ESG Bond Market Faces Decline but Poised for Climate-Driven Recovery

The ESG bond market is going through a complex phase, yet one brimming with potential. In the first half of 2025, global sustainable bond issuance fell 23% compared to the previous year, driven by macroeconomic and political uncertainty and a decline in new issuers.

However, a recovery is expected as the environment gradually improves. Growth will primarily be driven by financing for climate mitigation, adaptation, and nature conservation, while bridging the climate capital gap will be crucial in emerging markets.

Swami Venkataraman, Global Head of Sustainable Finance Assessments at Moody’s Ratings, one of the leading global ratings and financial analysis agencies, stated this in this interview with ESGnews.

What trends will drive the development of the ESG bond market in the coming years?

Global issuance of sustainable bonds decreased by 23% in the first half of 2025 compared to the same period the previous year, reflecting a decline in first-time issuers and increased political and macroeconomic uncertainty. We expect the market to recover as these uncertainties diminish, although regional fragmentation may persist as a long-term trend.

Growth will primarily be driven by financing for climate change mitigation, which will continue to stimulate the issuance of green and sustainability bonds. The new taxonomies and guidelines introduced by various market organizations, especially in Europe and Asia, highlight strong support for expanding finance for the transition to a low-impact economy.

Another impetus will come from growing interest in climate change adaptation and nature conservation projects. In emerging markets, closing the climate finance gap will be crucial. Multilateral development banks have already committed to using their balance sheets and expertise to expand innovative solutions, including blended finance instruments and guarantees.

What are the characteristics that investors most look for in ESG bond issues?

ESG bonds can be a tool for achieving and measuring environmental and social benefits, which are often key criteria for asset owners. These bonds can help mitigate portfolio risks, especially those related to the environmental transition and other related risks.

They can also offer diversification benefits through access to new issuing entities and new business models, less dependent on traditional investments. Access to a new set of investors is a key element for entities interested in issuing sustainable bonds.

In terms of risk-return of ESG bonds, what trends will we see?

Although sustainable bonds require funds to be allocated to green or social impact investments, there is no separation of cash flows from such investments to meet debt sustainability. Therefore, the risk and return of sustainable bonds generally reflect the credit quality of the issuing entities, as well as general market conditions related to credit spreads, interest rates, and liquidity. In the project finance market, where debt sustainability is guaranteed by asset-specific cash flows, sustainable bonds can reflect the risk-return profile of the asset or specific investment.

Issuers have managed to achieve a “greenium” (i.e., lower financing costs) through the issuance of ESG bonds, albeit modestly and not always guaranteed. This may indicate a lower perceived risk in these investments, but it often also reflects market supply and demand for sustainable bonds.

Which technological innovations are poised to have the greatest impact on the ESG emissions market (e.g., blockchain)?

Green technologies, such as green hydrogen, carbon capture and sequestration, biofuels, and large-scale energy storage, are among the technological innovations poised to have the greatest impact on the sustainable bond market. These technologies are crucial for a global transition to a low-carbon economy, but are currently uneconomical or untested at scale. Successful commercialization could spur significant growth in the issuance of sustainable bonds to finance these projects.

In November 2024, a group of over 60 European issuers, together with four central banks, concluded a series of trials exploring the use of blockchain technology for the settlement of financial transactions in central bank money. The trials aimed to test whether digital bond issuances could be settled in central bank money and, by eliminating some intermediaries, enable faster settlement times and lower issuance costs. These trials could foster greater acceptance of blockchain technology, although we do not believe this is specific to the sustainable bond market.

Are there any developments in the process of assigning an ESG rating to an issue?

There have been important developments in recent years. The first concerns the development of a series of standards and taxonomies with a regional focus (such as in the EU, Singapore, Australia, ASEAN, Mexico, and Brazil) or a thematic focus (such as blue bonds, Amazonia bonds, natural gas financing guidelines, and sukuk). Moody’s has issued a series of SPOs certifying the alignment of sustainable financing frameworks with these standards, in addition to the ICMA and LMA principles.

2025 also saw the introduction of the first regulated, though still voluntary, standard for green bond issuance: the European Green Bond, or EuGB. It requires alignment with the EU Taxonomy, has well-defined reporting templates, and requires mandatory external audits before and after issuance. Importantly, it includes a system for registering and overseeing the EuGB’s external auditors.

Will we see greater differentiation in the types of issuance, for example green bonds, sustainability bonds and transition bonds?

Each issuance type has well-defined characteristics. We expect green bonds to remain the dominant label, driven by climate mitigation financing and growing interest in climate change adaptation and nature conservation. The progressive adoption of EuGBs and continued investor demand could significantly influence the market.

Social impact bonds could be hampered by a lack of adequately sized projects, limited sector participation, and the cessation of issuance related to the Covid pandemic. There is a supranational push for social impact projects; however, these entities are more likely to issue sustainable bonds that can be used to finance both environmental and social investments.

We expect sustainability-linked bonds (SLBs) to remain a niche segment. Issuers may maintain a cautious approach to SLBs, as investors continue to scrutinize their ambitious goals and financial relevance. However, SLBs represent an opportunity for institutions that do not require significant short-term capital investments, unlike use-of-proceeds instruments.

Finally, “transition bonds” do not exist as an independent label outside of Japan, where all bonds with this label are currently issued. However, several regional efforts are underway to stimulate the growth of transition finance, both with and without the use of an explicit label, and this area has significant growth potential in the future.

Which metrics or KPIs will be crucial for attracting capital to next-generation ESG bonds?

When considering the metrics that will have the greatest impact on the growth of all types of sustainable bonds, a key factor could be sovereign issuers’ strong commitment to both climate mitigation and adaptation. Metrics that indicate plans for widespread reductions in greenhouse gas emissions, as well as clear and ambitious metrics for other environmental initiatives, will be crucial in attracting capital to sustainable bonds.

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(Featured image by Bhautik Patel via Unsplash)

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