· 8 min read
• Bond investors remain largely disengaged from climate and nature finance in emerging markets, despite vast capital pools
• Sovereign green bonds have helped fund climate projects, but nature-focused bonds need clearer fiscal integration
• Expanding nature finance through bonds requires investor engagement, strong fiscal frameworks, and impact tracking
Bond investors hold vast pools of capital but are barely engaged in addressing the climate and nature crisis in emerging markets. Sovereign green bonds are now well-established in debt markets and have helped finance a small but meaningful share of climate-related spending. To utilise such bonds also for raising nature finance governments will need to demonstrate that conservation targets are integrated in fiscal management, and investors in turn will need to skill up in tracking the related spending and its impact.
Bond investors in the climate and nature agenda
Global bond markets remain a potent yet fickle funding source for emerging markets and developing countries (EMDEs). According to the Institute of International Finance, an industry association, emerging markets other than China attracted USD 219 billion in net bond inflows in 2024. This was a welcome recovery from the previous year and the complete stop of flows in 2022. But given the size of the global bond market, at roughly USD 140 trillion, this was no more than a trickle. Moreover, only about a dozen emerging market governments are rated at or above investment grade and hence have regular and immediate access to international bond markets. Global institutional investors, such as pension funds and insurance companies, remain marginal investors in emerging markets. This is doubly true for these investors’ exposures to the projects that address the accelerating climate and nature crisis in the developing world.
The ESG bonds of emerging market governments
In an attempt to bridge the disconnect, about 38 governments in advanced and emerging markets governments have issued green bonds as part of their regular debt financing operations. The roughly USD 400 billion that have been raised in total is not large relative to finance raised in global bond markets, but comes on top of the green bond issuance by supranational bodies, such as the World Bank, which is subsequently channelled to projects in climate mitigation and adaptation. In using this instrument, even irregular government issuers or those with only marginal sovereign credit quality seem to have regained capital market access and expanded their investor base, often with the help of development finance agencies. Green bond standards and investor scrutiny have tightened since the first government green bond in 2016. On the whole, the interaction with ESG-investors and the broader green bond ecosystem have led governments to implement sensible reforms in tracking allocation to green projects and impact reporting.
ESG investors and financial regulators increasingly assess biodiversity loss as an additional source of financial risk. Ocean and coastal areas, for instance, provide substantial value to economies, including storm surge defences, fisheries and livelihoods in tourism. Many of the world’s most ecologically valuable and threatened marine and coastal sites lie in EMDEs, especially small island states, which are highly exposed to climate change.
A number of recent market developments suggest institutional investor mandates are now also supportive of the needed government funding for the nature and biodiversity agenda:
• Between 2021 and 2024 the World Bank issued six so-called outcome bonds, which offer the Bank’s regular investors targeted development impact, such as coral reef conservation, on the back of a key supranational issuer’ AAA credit quality.
• Over the same period, six governments restructured their debt in commercial debt-for nature swaps, engaging bond investors in public markets. In several cases, such as the latest transaction with Ecuador, new types of bonds emerged whose contractual terms set out long-term nature or conservation outcomes monitored by independent trust funds.
• Several sovereign green or sustainability bonds issued by emerging market governments, such as Malaysia or the Philippines, already foresee spending on nature and blue economy programmes alongside the traditional projects in climate mitigation.
• A number of government issuers also leveraged investor appetite for bond instruments that promise more specific impact. Four EMDE governments issued dedicated blue bonds, as did a number of other public sector issuers, such as supranational institutions or municipalities. Indonesia’s USD 150 million issue in 2023 for instance was offered in the open market to institutional investors, primarily in Japan.
These transactions underline that investors are becoming more sensitive to nature risks or adopt impact frameworks that track outcomes in terms of widely understood development goals, including in terms of forest conservation or the rehabilitation of coastal areas. Given the relative success of sovereign green bonds, can government debt managers expect that a similar type of bond finance will emerge for the needed nature and blue economy spending?
From green to blue and nature bonds
A sovereign bond stands out for the scale of individual financing rounds, and the maturity of funding. Nature finance seems a good fit. For instance, the UN sustainable development goal (SDG) covering ‘life below water’ is estimated to require annual funding of US$ 175 billion per year (a separate SDG on water and sanitation is of course closely linked). While very large, this funding would cover much of the needed resources for climate change mitigation and adaptation in coastal states. Nature-based solutions, such as mangrove or coral reef rehabilitation, deliver on both climate mitigation and adaptation, and do so cheaply.
But the public rather than the private sector will need to shoulder the bulk of this nature finance spending. Unlike in the area of climate mitigation, cost-competitive projects, such as in renewable energy, are the exception. Most nature projects will have a ‘public goods’ quality, putting the government centre-stage in attracting the relevant funding from debt markets.
When a thematic bond makes sense
The green bond concept, under which the issuer is accountable for spending on specific eligible projects, has already been adapted for the nature finance context. In 2023, capital market association ICMA issued guidance on blue bonds which raise funds that are exclusively invested in oceans and other water resources. This may not only provide a match to investor mandates clearer than regular bond instruments, but could also help attract concessional finance, alongside that of institutional investors.
For government debt managers, blue and other nature bonds could be an interesting option in the broader ‘ESG’ sovereign bond market. They will weigh the potential benefits of a dedicated bond instrument funding nature outcomes against alternative instruments and some uncertainty in a nascent market.
Empirical studies suggest that green bond issuers access a broader group of investors which on the whole adopt more patient buy-and-hold strategies. Maturities may be longer for that reason. Debt finance costs in the form of bond coupons may be slightly lower, though this will need to be evaluated in the light of transaction costs. Sustainable bond issuance also seems to help the government with subsequent issuance of regular instruments and foster a local sustainable bond market of the private sector. This could be especially relevant where a government or public agency blue bond is issued in the local market, as was the case with the USD 220 million blue bond issued by Mexico’s Trust Fund for Rural Development (FIRA).
Investors with an ESG mandate will no doubt become more engaged where the government’s sustainable bond framework clearly explains how nature outcomes are targeted, and whether its debt issuance strategy envisages a regular return to the market.
But nature finance in bond markets poses challenges beyond those in green bonds. As any other instrument that ties the issuer’s hands on the use of funds’ debt managers will need to work with other government departments and account for budgetary allocations. Compared to traditional green bonds, allocations to nature outcomes will cover a somewhat narrower set of activities, including current expenditures such as enforcing restrictions in a marine protected area.
Investors will naturally focus on countries with an established presence in international capital markets and suitable credit quality which also have a demonstrable funding need in conservation. The new Global Biodiversity Framework already commits states to safeguarding 30% of their marine and terrestrial areas by 2030. This is yet to be translated into investable nature plans that spell out the policies, expenditures and projects that deliver on this goal. These plans can then be translated into dedicated bond frameworks, as illustrated by Indonesia’s blue economy strategy, giving investors demonstrable impact in support of an internationally-agreed outcome.
But a good part of the needed nature and blue economy expenditures will lie in countries with only intermittent access to global bond markets (or even those deemed to be debt-distressed). Risk and the limited size of bond issues compared to those in advanced markets will be key constraints. Multilateral development banks, individual donors and philanthropies can help bridge these constraints. The Asian Development Bank’s blue bond programme is an illustration of how international bond markets can be mobilised even for a portfolio of smaller public sector projects in the bank’s member states. For sub-investment grade government issuers a key motivation will be that the blue bond format creates transparency and accountability which can be supported by donors or development institutions. This will in turn mobilise institutional investors.
The composition of the global debt market has developed rapidly since the first green bond issue in 2007. ESG investing continues to evolve and should increasingly open bond market access for issuers with credible frameworks that target biodiversity and resilient ocean economies. To make the market broaden in this way, issuers will need to implement strong fiscal frameworks, and investors need to tackle more varied spending allocations and impact monitoring.
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