For investors, there are several key advantages to investing in impact bonds.

1. The use of impact bonds' proceeds is specified (that is, the issuers have clearly defined what types of projects are eligible for financing by it). This level of detail helps investors to make informed decisions about which activities they will directly invest in. Standard vanilla bonds do not offer this clarity over use of proceeds.
2. Issuers are to report on the impact that will be or has been enabled with the funds raised by the bonds. So, investors have the data to measure the impact of their portfolios.  

Additionality

The basic principle behind impact bonds is to allocate money to new projects that bring social and/or green benefits, meaning that the balance sheet of the issuers also become more sustainable. This 'greening' is referred to as the additionality of the bonds.

Mandating that bond proceeds may only be allocated to new projects, though, presents a risk for issuers – in that it’s possible they will not be able to identify enough new projects that qualify under their framework. And, since the market expects liquidity, issuers need to raise a minimum of EUR 500 million in the bond offering. So, for these kinds of impact bonds to be successful, issuers need to have a significant pipeline of new eligible projects.

Another strategy issuers can use for their impact bonds is to register projects that fall under the framework, and when they have reached a large enough stock, often around EUR 500 million worth of projects, they will issue the bond. The look-back period for these bonds is often a maximum of one year. This strategy is often used by governments. The advantages of this strategy are that it is clear what projects will be financed and that there are no unallocated proceeds.

Both aforementioned strategies have been used in the impact bond market. We welcome these strategies, as they both enable real social and green additionality.

Refinancing

A worrying trend in the market, however, is that impact bonds are increasingly used as a basic refinancing tool. In this strategy, the issuer develops a framework and then searches its balance sheet to find eligible existing projects. Once enough projects are identified, they move forward with issuing an impact bond and use the proceeds for refinancing.

More and more, we observe that impact bond frameworks lack a defined look-back period, and projects qualifying under the framework could be more than 10 years old. In our opinion, these bonds have absolutely no additionality, meaning that they do not contribute anything additional to the sustainable transition (since the projects already exist). In short, the balance sheets of these issuers do not become more green. This strategy is relatively new, as emerged with the rapid growth in investor demand for impact bonds.

We do not support a refinancing-only strategy, and, in fact, qualify it as greenwashing. We are surprised to see frameworks with long look-back periods still receiving positive qualifications from second party opinion providers. These second party opinion providers judge impact bond frameworks based on their intended use of proceeds, the processes for project selection and allocation, and proposed impact reporting. Apparently, though, they do not consider the lack of additionality.

We hope that issuers and second party opinion providers (re)adopt a requirement for a look-back period of a maximum of two years (preferably one year) prior to the issuance date,  so that these impact bonds do exactly what they are aimed for: to bring about positive change.