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Lindsey Hall: Hi. I'm Lindsey Hall, Head of Thought Leadership at S&P Global Sustainable1.

Esther Whieldon: And I'm Esther Whieldon, a Senior Writer on the Sustainable1 Thought Leadership team.

Lindsey Hall: Welcome to ESG Insider, an S&P Global podcast, where Esther and I take you inside the environmental, social and governance issues that are shaping the rapidly evolving sustainability landscape.

We've been talking a lot on this podcast about the busy fall season of sustainability events that we're currently in. Climate Week NYC took place in September, and Esther and I brought you a lot of coverage from New York. 

Today, November 1, marks the end of COP16, that's the UN's biodiversity-focused Conference of the Parties in Colombia. We'll be back with key takeaways from that event. And then just a few weeks later, we'll be covering another UN Conference of the Parties, COP29. That's the UN's Climate Change Conference taking place in Baku, Azerbaijan.

Esther Whieldon: Across all of these events, there's one common thread: how to address the big financing gaps for a range of sustainability issues, including climate mitigation and adaptation, nature and social equity. To put a dollar figure on it, the UN estimates developing countries will need an additional $4.2 trillion per year in financing to achieve the UN's 17 Sustainable Development Goals by 2030.

In today's episode, we'll explore how the fixed income market is evolving to help fill in some of those sustainable finance gaps with Stephen Liberatore, who heads ESG and impact for global fixed income at Nuveen. Nuveen is a global asset manager with about $1.2 trillion in total assets under management. We'll hear a more detailed definition of fixed income from Stephen in a moment. 

But in a nutshell, the term refers to debt instruments where an investment pays a fixed amount on a set schedule until it reaches maturity. A bond is one example of a fixed income security. I sat down with Steve on the sidelines of The Nest Climate Campus where ESG Insider was an official podcast during Climate Week NYC. Here's Steve.

Stephen Liberatore: currently manage a little over $20 billion, all of which is active total return against common fixed income benchmarks. So we're effectively trying to deliver excess return associated with higher ESG quality and direct and measurable impact.

Esther Whieldon: So for someone who may not know what fixed income is, can you describe that roughly?

Stephen Liberatore: Sure, absolutely. So fixed income is the largest asset class that no one seems to really know a whole lot about. The simplest form of fixed income is when an entity borrows money from the capital markets and investors in order to initiate a capital expenditure program or refinance existing debt. Issuers come to the capital markets. And it's an interesting space because that -- most people think of the equity market and they think of equity issuers, so public companies.

The real interesting part about fixed and one of the reasons that makes it the largest asset class available is that our issuer universe is much broader than that. So we have sovereign issuers. So the U.S. Treasury, when they issue debt to fund deficits or fund budget, what they do is they come to the public fixed income market. We also have agency securities, super sovereign issuers like the World Bank or the IFC.

We have municipal issuers as well as structured securities where you're able to pool together various types of assets in an underlying portfolio and take cash flows out from that as your return. So think of auto loans, mortgages, student loans, things of that nature. It's another way in which you can access capital through the utilization of fixed income concepts.

Esther Whieldon: Steve described how incorporating environmental, social and governance factors into fixed income portfolio construction helps ensure the issuer is able to pay off the investment over the long term.

Stephen Liberatore: So for us, one of the things that is really important to our investors is that we look for issuers and issues that have environmental benefit or environmental stewardship. And it's really important in the fixed income market that we focus on environmental, social, governance factors in the portfolio construction process because we're an asymmetric payoff asset class.

So for us, if you're doing this correctly, what you're really looking for are securities and issuers that have more stable free cash flow over time. So that's how we are able to be repaid, is by ensuring that the investment we make today is into an issuer or an issue that we know in the future will be able to repay us.

So the concept is really different than, say, what you would think of in the equity market in fixed income, how you generate outperformance isn't picking winners, it's avoiding losers. So that focus on identifying stability of free cash flow or increasing free cash flow in the future is really critical to how we're repaid. And there's a lot of environmental factors that kind of go into that.

So I think of really simple things that we've looked at on the fixed income side of, how do you create a security that you feel will have more stable free cash flow in the future? We have -- a really simple example that I like to use is that last year, we invested in an affordable housing project in Sonoma. And obviously, for the folks that aren't familiar with Sonoma, that's the wine-growing region in California, so land is very expensive there. So it's very difficult to obtain affordable housing.

So this particular affordable housing project had about 500 residents. About 87% of those would be considered low- or very low-income individuals. So this project was really important because that was equivalent to the same number of affordable housing units that the county had been able to build in last 20, 25 years.

But very thoughtful forward-looking management team, why is it so expensive to live in Sonoma? It's the weather. It's the sun. So part of the project was putting a solar array on ground. That solar array has lowered the cost of energy for the residents by over 90%.

So when you think about how that translates into the investment thesis, right, you're looking at an affordable housing project, you're looking at including an environmental investment in a solar project that's translated into lower energy costs. You have therefore increased the disposable income of the residents by reducing their energy bill, which increases the likelihood that they can pay their rent every month, which increases the likelihood that the developer can pay us our interest payment and principal payment on time.

So that's a simple way to show what we're really looking for, which is the environment impacts society, which impacts the economy. And if you can create that virtuous cycle and find investments that look that way, you have very attractive investment opportunity where environment is a critical component of future repayment.

Esther Whieldon: Does it also, in some ways, lend itself more easily to thinking about long-term climate risks?

Stephen Liberatore: Absolutely. And that's one of the real great things about our investor base. They all recognize that the issues that they're trying to identify and invest in are longer-term issues. They're not things that are going to be resolved overnight. And that's why it's really critical, when you're contemplating the use of ES&G characteristics in your analysis or impact investing, you have to have a longer-term lens.

And so to me, one of the real reasons that using ES&G and impact in portfolio construction has grown so rapidly is because it's almost the purest form of long-term investment now because you're looking at solving issues that have a longer duration associated with them, and the investor base knows that. They know this is not a quick fix and that it will take time in order to fix or resolve the issues that are important to them.

Esther Whieldon: One area of the sustainable debt market involves use of proceeds bonds, which can include green bonds, social and sustainability-focused bonds. For these kinds of bonds, the net proceeds are used to finance or refinance new or existing projects that provide an environmental or social benefit. For example, it could be used for renewable energy, green buildings or social issues such as more equitable access to education, health care or food security. I asked Steve what trends he's seeing in the market. Here's what he said.

Stephen Liberatore: That particular market this year is on a record pace. We're looking at probably issuing over $1 trillion, which would be the second time in history, that would leave us to having had more than $5 trillion issued in that labeled space from the beginning of the market, the inception of the market, and there would be over $4 trillion of outstanding securities that carry a label.

And what you have seen has been a rapid diversification and granularization of that market. So you have increasingly specific opportunities that you can look for. So obviously, green bonds are the main driver, still the largest part of the market, but we've also seen a rapid increase in things like social bonds, which fund things like affordable housing.

But then you also have -- within those areas, you're starting to see very specific outcomes that are being funded. So one of the biggest areas of growth has been in biodiversity. So where you're investing in things like that, it's -- you can be investing in marine-based projects, so what would be called blue bonds because the environmental benefit is marine-based. You're also seeing things around carbon credits, reforestation, clean water projects globally. So there's a rapidly expanding universe that also allows for investors to find very specific investment opportunities that may align with their own purposes or their own goals.

On the social bond side, we've really expanded out to include things like orange bonds, which are gender lens investment opportunities, where you're specifically finding opportunities to lend to women in parts of the world where maybe they're not as well served or they're underserved. And those could have a variety of different outcomes. There are some green component to it as well. But it's a great opportunity to find, again, a very specific issue and a specific problem of a financial gap or a financing gap and being able to fill that in.

And we've also seen things -- biodiversity, back to that because there's just been so much going on there, you have things like debt for climate swaps, where you're able to reduce the debt of an outstanding issuer and transition some of those debt savings into environmentally beneficial projects that also have societal and economic opportunity associated with them.

Esther Whieldon: So last year, I heard a lot about the very, very expensive impacts of climate change and how these countries are going into more and more debt just to be able to afford that, much less make these. And that sounds like that is a part solution to that challenge of wanting to do both things but not really being able to afford both.

Stephen Liberatore: That's exactly right. It's extremely expensive to deal with and correct and mitigate the change -- climate change in general. But the majority of that burden is really carried by the Global South. So a lot of the countries that are in the Global South are struggling with debt burden issues but also have increasing exposure to negative climate outcomes that also directly affect their economy.

So the key for these debt for climate swaps is really being able to reduce the outstanding debt of an issuer, provide them with capital at an even lower cost than they would be able to receive in the marketplace and then help direct that savings, part of that savings into environmentally beneficial projects that will have a societal and economic benefit for the issuer.

So a good example would be an investment we made in a debt for climate swap for Ecuador. These proceeds were utilized to fund various programs around marine protected area enhancement in the Galapagos but also helping to transition and standardize their fishing industry in a more uniform manner.

So as an example, within that, Ecuador, their second largest industry is fishing, but they have a lot of illegal fishing, and they also have a process that doesn't allow for their catch to be sold into the EU. So this part of the programs that were being utilized from this debt for climate swap were going towards making that process in that entire industry one where the resultant catch can be sold into the EU.

So what you're looking at is roughly a saving -- an elimination of about $1 billion of outstanding debt, a material reduction in debt cost for the additional $656 million subsequent deal, and in this case, you're also providing an opportunity to show economic growth by increasing the opportunity to sell into a market you can access, which then obviously has benefit for society and the credit as a whole. So you're seeing, again, that environment impacts society, which impacts the economy, and trying to tie all of that together. So the debt for climate swap is starting to evolve as something that could be beneficial for certain issuers especially in the Global South.

Esther Whieldon: Is this one of the first years that's kind of been crafted? Or how long has that been around?

Stephen Liberatore: They've been around for about 3 years. They're fairly complex. They take a while to come to fruition, but they're starting to become more standardized. And that's another real benefit of the fixed income market. As I mentioned earlier, we are the largest asset class with an outstanding value -- the ability to find security structures that can be templated and replicated allows for scalability, so you can start issuing more frequent and larger transactions, which helps to improve the situation for an increasing number of potential issuers.

Esther Whieldon: Earlier, Steve mentioned that Nuveen has worked with a variety of issuers, including the World Bank. Here he is giving 2 examples of those transactions.

Stephen Liberatore: We were the lead investor in a transaction that the World Bank issued that helped to reforest parts of the Amazon. In this particular transaction, the capital that was raised, the $225 million deal, went to an operating company called Mombak in Brazil, who would purchase degraded farmland or degraded Amazonian rainforest, obtain the full legal control and ownership, then do a very scientific in-depth study, analyzing the topography, the geography, the climate that's very native to that particular plot of land and then create the appropriate mix of native species to replant there.

So it isn't just buying a piece of property and throwing in eucalyptus trees, for example, because they're fast growing. It's really taking the time to identify and how to rewild almost this property back to its natural state. The Mombak example that I'm mentioning is going to replant 3,300 hectares, which is the equivalent of about 7,400 football fields, U.S. football fields. And what the result of that will be will be carbon removal credits, which are extremely high quality, they are registered on the Verra carbon registry system, and there's a verification process, and there's auditing that occurs to ensure that what we believe is occurring is actually occurring and it's being measured.

And it's the first time we've had in the public fixed market a removal credit where you are actively doing something to take carbon out of the air. So the reforestation or replanting of this particular area would take carbon out of the air. And those carbon credits are being offtaken by Microsoft. So they -- Microsoft has a long history of expertise and focus on the carbon credit market. 

So you have a AAA offtaker who is taking these credits and being able to provide a monetary return to the investor. And then you have a principal protection provided by the World Bank on the issuance, on the principal. So it's what we would call a blended finance transaction where there's a derisking mechanism in place to basically scale in private investors such as ourselves.

We've done another transaction around emission reduction that distributed 300,000 water filters to about 8,000 schools in Vietnam that eliminated the need for those schools to burn biomass to obtain potable water. So that would be considered a reduction bond because that effectively was going to reduce carbon emissions by about 60,000 tonnes a year, and that's equivalent to not converting 400,000 acres of land from natural to farmland, for example.

Citigroup is the offtaker of the carbon credits that are being generated there that are also Verra-certified, audited, on the registry. So again, trying to create structures that can be replicated in a variety of different ways.

Esther Whieldon: What do you think -- the fact that there seems to be growing interest in the fixed income market in the carbon market, what can we glean as a signal from that?

Stephen Liberatore: I hope that what we can take from that is that the fixed income market is one, as I mentioned, especially for an investor like us on the impact side that are looking for direct and measurable, the ability to tie proceeds specifically to an outcome. I think that makes it cleaner, it makes it clearer for investors to understand how their capital is being used and the ultimate outcomes they're associated with.

And it is just another form of a cash flow and another asset to analyze and verify. And I think that level of granularity, that level of credibility and the measurability, I think, lends people more comfort that it's something that they would want to be invested in.

Esther Whieldon: It's interesting, so it can help with confidence in the market.

Stephen Liberatore: Yes.

Esther Whieldon: Where do you see this market evolving going forward?

Stephen Liberatore: Yes. I continue to expect that what we have seen to date with this increasing granularity and more unique outcomes, so as I mentioned, the biodiversity, the gender lens opportunities, I expect that's what we're going to see more of. We're going to see more debt for climate swaps. We're going to see more carbon credit-related transactions. We're going to see additional opportunity to find gender lens investment options.

And we're going to see things like in regenerative agriculture. We're going to see it more in distributed generation where we're securitizing individuals being able to put solar panels on their home, right? And the beauty of the securitization market is it makes things more affordable for the average person. And if that's the case, then more people are able to take advantage of renewable energy, bringing down that continued cost.

And I think that that's a real key area for me because I believe that most people, especially some of my age, have been told that to be sustainable is going to cost you money, and that just isn't the truth, right? You have your cheapest forms of marginal power, depending upon where you live in the U.S., are solar and wind, solar on the West -- in the West and wind in the Midwest.

So the concept of distributed generation and being able to help more people afford solar panels would allow them to see, well, wait a minute. I've been told being sustainable is going to be more expensive, but you're telling me I can put solar panels on my home, and it saves me money relative to my power bill. That's an entirely different discussion that I think helps people understand that at the end of the day, we're transitioning away from fossil fuels to renewables, not because of the environmental benefit but because it's cheaper. And that's, I think, the driving force in all of this.

Esther Whieldon: Some of the things we've heard on the podcast before is that more solutions are needed, that there's not enough creativity in the market for these things. And do you think that's still the case? Or do you think the market is starting to course-correct in that way?

Stephen Liberatore: I think the market is starting to recognize and acknowledge, and I think this is part of the ecosystem issues that we've been evolving through, is that historically, when people heard the word impact investing, they would immediately think, oh, that's private equity, it's venture capital, right? And it can only be in those 2 specific sectors or asset classes.

And I think now that, again, fixed income being the largest asset class, the ability to scale is now recognized as being able to deliver direct and measurable impact. So it's expanding out the opportunity set, and I think that's helping to drive additional cash flow.

There was a great chart that was put together by Bloomberg New Energy Finance that was showing that last year in 2023, $80 billion of equity was raised in either venture capital, private equity, public equity directly related to transition financing. That same study showed that $800 billion was raised in public fixed income. So it shows the scalability and the opportunity to really fund these changes.

And again, we're managing active total return funds. So first and foremost, we're looking for excess return. And we need to do that because we're not concessionary capital, we're not a charity and also because we know the cost of combating climate change is so astronomical, there's not enough grant money, there's not enough donations available to combat it, but there is enough investment capital. So if you can make this into an investment thesis and an investment argument that shows longer-term excess return, then you're able to bring in more investors and scale up these solutions and become more innovative over time.

Esther Whieldon: Well, was there anything we didn't get to talk about that you wanted to mention?

Stephen Liberatore: No, I think it's just -- it's interesting, to your question about the increasing innovation, I feel like I was here all last week, and I've been here for the past couple of days, and it's fascinating to me, the number of meetings I'm having with issuers, underwriters around new, unique, different types of structures that I think have the ability to be successful, can be scalable and actually will bring in an increasing number of investors because it's more specifically aligned with their maybe mandate or their goals, and I think that's a real opportunity.

Esther Whieldon: Thank you so much for taking the time to talk with us.

Stephen Liberatore: Thank you so much for having me.

Esther Whieldon:  So today, we heard some examples of how the fixed income market is evolving to fill gaps in sustainable finance. Two things Steve mentioned stood out to me. One was debt for climate swaps, which allow countries to both reduce their debt and invest in environmentally friendly technologies. 

And this is particularly relevant as COP16 wraps up and as we head into COP29 where the need to unlock financing for climate and nature in developing countries are a focus. Steve also mentioned how there's been a rapid diversification of the market to drive for specific outcomes, including for things like reforestation of Amazon or orange bonds that increase lending to women in underserved communities.

Lindsey Hall: Thanks so much for listening to this episode of ESG Insider. If you like what you heard today, please subscribe, share and leave us a review wherever you get your podcast. 

Esther Whieldon: And a special thanks to our agency partner, The 199. See you next time.

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