustainability and social bonds is growing faster (Figure 2.9 Panel B).

In addition, transition bonds, proceeds of which are used in heavy-polluting sectors such as oil and gas, steel, aviation and shipping, or so called “brown” projects that aim to reduce environmental impact or emissions, have been considered by a few sovereign issuers including Canada and Japan. While green bonds require climate and other environmentally beneficial projects to be identified for financing or refinancing, transition bonds focus on the use of proceeds categories that help governments progress towards their decarbonisation goals, thereby supporting countries’ transition from brown to “less brown” or “greener”. For example, the Japanese Ministry of Finance announced its plan to issue ‘GX Economy Transition Bonds’ in 2023, as part of the government’s plan to shift the current energy sources to greener power sources and to drive the country towards carbon neutrality by 2050 (Japanese Ministry of Finance, 2023[4]). However, this debt instrument has yet to become mainstream in sustainable financing due to a lack of widely accepted criteria for eligible transition projects. Similar to other sustainable bonds, it is important to establish transparency and clear criteria to help both issuers and investors navigate this complex market.

Figure 2.8. New issuance by type of instrument

While AEs are more likely to issue green bonds almost exclusively, EMDEs are more likely to issue social, sustainability and sustainability-linked bonds. Out of the 50 issuers of labelled bonds up until 2022, 23 countries solely issue social and sustainable bonds, while only 19 exclusively issue green bonds. However, out of the eight countries that have issued over USD 10 billion since 2016, seven have exclusively issued green bonds, including Belgium, France, Germany, Hong Kong, the Netherlands, Italy, and the United Kingdom, contributing to the dominance of green bonds in the global sovereign sustainable market. Box 2.2 summarises the theoretical considerations concerning the choice between green bonds and sustainability-linked bonds as well as the recent cases of Chile’s and Uruguay’s sustainability link issuances, the only sovereigns that have issued sustainability-linked bonds. It is worth noting that, differently from the sovereign sustainable bond market, sustainability-linked bonds are an important source of debt financing in the corporate sector. For instance, it accounted for 25% and 21% of all sustainable bond issuances in 2021 and 2022 for non-financial companies, respectively.

Box 2.2. Sustainability-linked or green bonds: theory and practice

A theoretical perspective: sustainability-linked bonds vs green bonds

Sovereign Green Bonds (SGBs) and Sovereign Sustainability-Linked Bonds (SSLBs) are both financial instruments that aim to finance environmentally sustainable projects. Although both instruments share a similar objective, the allocation of the proceeds and the methods to assess bond performance differ. SGBs are intended to finance green projects exclusively, such as renewable energy, energy efficiency, and clean transportation. The issuer uses the proceeds solely for these types of projects (i.e. proceeds are earmarked for green projects). In that way, the investor knows which green projects their investment helps to fund. On the other hand, SSLBs are issued with the issuer’s commitment to meet specific sustainability goals, proxied by a set of KPIs. Examples include reducing carbon emissions by an established amount or increasing the share of the country’s renewable energy production by a certain percentage. The bond’s coupon is linked to the achievement of these objectives in a way that the country is penalised if the objectives are not met (i.e. investors get a higher return if the issuer fails to meet the established goals). The proceeds can be used for any purpose, not just for environmentally sustainable projects. Thus, SGBs are a device to channel funds to green projects while SSLBs are a commitment device that penalises governments if they do not meet sustainable goals.

Sovereign issuers have shown a preference for green bonds over sustainability-linked bonds for several reasons. Firstly, green bonds come with a transparent framework that displays how the proceeds were used (allocation report) and their impact (impact report). Secondly, from the sovereign issuer perspective, green bonds may offer a cheaper cost of financing, as they have no mechanism that increases yields if goals are not achieved, and might also have a “greenium” (i.e. lower yield compared to a similar conventional bond). However, there are challenges related to issuing green bonds. There are substantial operational costs to set up these frameworks while there might be a lack of eligible expenditures to be funded through the proceeds raised by SGBs. In addition, governments did fund green projects before the emergence of SGBs and an increase in the issuance of these bonds will not necessarily lead to greener projects – governments may simply change the funding source of green projects from taxes or conventional bonds to SGBs. In fact, some sovereign issuers allocated SGB proceeds to fund projects done in the past, highlighting that the issuance did not impact future expenditures.

SSLBs offer an option that sovereigns can explore to address challenges related to the use‑of-proceeds instruments. As SSLBs’ proceeds are not earmarked, they don’t face the operational costs related to the allocation of funds and can enhance the commitment to sustainability goals even if there are no eligible expenditures available. SSLBs are also a closer replacement for conventional bonds, as, in essence, it is just a conventional bond with triggering criteria based on sustainability goals that might increase the coupon, and therefore a sort of hedge mechanism for investors against climate risks. However, challenges related to impact reporting are not entirely overcome, as SSLBs require a proper definition and monitoring of KPIs, which ideally should be ambitious, relevant, quantifiable, externally verifiable and benchmarkable. In addition, defining KPIs for climate adaptation that are consistent across countries is a challenge, given that climate change affects countries differently, with adaptation measures likely being country-specific and localised. SSLBs, therefore, can offer strong signalling towards achieving high-level climate change mitigation policy objectives. This signalling effect of SSLBs would be effective in proportion to the strength of the KPIs and their financial penalty characteristics.

The cases of Chile and Uruguay: the two issuers of sustainability-linked bonds

The Republic of Chile seeks to transition from a middle‑income to a high-income economy through a sustainable path built upon three key pillars: economic, environmental, and social. Over the years, Chile has strengthened its commitment to climate change mitigation and environmental protection through both national and international initiatives. It is in fact by far the largest issuer in the emerging market category, and after publishing its sustainability-linked bond (SLB) framework, Chile issued a USD 2 billion sustainability-linked bond in March 2022, the first sovereign SLB. This SSLB carries a 4.346% rate or 200 basis points above 20‑year US Treasury notes and is linked to the country’s ambitions concerning the Paris Agreement on climate change (S&P Global, 2022[5]).2 The bond stipulates that the country will emit no more than 95 million metric tonnes of carbon dioxide by 2030 and that 60% of its power output will be derived from renewable energy by that time. If one or both of these criteria are not met, the coupon step-up will be 12.5 (25) basis points (bps) compounded over eight years, resulting in a maximum total penalty of 200 basis points (bps).

	Sovereign Green Bonds	Sovereign Sustainability-linked Bonds
Advantages	Transparency: Framework and Reporting (Allocation and Impact) Proceeds are exclusively used for environment and socially beneficial projects determined by a set of rules. Might have a cheaper cost of financing (“Greenium”)	Use of proceeds is not restricted to a set of eligible expenditures Hedging against climate risks for investors SSLBs and conventional bonds are roughly interchangeable
Disadvantages	Additional operational costs with complex allocation process and impact reporting Lack of eligible expenditures No hedging against climate risks for investors	Difficulties in defining targets for KPIs and pricing Difficulties in measuring variables KPIs may not be well-suited for climate change adaptation

Sovereign Green Bonds

Sovereign Sustainability-linked Bonds

Advantages

Transparency: Framework and Reporting (Allocation and Impact)

Proceeds are exclusively used for environment and socially beneficial projects determined by a set of rules.

Might have a cheaper cost of financing (“Greenium”)

Use of proceeds is not restricted to a set of eligible expenditures

Hedging against climate risks for investors

SSLBs and conventional bonds are roughly interchangeable

Disadvantages

Additional operational costs with complex allocation process and impact reporting

Lack of eligible expenditures

No hedging against climate risks for investors

Difficulties in defining targets for KPIs and pricing

Difficulties in measuring variables

KPIs may not be well-suited for climate change adaptation

Sources: OECD analysis based on Lindner and Chung (2023[6]), Sovereign Sustainable Bond Issuance. A guide Note For Sovereign Debt Managers, https://www.imf.org/en/Publications/WP/Issues/2023/03/11/Sovereign-ESG-Bond-Issuance-A-Guidance-Note: for-Sovereign-Debt-Managers-530638; C. Hardy (Forthcoming[7]), Sovereign Sustainability Bonds: Can We Do Better?; S&P Global (2022[5]), World’s 1^st sovereign sustainability linked bond issued by Chile, https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/world-s-1st-sovereign-sustainability-linked-bond-issued-by-chile-69226229; Inter-American Development Bank (2022[8]), Uruguay Issues Global Sustainability-Linked Bond, with IDB Support, https://www.iadb.org/en/news/uruguay-issues-global-sustainability-linked-bond-idb-support; Ministerio de Hacienda, (n.d.[9]), ESG Bonds, https://www.hacienda.cl/english/work-areas/international-finance/public-debt-office/esg-bonds/sustainability-linked-bonds; Ministerio de Hacienda (2022[10]), Sustainability-linked bonds framework (Chile), https://www.hacienda.cl/english/work-areas/international-finance/public-debt-office/esg-bonds/sustainability-linked-bonds/chile-s-sustainability-linked-bond-framework; Uruguay DMO (2022[11]), Sustainability-linked bonds framework, http://sslburuguay.mef.gub.uy/30701/20/areas/sslb-framework.html; BIS (2022[12]), Quarterly Review: September 2022, https://www.bis.org/publ/qtrpdf/r_qt2209d.pdf.

A few months later, Uruguay issued its first SSLB on 24 October 2022.3 The bond is aligned with the country’s sustainable strategic priorities and establishes goals regarding performance indicators, one linked to the evolution of the intensity of greenhouse gas emissions and the other to the protection of native forests. Through that bond, USD 1.5 billion has been issued at a 5.75% rate. In this issuance, Uruguay innovated by becoming the first issuer to include a coupon step-down if it overperformed on the pre‑defined targets by a certain threshold. In fact, Uruguay’s SSLBs may be adjusted upwards or downwards by 25 basis points based on performance relative to 2025 targets for two KPIs, namely a reduction of economy-wide greenhouse gas (GHG) emissions per unit of real GDP relative to 1990 levels and the maintenance of native forest cover; performance is measured with a lag. For both KPI objectives, the same measures are used, and when a KPI is near its objective, no adjustments are made.

Both Chile’s and Uruguay’s SLB Frameworks have been reviewed by Sustainalytics,4 which has provided a positive evaluation of the alignment of the SLB Frameworks and associated documentation with the International Capital Market Association (ICMA) Sustainability-Linked Bond Principles, including an evaluation of the relevance, robustness, and reliability of selected KPIs, the rationale and level of ambition of the proposed SPTs, the relevance and reliability of selected benchmarks and baselines, and the credibility of the proposed SPTs (Ministerio de Haciendo, 2022[10]; Uruguay DMO, 2022[11]).

1. New Zealand has highlighted the operational costs of SGBs in the 2022 OECD and accession countries Survey on Primary Market Developments, while Colombia underlines the fact that sustainable instruments require a full-time team dedicated to them. In addition, 23 out of 41 countries view the limited size of eligible expenditures as a drawback to SGB issuance.

2. S&P Global is a leading provider of credit ratings, research, and analytics, offering a wide range of services to help investors, businesses, and governments manage credit risk and make informed decisions in the global financial markets. In this context, S&P Global provides information on the performance of various financial instruments, including the 20‑year US Treasury notes mentioned.

3. The Inter-American Development Bank (IDB) is a regional development bank focused on improving lives in Latin America and the Caribbean. The bank supports efforts to reduce poverty and inequality, improve health and education, and advance infrastructure in the region. IDB’s involvement in Uruguay’s SSLB issuance highlights the institution’s commitment to promoting sustainable development and financing in the region.

4. Sustainalytics is an independent provider of Environmental, Social, and Governance (ESG) research, ratings, and analysis, serving investors and financial institutions around the world. The firm evaluates and assesses ESG-related risks and opportunities for issuers, providing valuable insights to help market participants make informed decisions regarding sustainable bond issuances, such as Chile’s and Uruguay’s SLBs.

2.4. From setting up a framework to impact reporting: A dive into OECD practices

As explored in the previous edition of the SBO, the operational process of sustainable bond issuance is complex and labour-intensive, as it demands extensive collaboration between various government departments and a thorough understanding of environmental and social matters, all of which are not necessary for a conventional bond issuance (OECD, 2022[1]). In summary, issuing a sustainable bond requires developing a governing framework detailing eligible expenditures, management of proceeds, allocation and impact reporting, and third-party verifications, all in line with international standards and taxonomies (Figure 2.9). In addition, these steps require more expertise than a typical DMO often has, which makes it necessary to co‑ordinate with relevant government departments, investors, and external reviewers, which is often operationalised through an interagency committee of experts from different ministries. This section aims to describe the different operational aspects, especially for OECD countries issuing sustainable bonds. It complements Chapter 2 of the 2022 edition of this publication by diving into each of these processes drawing on OECD countries’ framework, allocation and impact reports.

Figure 2.9. Sovereign sustainable bond process: Main operational phases

2.4.1. All sovereign frameworks in OECD countries are aligned with ICMA guidelines and most of the EU countries also are aligned with the EU Taxonomy

In recent years, sustainable finance has significantly progressed, driven by increased environmental and social considerations in investment strategies and regulatory developments. With the involvement of national governments, market associations such as the International Capital Market Association (ICMA), and supranational institutions such as the European Union (EU), these advancements aim to provide investors with confidence and assurance by clearly defining sustainable investments and facilitating policy implementation for tracking sustainable finance flows (OECD, 2022[1]).

By analysing OECD countries’ sovereign sustainable bond frameworks, all 24 OECD countries that have issued sovereign sustainable bonds have developed their frameworks in alignment with the guidelines set by the ICMA corresponding to the type of sustainable security that they issued. The ICMA principles provide the core components of frameworks for different types of sustainable bonds, including the use of proceeds, the process for project evaluation and selection, management of proceeds, and reporting. In addition, the European Taxonomy has become a widely adopted classification system for sustainable investments, with 13 out of the 16 European member countries of the OECD incorporating it into their frameworks (only Ireland, Lithuania and Sweden do not mention the EU Taxonomy in their frameworks).

The European Union (EU) has been leading the development of standard frameworks and guidelines for sustainable bonds and on 28 February 2023, the European Parliament and member states agreed on the conditions for a European green bond standard (European Commission, 2023[13]). The EU Green Bond Standards help in promoting transparency and accountability in the market for sovereign sustainable bonds by providing a framework for green bonds issued by EU sovereigns and setting out eligibility criteria for projects, the use of funds, as well as reporting and disclosure requirements. The EU hopes that the European standard will be adopted worldwide and serve as a global benchmark for sustainable investments (European Commission, 2022[14]). Investors benefit from greater clarity and transparency regarding the environmental impact of their investments while promoting the transition to a low-carbon economy. As a result, the EU’s leadership in this area is likely to be an important factor in attracting investors and promoting sustainable economic growth, as highlighted by OECD countries (Box 2.3).5

Box 2.3. The EU Taxonomy for Green Bonds: Origins and the perspective of sovereign issuers

The origins of the EU Taxonomy

The European Union developed the “EU Taxonomy” as a key component of the “Financing Sustainable Growth” action plan, established in 2018, to direct private financial flows towards sustainable investments and related economic activities.1 This classification system defines and labels sustainable economic activities, supporting the EU’s climate neutrality goal by 2050. The taxonomy serves as an essential financing tool for the transition to a sustainable, low-carbon economy.

The EU Taxonomy comprises environmental objectives and technical criteria, with the EU Taxonomy Regulation providing its legislative foundation. A Technical Expert Group (TEG) is responsible for creating and maintaining the taxonomy, and advising the European Commission, which maintains and regularly updates it.2 The taxonomy’s voluntary usage is anticipated to significantly influence the investment decisions of financial institutions and investors.

Sovereign issuers’ perspective

Sovereign issuers face challenges in implementing the taxonomy due to its initial design for corporate issuers. Certain spending areas in the allocation report of OECD countries, such as research and development (e.g. France, Germany, Luxembourg, Italy, and Slovenia) and international co‑operation (e.g. Germany), which indirectly influence the energy transition, are not included. The existing taxonomy delegated regulations, yet to be completed, exclude some economic activities with well-established positive environmental impacts.

Furthermore, since the EU Taxonomy targets private companies rather than governments, some governments struggle to fully align with the classification system. In France, for example, expenditures not covered by the taxonomy or where eligibility is not fully assessed amounted to 22% of the allocation in 2021 (Agence France Trésor (AFT), 2021[15]). These challenges highlight the need for adjustments to the taxonomy to better accommodate the unique requirements of sovereign issuers.

Using a taxonomy designed for the private sector in the public sector has significant implications due to the different ways in which private entities and governments contribute to climate change mitigation and adaptation. Governments have means that are not available to the private sector such as providing subsidies, fostering country-wide research and making commercial agreements. This disparity highlights the need for a tailored taxonomy considering the unique roles and responsibilities of governments in addressing climate change. A more inclusive taxonomy could foster greater collaboration and synergies between the private and public sectors, ultimately accelerating progress toward a more sustainable future.

1. The European Commission’s “Financing Sustainable Growth” action plan, introduced in 2018, seeks to reorient capital flows towards sustainable investments, manage financial risks arising from environmental, social, and governance (ESG) factors, and foster transparency and long-term in financial and economic activities. This comprehensive strategy is aimed at integrating sustainability considerations into the European Union’s financial system and establishing a supportive framework for sustainable investments. The plan consists of a series of measures and initiatives, including the development of the “EU taxonomy,” which is a classification system for sustainable activities.

2. The Technical Expert Group (TEG) on Sustainable Finance is a group of experts from various sectors, including industry, academia, and civil society, established by the European Commission in 2018. The TEG’s primary objective is to assist the Commission in developing technical recommendations for the implementation of the “Financing Sustainable Growth” action plan.

Source: European Commission (2021[16]), EU Taxonomy Regulation, https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12252-EU-Taxonomy-regulation; European Commission (2022[17]), Technical Expert Group on Sustainable Finance (TEG), https://ec.europa.eu/info/publications/technical-expert-group-sustainable-finance-teg_en; European Investment Bank (European Investment Bank, 2022[18]), Green Bonds and the EU Taxonomy, https://www.eib.org/en/thEMDEs/sustainable-investment/green-bonds-and-the-eu-taxonomy; Agence France Trésor (2021[15]), Allocation and Performance Report, https://www.aft.gouv.fr/en/green-oat.

2.4.2. The diversity in the eligibility of expenditures reveals diverse priorities and investment strategies, shaped by each country’s characteristics

The allocation report provides information on how the proceeds from bonds have been allocated to specific projects and activities. It is published annually across all OECD countries that issue sovereign sustainable bonds. This report may include details about the geographic distribution of the projects, the sectors in which the projects are located, and the expected timeline for completion. Figure 2.10 Panel A offers a summary of the various allocation sectors of SGBs proceeds based on the allocation reports published by DMOs, indicating the diversity of priorities and investment strategies among the 19 selected OECD countries.

The three most common sectors for allocation of proceeds from sovereign labelled bonds are renewable energy, energy efficiency, and clean transportation, considered relevant regardless of countries’ sizes or geographic locations. Renewable energy emerges as the unanimous choice, reflecting the global urgency to transition towards sustainable energy sources and mitigate climate change impacts. Energy efficiency,6 endorsed by approximately 95% of the countries, exemplifies the growing awareness of the need for sustainable technologies to optimise energy consumption. Clean transportation,7 featured in roughly 95% of the countries, further underscores the ongoing shift towards eco-friendly transport options, such as electric vehicles and enhanced public transit systems. Other sectors of allocation include environmentally sustainable management of living natural resources and land use (75%), sustainable water and wastewater management (70%), climate change adaptation (60%), terrestrial and aquatic biodiversity (50%), pollution prevention and control (45%), green building (45%), research, innovation and raising awareness (30%), international co‑operation (25%), and circular economy (25%).

The set of eligible expenditures also varies with countries’ characteristics and understanding these patterns can provide valuable insights into the complexities of sustainable investment strategies worldwide and help identify areas for further collaboration and knowledge exchange. Countries with significant agricultural or forestry sectors, such as Austria, Canada, Hungary, Latvia, and New Zealand, make environmentally sustainable management of living natural resources and land use eligible expenditures. Countries with high exposure to climate change impacts, such as coastal or low-lying nations including Belgium, Canada, Ireland, and the Netherlands, make climate change adaptation expenditures eligible, likely to invest in measures to reduce vulnerability to extreme weather events such as sea-level rise. Countries that face challenges related to water scarcity or water pollution, such as Chile, Mexico, and Spain, can use the proceeds to invest in sustainable water and wastewater management. Countries with a high degree of international co‑operation, such as Canada, Germany, and Switzerland, can use the proceeds of sovereign sustainable bonds to address environmental challenges through collaborative efforts (IEA, n.d.[19]), (Statista, 2023[20]).

2.4.3. Clean transportation often receives more than half of the proceeds

Figure 2.10 Panel B reveals a diverse allocation of funds from sovereign sustainable bonds, with clean transportation, energy efficiency, renewable energy, and sustainable water and wastewater management emerging as the primary sectors receiving the majority of proceeds in the selected OECD countries.

Several countries allocate more than 50% of their sovereign sustainable proceeds to clean transportation, including Chile, Luxembourg, Hungary, Belgium, Italy, Ireland and Germany. The focus on clean transportation can be attributed to each nation’s unique characteristics, commitments, and strategies. Chile’s emphasis on clean transportation is driven by its commitment to electric vehicles and the significant production of essential resources such as copper and lithium. Luxembourg, known for its efficient public transportation system, prioritises investments in this sector to further improve mobility and reduce emissions. Hungary’s dedication to Clean Transportation is fuelled by its expanding automotive sector, which is increasingly focusing on the development and production of electric and hybrid vehicles. Germany, Ireland, Italy, and Belgium also invest heavily in Clean Transportation to promote sustainable mobility solutions and reduce greenhouse gas emissions (IEA, n.d.[21]).

Figure 2.10. Allocation composition by Green Sector in selected OECD countries

Energy efficiency and renewable energy receive substantial investments in France, the United Kingdom, Belgium and the Netherlands. Sustainable water and wastewater management (SWWM) is a key area of focus for the Netherlands, which dedicates 33% of its proceeds to this sector given its low-lying geography and vulnerability to climate change. Other notable expenditures include France’s investments in the circular economy. France’s more diversified use of proceeds might also reflect the fact that it is the largest issuer of sovereign sustainable bonds and, thus, can fund more projects with these proceeds. Germany also invests in international collaboration in the green sector and research, innovation and awareness-raising, underscoring its recognition of the importance of cross-border co‑operation and fostering innovation to combat climate change.

As the market for sovereign sustainable bonds continues to grow, it is essential that countries maintain transparency and accountability in their allocation of funds and reporting on the impact of their investments on specific environmental and social goals. This will help build investor confidence by ensuring that the funds raised through sustainable bonds are used according to the securities’ prospects.

2.4.4. Reporting the impact of green projects funded by the proceeds is the most challenging aspect of sustainable bonds

The successful implementation and monitoring of sovereign sustainable bond issuances rely heavily on impact reporting (i.e. impact reporting in sovereign sustainable issuances refers to the process by which government entities disclose the outcomes and the progress towards achieving the intended environmental and social objectives). Ultimately, the goal of sovereign sustainable purchases is to have a concrete impact on climate change mitigation or adaptation, with the allocation of proceeds being just one means to achieve this end. Impact report is, thus, the pillar that links the use of proceeds to the impact that investors are aiming at. Without such a link, it is difficult to assert whether the expenditures, although being allocated accordingly to the bonds’ prospects, achieved their objectives. It also is the most challenging aspect of sovereign sustainable issuance, given the difficulty of assessing the outcome of specific projects in a complex and interdependent problem.8 Climate change is considered a “wicked problem”, since its causes are multiple and complex, its impacts are uncertain and interrelated, and potential solutions to climate change might well cause further problems (Stang and Ujvari, 2015[22]). Any assessment in this context is challenging. In order to aid issuers in such a complex environment, ICMA has issued guidelines titled “Handbook for Green, Social and Sustainability Bond Issuers” (ICMA, 2020[23]).9 These guidelines offer a framework for issuers to evaluate, measure, and report on the environmental and social performance of projects funded through sustainable bonds. The guidelines require annual reporting until the bond matures or until green projects are completed, whichever is later. This extended reporting period ensures investors are informed of significant deviations from previous reports and any unexpected results that may have occurred during project implementation. This approach highlights the importance of transparency in the sustainable bond market, enabling investors to make informed decisions based on the latest available information.

The methodologies used to assess the impact of sustainable bond proceeds vary depending on the specific bond and its objectives. Generally, the assessment process involves setting clear key performance indicators and targets aligned with international standards such as the UN Sustainable Development Goals (SDGs) or the ICMA Green Bond Principles (GBP).10 Additionally, third-party verification by specialised agencies helps to ensure the credibility and reliability of impact assessments.

Nevertheless, it should be mentioned that there is no direct consequence for a green bond issuer if the proceeds of a green bond are not used for green projects, or if there are no resulting environmental benefits from using the proceeds as promised (BIS, 2022[12]). However, failure to meet investors’ expectations could lead to exclusion from a green bond index or reputational costs that also influence the bond value.

The impact of sustainable bond financing is assessed using various methodologies that fall into four categories: project-level analysis, portfolio-level analysis, comparative analysis, and modelling. The project-level analysis focuses on assessing the impact of individual projects funded by the proceeds of certain metrics, such as greenhouse gas emission reductions. The portfolio-level analysis evaluates the aggregate impact of a multitude of projects financed by sustainable bonds, providing a broader perspective on the overall performance and alignment with environmental and social objectives. A comparative analysis compares the impact of the projects funded by the sustainable bond to alternative investments or benchmarks. Modelling uses quantitative tools and techniques to estimate potential environmental and social impacts under various conditions and assumptions.

2.4.5. GHG emission and renewable energy metrics are the most common in impact reporting

Countries’ impact reports use different metrics that reflect their environmental priorities and unique challenges. Greenhouse gas (GHG) emissions are a common metric in all nine of the selected OECD countries (Table 2.2), demonstrating the significance of reducing emissions to address climate change. Renewable energy generation and energy efficiency improvements are also essential metrics, indicating countries’ efforts to shift towards cleaner energy sources and reduce energy consumption. Water conservation is a priority for eight of the nine selected countries, while biodiversity preservation is for six countries. Furthermore, seven of the nine selected OECD countries emphasise climate change adaptation and six economic benefits, recognising the need to reduce greenhouse gas emissions and adapt to the impacts of climate change while acknowledging the potential economic benefits of transitioning to a more sustainable economy. Five of the nine selected countries measure pollution-linked indicators and economic benefits in their impact reports.

A pattern that emerges in the selected countries is that they tend to measure the impact of their investments in the sectors in which they are eligible to use the proceeds of the labelled bonds. For instance, most countries invest in renewable energy and energy efficiency, and as a result, they also assess the impact of these investments using GHG emissions and energy efficiency improvement metrics. Similarly, countries investing in SWWM often measure their progress using water conservation metrics. Another conclusion is that countries that do not use a specific metric tend to not have eligible expenditures in the related sector. For instance, Slovenia does not measure adaptation to climate change or biodiversity preservation, and correspondingly, it does not have eligible expenditures in climate change adaptation or terrestrial and aquatic biodiversity.

It is crucial to note that the different metrics are interconnected and addressing one metric can have positive spillover impacts on others. For example, reducing greenhouse gas emissions can mitigate climate change impacts, improve air quality, and positively affect human health and biodiversity. Similarly, transitioning towards renewable energy sources can reduce greenhouse gas emissions, improve air quality, and conserve water resources. Hence, on the one hand, taking a holistic approach that addresses multiple metrics simultaneously can be a good solution to capture interdependencies and the breadth of climate change (IPCC, 2021[24]). On the other hand, countries have varying preferences, which are linked to their different degree of exposure to certain climate risks and their climate footprint. This makes it harder to standardise a core set of metrics across countries.

	GHG	Energy efficiency improvements	Water conservation	Renewable energy generation	Adaptation to climate change	Biodiversity preservation	Economic benefits	Pollution linked indicators
Austria	X	X	X	X	X	X
Chile	X	X	X	X
France	X	X	X		X	X	X	X
Germany	X	X	X	X	X	X		X
Hungary	X	X	X	X	X	X	X	X
Italy	X	X	X	X	X	X	X	X
Luxembourg	X	X	X	X	X	X		X
Netherlands	X	X	X	X	X
Slovenia	X						X

Note: Examples of indicators for each type of indicator.

Source: Countries’ sustainable bonds frameworks (see Annex A for details).

2.4.6. Most countries rely on the same companies as a third-party auditor of sovereign sustainable bonds

Third-party verification ensures transparency and credibility in sustainable bond issuances by assessing their alignment with established frameworks and standards. It offers significant advantages over internal verification by DMOs. Independent verification provides expertise in environmental and social criteria, access to specialised data, and a reputation for impartiality, enhancing the credibility of issuers’ commitment to sustainable outcomes. ESG research and rating providers, such as Sustainalytics and Vigeo Eiris, and specialised third-party auditors, including ISS and CICERO Shades of Green, offer verification services for sustainable bond issuances in various countries, providing investors with confidence in the bonds’ sustainability impact.

Sustainalytics and Vigeo Eiris focus on evaluating issuers’ environmental and social strategies, governance structures, and methodologies. Their verification process involves assessing the alignment of bond issuances with the issuer’s Sustainable Bond Framework and relevant international standards, such as the Green Bond Principles or the Social Bond Principles. Although both providers cover similar aspects of the verification process, their evaluation criteria, focus areas, and reporting formats may differ. For example, Sustainalytics adopts a risk-based approach that assesses the issuer’s management of ESG risks and opportunities, while Vigeo Eiris emphasises the issuer’s contribution to sustainable development objectives and its integration of environmental and social factors into its governance and risk management systems.

ISS and CICERO Shades of Green specialise in appraising environmental aspects of sustainable bond issuances. Both auditors evaluate bond issuances’ alignment with internationally recognised standards, project eligibility, and impact reporting efficacy. However, their methodologies and rating scales may differ. ISS employs a more quantitative approach, using metrics such as greenhouse gas emissions reduction and energy efficiency improvements to evaluate projects. In contrast, CICERO Shades of Green focuses on a qualitative assessment of environmental risks and opportunities, examining factors like climate resilience, adaptation, and mitigation measures implemented within the projects.

2.5. Some challenges become more prominent over time

2.5.1. In addition to impact reporting, changes in taxonomies and lack of eligible expenditures pose significant challenges

The 2021 Survey on Primary Market Developments issuers reported major challenges in environmental and social sustainability-related communication practices including the identification of relevant information, co‑ordinating among public institutions, accessing data, and having sufficient staff and technical resources (OECD, 2022[1]). DMOs often lacked the necessary expertise in environmental, climate and social-related policies and struggled to address investor questions or verify the reliability of the information. To overcome these challenges, the survey highlighted the importance of enhancing co‑ordination between DMOs and line ministries, as well as building capacity and raising awareness among staff.

These challenges slightly changed in 2022s survey results. With 24 OECD countries having already issued sustainable bonds, challenges related to reporting emerge as the most common. Twenty-seven out of the 41 OECD and accession countries identified impact reporting as a challenge to sustainable bond issuance (Figure 2.11). Another challenge that debt managers face when issuing sustainable bonds is changes in taxonomy, which can create ambiguity and inconsistency in reporting. Taxonomy pertains to the categorisation of investments based on their environmental or social impact. Changes in taxonomy can make it difficult for debt managers to precisely report on the effects of their investments and could deter potential investors.

Furthermore, a lack of eligible expenditures can be a significant hurdle in the issuance of sustainable bonds. This could limit the potential pool of capital for socially responsible” or “environmentally friendly” projects and make it more challenging for debt managers to issue these types of bonds. For example, a significant challenge for the Spanish Treasury in its green bond programme is the limited eligible expenditure, despite substantial public spending on ‘socially responsible’ or ‘environmentally friendly’ projects in Spain. This is attributed to the highly decentralised nature of the public sector, which results in ESG-related spending being primarily carried out at the regional level, rather than by the central government. Consequently, regions have more eligible expenditures than the Central Government, with some regions even implementing their green bond programmes.

Debt managers face difficulties in co‑ordinating with other government entities, which may prolong the process and add to its complexity. The procedure may involve numerous government agencies, necessitating the establishment of an interagency committee to ensure co‑operation and communication between the DMO, the relevant Ministry of Finance units, and other line ministries. Seventeen issuers in the OECD have already formed inter-ministerial working groups to this end, while others have relied on collaboration with ministries without establishing a distinct entity. As part of the process, various ministries may evaluate projects under their jurisdiction to determine their suitability for funding based on the sustainable bond framework’s criteria and required budget. Working groups collaborate with relevant agencies to identify qualifying projects with a positive environmental and social impact and may seek input from external stakeholders to ensure alignment with community priorities (see Box 2.4). However, this may lead to delays and additional administrative burdens on debt managers, making it challenging to issue sustainable bonds.

Moreover, as the sovereign sustainable market develops, changes in regulation can arise, increasing costs and administrative burdens for debt managers. This challenge was cited by 23 of the 41 OECD and accession countries in the Survey on Primary Market Developments, with Austria, the Netherlands, Spain, and Switzerland highlighting it in their responses, while Hungary identified it as the “main” challenge associated with sustainable bond issuance. This can lead to uncertainty and risk for debt managers, potentially discouraging investors.

Figure 2.11. Drawbacks or challenges associated with sustainable bond issuance for DMOs

Box 2.4. Multi‑agency co‑ordination for sovereign sustainable bond issuance: Case of Canada

The organisation of a sovereign sustainable bond issuance requires a collaborative interagency process, involving several key ministries and government agencies. This is important to ensure that the issuance aligns with the country’s broader economic and environmental objectives while also meeting the specific criteria of the sustainable label. The involvement of multiple government agencies in the issuance process can also help to create a more comprehensive and credible sustainable bond framework, increasing the likelihood of attracting sustainability-focused investors (IDB, 2021[25]).

In Canada, the interagency committee responsible for managing the issuance typically comprises representatives from the Department of Finance, the Ministry of Environment and Climate Change, and other relevant agencies (Government of Canada, 2022[26]). The committee works together to develop a set of criteria for the issuance that aligns with the country’s broader economic and environmental goals. This process involves an assessment of Canada’s current economic and environmental situation, including an evaluation of key environmental and social metrics and indicators.

Once the criteria have been established, the committee works with the Department of Finance to structure the bond issuance in a way that aligns with these objectives. This may involve selecting specific projects or initiatives that will be funded through the issuance or incorporating specific reporting and transparency requirements to ensure that the funds are used in a socially and environmentally responsible way. Throughout the process, the interagency committee works closely with other relevant ministries and agencies, including the Ministry of Foreign Affairs, Trade and Development, to ensure that the issuance aligns with Canada’s broader international commitments and obligations. This approach helps to build investor confidence and support, while also contributing to the achievement of Canada’s broader sustainable development goals.

Sources: Government of Canada (2022[26]), Green Bond Framework, https://www.canada.ca/en/department-finance/programs/financial-sector-policy/securities/debt-programme/canadas-green-bond-framework.html; IDB (2021[25]), How Governments can issue sovereign sustainable bonds to finance green recovery, https://www.iadb.org/en/news/how-governments-can-issue-sovereign-esg-bonds-finance-green-recovery.

2.6. Outlook for sovereign sustainable bonds

2.6.1. Most sovereign debt managers observed an increase in the demand for sustainable bonds and are willing to increase their issuances

The majority of OECD and accession countries have noted market participants’ interest in the government’s environmental and social activities and already incorporated environmental and social considerations into debt management policies (Figure 2.12 Panel A). Furthermore, 70% of responding countries experienced a surge in investor demand for sovereign sustainable bonds, 27% reported stable investor interest, and only 3% reported a decline. On the supply side, similar findings were observed, with 60% of countries willing to increase their issuances and the remaining countries aiming to stabilise issuance. No country reported interest in decreasing issuance.

Nevertheless, given the limited resources that constrain policy makers, the outlook for any government policy depends on its effectiveness in achieving its objectives. If not, alternative policies must be designed, implemented, and assessed for effectiveness, and this applies equally to sovereign sustainable bonds. Thus, in order to analyse the outlook for incorporating environmental and social matters in public debt management, it is essential to begin with the objectives that the incorporation of these matters seeks to achieve.

The integration of environmental and social matters into public debt management is motivated by various factors (Figure 2.12 Panel B), including supporting the market for sustainable finance instruments, aligning with government ESG policy, and diversifying the investor base

Figure 2.12. DMOs’ views on the incorporation of environmental and social matters in public debt management

The impact of sovereign ESG-related initiatives on sovereign creditworthiness is not a primary motivation for most OECD and accession countries. It should be noted, however, that these countries may differ from EMDEs. AEs are generally not among the countries most vulnerable to climate change and have virtually no credit risk. Conversely, some EMDEs, particularly in Africa and southern Asia, are among the countries most susceptible to climate change,11 making them more likely to have their debt repayment abilities impaired by climate change episodes. As a result, sovereign sustainable activities may have a more significant impact on creditworthiness in countries more vulnerable to climate change. Supporting this point is evidence that investors are willing to pay a premium to hold sovereign sustainable bonds, predominantly for bonds issued by climate‑vulnerable countries. In contrast, bonds issued in AEs have virtually no or very small “greenium” (Bolton et al., 2022[27]; OECD, 2022[1]).

2.6.2. Some EMDEs issued sovereign sustainable bonds enough to significantly diversify their investor base, while most AEs did not

For sovereign sustainable issuances to significantly impact the diversification of the investor base, the investor profiles for labelled bonds ought to differ from those of conventional bonds, and the volume issued cannot be insubstantial as a share of total issuances. With regard to the former, there is evidence suggesting that investors in labelled bonds are diverse and, to some extent, distinct from those who purchase conventional bonds. For example, France reported that their green inflation-linked sovereign bond was acquired by a varied group of investors worldwide, with only 29% based in France, and comprising diverse types such as banks, asset managers, pension funds, and insurance companies (Agence France Trésor, 2022[28]). Similarly, Spain disclosed the investor base of its 2021 inaugural sovereign green bond issuance, revealing that a mere 8.3% of investors were from Spain, with particularly strong demand from pension and insurance companies, which procured 47% of the issuance (Government of Spain, 2021[29]). The share of purchases made by foreign pension and insurance companies was notably high when compared to investors of conventional bonds.

In terms of the volume issued as a share of total issuances, considering only the countries and years in which at least one sovereign sustainable issuance occurred, sustainable bonds accounted for an average of 7.7% and 30% of AEs’ and EMDEs’ gross borrowings, respectively. Substantial disparities exist between large and small issuers, with sovereign sustainable issuances constituting 34% of the gross borrowings of small issuers versus 3.3% of large issuers during the same period.12 These figures also fluctuated considerably, with some small issuers issuing exclusively sustainable bonds in a given year (e.g. Andorra in 2022, Isle of Man in 2021), while in other countries and years, these instruments accounted for less than 0.1% of all gross borrowings. Out of the 50 countries that issued sovereign sustainable bonds until 2022, in 21 these issuances represented over 10% of gross borrowings in the years where at least one labelled bond was issued – and all are small issuers and also EMDEs except for Andorra, Denmark, Latvia, and Luxembourg. This demonstrates that some small issuers, particularly from emerging market economies, issued sufficient sovereign sustainable bonds to significantly diversify their investor base. However, due to the limited demand for and challenges in the supply of sovereign sustainable bonds compared to conventional bonds, large issuers face greater difficulties in expanding the share of their labelled issuances than smaller issuers. One caveat is that although diversifying the investor base is advantageous, sustainable bond investors tend to retain these securities for longer durations, reducing the market free float and, consequently, the liquidity of these securities. This raises costs for both the sovereign and investors when trading substantial volumes.

2.6.3. There are several synergies between the issuance of sovereign sustainable bonds and the adoption of green budgeting practices

With respect to alignment with government sustainability policy, the issuance of sovereign sustainable bonds represents one optional step among many others in governments’ sustainability policies. Other steps include developing a national plan on climate change and the environment, employing budgetary policy tools to finance projects related to the plan, and utilising reporting mechanisms to ensure transparency and accountability. Labelled issuances aim to raise revenue for green and sustainable projects, but these projects can also be funded through alternative revenue streams, such as taxes or conventional bonds.

The most pertinent aspect of governments’ sustainability policies is the implementation of green and sustainable projects, with the means of raising revenue being less relevant due to the fungibility of money (i.e. the source of funds does not affect how they can be used). Given the importance of greening expenditure, an increasing number of countries are concentrating on green budgeting (i.e. employing budgetary policy making tools to help achieve climate and environmental objectives) and often combining this approach with sustainable bonds given their numerous synergies (Box 2.5).

Box 2.5. Green budgeting and sovereign sustainable bonds

Green budgeting is the application of budgetary policy making tools to achieve climate and environmental goals. Just as budgets play a crucial role in co‑ordinating public revenue and expenditure, green budgeting aligns revenue streams for green projects and can enhance the quality of green expenditures. As an outcome‑based approach, green budgeting generates evidence to inform decisions on the potential climate and environmental impacts of a budget, creating an evolving fiscal policy that aligns with climate and sustainability goals through existing accountability and feedback mechanisms in the budgetary process. Furthermore, green budgeting can help address a diverse range of climate‑related fiscal risks through contingencies for climate‑related changes and measures related to climate change mitigation and adaptation. It can also improve the macro-fiscal and long-term sustainability analyses by incorporating climate change risks and elements.

Green budgeting and sovereign sustainable bonds share synergies that mutually reinforce their development and effectiveness in achieving their goals. First, developing a robust framework for tagging expenditures in green budgeting can help establish criteria for eligible projects in sustainable bonds given that both green budgeting and sustainable bonds require the identification of green and sustainable expenditures to ensure funds are allocated accordingly. Second, effective policy impact analysis used in green budgeting can contribute to more accurate and reliable impact reporting for sustainable bonds as both aim to demonstrate progress toward sustainability objectives. Third, strengthening expertise in environmental and sustainability issues across government can enhance the effectiveness of both green budgeting and sustainable bond issuance, as better-informed policy makers can make more strategic decisions in allocating funds and designing green and sustainability policies. Fourth, proceeds from green bonds can be linked to expenditures defined in the green budgeting process while for sustainability-linked bonds, green budgeting offers a way to maximise the chances of meeting the established goals, avoiding the payment of the premium.

Multiple OECD countries that issued sovereign sustainable bonds also are adopting elements of green budgeting (Figure 2.13). Based on a sample of 39 OECD and accession countries that answered a survey on green budgeting, half of the 24 countries that issued sovereign sustainable bonds also practise some form of green budgeting. Only Norway and Portugal adopted green budgeting elements without issuing sovereign sustainable bonds, while 13 countries did not engage in either. Among the challenges most mentioned in this survey, there is the lack of methodologies for assessing environmental impact and the lack of resources or technical expertise, which are closely aligned with the challenges that DMOs face when issuing sustainable bonds.

The broader perspective brought by green budgeting in comparison to the issuance of sustainable bonds might suggest that in the future the issuance of sovereign sustainable bonds will be only one element, if any, of the green budgeting process. The breadth of green budgeting, which encompasses the government’s revenue streams and all expenditures combined with the involvement of multiple government stakeholders and a well-established feedback and accountability mechanism, is a more robust tool to achieve environmental and sustainability goals than the issuance of sovereign sustainable bonds. A greener and more sustainable future is more likely with the adoption of green budgeting elements with the optional support of revenues raised by or commitments made by sustainable bonds.

Figure 2.13. Green Budgeting and sovereign sustainable bonds across countries

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Annex 2.A. Methods and sources

Primary sovereign bond market data and country groupings

Primary sovereign bond market data are based on original OECD calculations using data obtained from Refinitiv that provides international security-level data on new issues of sovereign bonds. The dataset covers sustainability bonds issued by sovereigns in the period from 1 December 2016 to 26 April 2023. The database provides a detailed set of information for each bond issue, including the proceeds, maturity date, interest rate and interest rate structure.

Refinitiv provides bond type information for most of its government securities entries. Sustainable bonds are those classified under ESG in the database. In addition, Refinitiv provides a categorical indicator variable to specify whether an ESG issue is a green bond. Hence, to further subset the data according to the specific bond label (“Green” and “Social and Sustainable”), securities that were classified as being ESG-labelled but not green were considered to be part of the “Social and Sustainable” category.

The definition of emerging markets used in this report is consistent with the IMF’s classification of Emerging and Developing Economies used in its World Economic Outlook.

A number of bonds have been subject to reopening. For these bonds, the initial data only provide the total amount (original issuance plus reopening). To retrieve the issuance amount for such reopened bonds, specific data on the outstanding amount on each reopening date for the concerned bonds have been downloaded separately from Refinitiv. As the reopening data only provide amounts outstanding in order to obtain the issuance amount on each relevant date, the outstanding amount on the previous date is subtracted from the outstanding amount on that given date. These calculated issuance amounts are converted on the transaction date using USD foreign exchange data from Refinitiv. To ensure consistency and comparability, the same method is used for all bonds, including those which have not been subject to reopening.

Exchange offers and certain bonds in the dataset have been manually excluded when they did not have any identifier (ISIN, RIC or CUSIP) and when they have not been able to be manually confirmed by comparing with official government data.

Data gathered from countries’ reports

Notes

← 1. Against this trend, Germany, one of the top five issuers of sovereign sustainable bonds, increased its green issuances from euro 12.5 billion in 2021 to euro 14.5 billion in 2022.

← 2. The feed-in tariff is a policy mechanism designed to encourage the adoption of renewable energy sources. It typically guarantees that energy producers using renewable sources will receive a set price for the electricity they generate and supply to the grid, promoting the growth of the renewable energy sector.

← 3. Agence France Trésor (AFT) is a French Government agency responsible for managing the country’s debt and cash positions. It operates under the aegis of the Ministry of Economy and Finance.

← 4. Issuance of sustainable bonds has been an integral part of Chile’s sovereign debt management since 2018. Chilean DMO seeks to promote the development of sustainable instruments to attract foreign investment and support the country’s sustainable infrastructure needs, while diversifying the investor base. As of the end of 2022, the sustainable bonds with Green, Social, Sustainable or SLB labels amounting to a total of USD 31.7 billion constitute 31% of Chile’s outstanding government bonds.

← 5. Hungary, Italy, and Mexico highlighted the key role done by the EU in the 2022 OECD and accession countries Survey on Primary Market Developments.

← 6. Energy efficiency refers to the process of reducing the amount of energy required to produce a given output, provide a service, or perform a specific function. This can be achieved through various means, such as utilising advanced technologies, improving insulation in buildings, adopting energy-saving practices, or implementing more efficient production processes.

← 7. Clean transportation refers to the use of vehicles, systems, and infrastructure that minimise the environmental impact of transportation activities, reduce greenhouse gas emissions, and improve overall air quality. Examples of clean transportation solutions include electric vehicles (EVs), hybrid vehicles, fuel cell vehicles powered by hydrogen, and vehicles that run on alternative fuels like biodiesel, ethanol, or compressed natural gas (CNG). Clean transportation encompasses public transit systems, such as buses, trains, and trams, as well as non-motorised options like cycling and walking. Policies promoting clean transportation aim to reduce the reliance on fossil fuels, lower carbon emissions, and contribute to sustainable urban development.

← 8. According to the responses of the 2022 OECD and accession countries Survey on Primary Market Developments.

← 9. The International Capital Market Association (ICMA) “Handbook for Green, Social and Sustainability Bond Issuers” serves as a comprehensive compendium for market participants seeking to issue green, social, or sustainability bonds. This resource amalgamates best practices, case studies, and practical insights, enabling issuers to proficiently navigate the process of bond issuance in adherence to the ICMA’s Green Bond Principles (GBP), Social Bond Principles (SBP), and Sustainability Bond Guidelines (SBG). The handbook aspires to support issuers in grasping the fundamental components of successful issuance, including the selection of eligible projects, the establishment of a robust framework, obtaining external reviews, and providing transparent reporting. It is an invaluable instrument for fostering growth and development within the sustainable finance market by encouraging the adoption of internationally recognised principles and guidelines.

← 10. The United Nations Sustainable Development Goals (UN SDGs) is a collection of 17 global goals designed to address the most pressing social, economic, and environmental challenges facing the world. Established in 2015 as part of the 2030 Agenda for Sustainable Development, the SDGs serve as a blueprint for governments, businesses, and civil society to work collectively towards achieving a more sustainable, equitable, and prosperous future for all. The goals are comprehensive in nature, encompassing areas such as poverty alleviation, quality education, clean water and sanitation, affordable and clean energy, decent work and economic growth, climate action, and responsible consumption and production.

← 11. According to the European Commission’s INFORM Climate Change Risk Index.

← 12. Large issuers refer to the group of 26 issuers that issued more than 0.2% of all gross borrowings since 2017. Smaller issuers refer to the rest of the countries.

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