The global sustainable debt market may struggle to surpass its high-water mark again for a third year as borrowers grapple with additional labelling costs, higher interest rates and heightened ESG scrutiny.

The share of overall bond sales labelled as ESG plunged this year to its lowest level since 2020, data compiled by Bloomberg showed. The slide was most pronounced in North America, where ESG bonds made up just 2 per cent of all sales.

Investors and credit strategists are tempering their expectation for a resurgence in 2024. Sustainable Fitch said it expects issuance to be muted if rates remain high. Bloomberg Intelligence senior ESG credit strategist Christopher Ratti said he expects sales to beat this year’s tally, though remain below the 2021 record high. That is a sentiment echoed by analysts at Barclays. Meanwhile, BNP Paribas said it expects issuance of green bonds – the largest sustainable debt category by volume – to stay flat if borrowing costs remain high.

“ESG has kind of taken the backseat,” said Rob McDonough, director of ESG and regulatory initiatives at Angel Oak Capital Advisors. “Now is just a difficult time.”

Hassle factor

While companies are still forging ahead with their sustainability goals, there is much less incentive to issue a ESG-labelled bond right now, McDonough said. Attaching an ESG label to a bond has become a more of a hassle as borrowers have to spend more time and incur additional costs when issuing labelled bonds, including drafting frameworks and getting third-party verification, while finding favourable windows to issue amid market volatility.

“Calling attention to ESG through labelling your bond in the capital markets is probably a detriment right now and not an advantage, as was the case when these markets first started,” McDonough said. 

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In Europe, issuers do not have to contend with the same reputational issues, given ESG has not faced such a pronounced political backlash as in the US. Still, sustainable issuance is already entrenched into the region’s debt capital markets, making further material gains there challenging. 

“For some issuers, it may be getting to a point where it becomes more difficult to identify additional green assets for dedicated use-of-proceeds bonds” said Mirko Gerhold, head of corporate bond origination and solutions at Commerzbank. “That’s why we think that the relative share of the sustainable bonds will remain about stable.”

The slice of ESG bonds as a share of overall debt sales has shrunk the most in the US, as backlash and scrutiny from investors and Republican politicians mounts. Goldman Sachs Group and BNP are among banks expecting the slowdown to persist. And the potential for borrowers to overstate the benefits of ESG bonds still remains a big concern among investors, according to a recent poll by Citigroup.

Green dominance

Green bonds are expected to continue to dominate the market. Borrowers raised US$527.5 billion in new green bonds this year through Dec 21, making it the second busiest year after a record US$530.4 billion issued in 2021, according to data compiled by Bloomberg.

BNP is forecasting US$600 billion in global green bond issuance next year, which is flat compared with its 2023 forecast, as interest rates could potentially “still be a bit high for some corporates”, said Trevor Allen, head of sustainability research at the bank. Allen said he expects green bond issuance to pick up as more existing debt matures and central banks start to cut rates. He is projecting US$700 billion in green bond issuance globally in 2025, and US$850 billion in 2026.

“That is largely going to be driven by more corporate issuance, but also lower interest rates that’s going to bring them back to the market,” said Allen.

Sustainable Fitch, meanwhile, expects investor interest in blue, orange – earmarked for gender equality initiatives – and transition bonds to rise in 2024, but these newer types of notes will remain a specialty area, dwarfed by the more traditional labels like green, social and sustainability bonds.

For Gregor Vulturius, a climate and sustainable finance adviser at Sweden’s SEB, 2024 will see a pickup in sustainable debt transactions compared to 2023. However, that growth will only prove “marginal” at around 10 per cent, partly because not enough funds will find their way to impactful projects in emerging markets, he said. 

“More efforts are needed to provide access to funding where it’s needed the most, which is in the developing world,” said Vulturius. Bloomberg