Sustainable disclosures: A three-layer transparency path towards darker green bond markets

In fixed income, environmental, social, and governance (ESG) still represents a small part of the universe.

We expect numbers and volumes to increase as the headline domination of ESG in financial institutions is only in its infancy.

Article 8 & 9 categorisations will stimulate higher ESG allocation and demand. However, uncertainty on SFDR interpretation and its exact definitions has contributed to asset managers' cautious classification thus far.

The principal adverse impact component will need more clarity to grow in importance. The publication of PAI statements is the first step. The taxonomy-related disclosures will impact all bonds issued, whether marketed as sustainable or not. Investors will favour those contributing most to the taxonomy KPIs.

The SFDR pushes the buy-side (demand) further in the direction of ESG and thus further stimulates issuers to print sustainable bonds (supply). The slow, lagging effect of this one-sided push adds, in the meantime, to a wider “greenium” (green premium).

Since 10 March 2021, the EU sustainable finance disclosure regulation (SFDR) requires portfolio managers to “show colour” to what extent their investment funds and portfolios consider sustainability aspects. For now, these disclosures only concern the high level and principle-based provisions (level 1) detailed in the SFDR. However, once there is more clarity on the level 2 disclosure technicalities, this important piece of ESG disclosure regulation will only serve to further guide investments away from less sustainable issuers and assets and towards more sustainable alternatives.

The SFDR has three important funnel stages to achieve this goal, which we discuss in detail in this report.

• The classification of funds as Article 6, 8 or 9: asset managers will strive to classify most funds in the light green (Article 8) and, preferably, the dark green (Article 9) categories. This will increase the demand for assets supporting ESG objectives.
• The principal adverse impact (PAI) assessments will form an additional incentive for asset managers to stay away from investments that realise substantial negative sustainability impacts, such as in companies active in the fossil fuel segment.
• The reporting on EU taxonomy compliant investments: transparency requirements on the taxonomy alignment of investments will support the demand for investment alternatives that qualify as environmentally sustainable under the taxonomy, such as for bonds issued in line with the forthcoming EU green bond standard.