Rapid urbanisation lifted many people out of poverty and drove massive economic growth. But that also contributed to levels of pollution that are changing the climate. With over half the world’s population now crowded into cities, making urban areas sustainable is central to solving the climate crisis. Often located in areas of high climate risk, cities face some of the worst consequences of natural disasters. Infrastructure investment is sorely needed. But with government coffers nearly empty after a nearly two-year-long battle with Covid-19, how will this be paid for?
Private capital will only grow in importance for building resilient infrastructure and making cities more sustainable. Private investors are increasingly interested in urban initiatives, with pension funds playing an important first mover role, particularly in developing economies, and demonstrating that these programmes are effective.
This is giving the sustainable municipal bond market a boost, which is especially important since many governments have committed to large infrastructure programmes. President Joe Biden’s massive spending ambitions in the US will benefit from private sector demand for such bonds. But less developed markets don’t enjoy the same luxury. Here, the market for infrastructure assets suffers from a combination of illiquidity, non-standardisation and complexity.
Lack of labelling is an added difficulty. Though investors are clamouring for sustainable bonds, there is still no easy way for them to know if a bond actually helps a city achieve its sustainability targets. This leads to a lot of missed opportunities. If you apply a positive impact framework, many bonds, particularly those issued by municipalities, sovereigns, supranationals and agencies, are likely to display sustainable characteristics. These range from increasing access to education and water to improving public transport and healthcare.
Such frameworks have been developed, though there is little precedent for best practices. And while the green bond designation is a familiar one, with Gothenburg and Ile-de-France early municipal issuers, labels continue to grow more colourful. The Seychelles were the first sovereign to issue blue bonds, which can be used to fund ocean-related assets and conservation efforts but also finance wastewater treatment. Brown, or transition, bonds help companies and actors move away from the most polluting activities. These are in addition to the more prosaically named, and increasingly popular, social and sustainability bonds. One example is Hannover’s 2018 Green & Social Schuldschein (debt certificate), which has both green and social purposes.
The United Nations sustainable development goals, established in 2015, are a globally agreed sustainable framework and already act as a capital allocation guide for capital markets. Investors can use the SDGs as an investment case, helping to improve long-term financial performance. But it may not all be about profitability.
Social impact bonds target a specific issue and have a precise outcome in mind. This could be improving internet access in remote areas or housing the homeless. Investors could tolerate slightly lower returns in exchange for the knowledge that they are contributing to solving real problems. Early success with such bonds will only encourage further investment, by showing that well-defined outcomes are achievable and appropriate.
Though there have been examples of how these instruments can be used in medium-sized and smaller cities, municipalities often lack the skills and knowledge necessary to assess and manage these transactions, and volumes remain too small for them to resort to these instruments alone. Closer coordination and co-operation between national and regional municipalities can generate economies of scale. Multilateral and national development banks, as well as federal and state governments, can establish platforms that ensure the sharing of case studies and best practice, and become more active themselves as issuers of pooled sustainable municipality bonds.
Urbanisation fostered and was fostered by economic expansion, fuelling environmental and social stress. But cities also provide many opportunities for sustainable living. People concentrated together are easier to serve, using fewer resources. But the infrastructure needs to be in place for this to be possible. Using the SDGs as a framework, investors can target projects and bonds that drive sustainability more easily, cheaply and effectively.
Adam Cotter is Senior Vice President at DZ BANK.