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Can green bonds help power emerging Asia's fixed income markets?
AT a time when climate change is an acute threat to global development, governments across the world are creating policies to shift investments towards climate-smart businesses, such as renewable energy and sustainable infrastructure. This is imperative to fulfil the Paris Agreement and offers huge opportunities for investors.
On the flip side, if the commitments are not realised, it could push an additional 100 million people into poverty by 2030. Given the scenario, green bonds can play a crucial role in aligning capital markets with climate finance, with the proceeds being used to support eligible projects with environmental benefits.
Globally, most green bonds have come from developed nations. Over the course of just one year - 2017 - new green-bond issuance grew by 78 per cent to more than US$155 billion worldwide. The number is expected to reach US$250 billion in 2018, according to the Climate Bonds Initiative, an international non-profit.
In contrast, the green bond market in Asia is still in its nascent stage. While there is growing interest from a more diverse base of investors, few Asian banks and companies outside of China have issued green bonds.
Part of the reason for low issuance can be attributed to factors including a lack of accepted standards and definitions, underdeveloped local bond markets, and a mismatch of scale between projects, bonds and institutional investors.
Yet, there is massive untapped potential, considering Asia's huge energy and infrastructure needs. The IFC Climate Opportunities Report identified substantial climate-smart investment opportunities in South and East Asia from now until 2030.
The question is what will enable Asia to take on a larger role in this arena?
MAPPING THE FUTURE
First, diversification of the green bond market is imperative. This includes expanding the market to new issuers and transactions in new currencies.
Institutional investors, who have trillions of assets under management, have a key role to play in terms of providing the necessary capital. In addition, cornerstone investment from development institutions can boost the market by reducing perceived risk for private investors and by crowding in more mainstream investors.
There is also an urgent need for an enabling environment in Asian sovereign green bond markets. Ideally, governments should support the growth of green bond markets by issuing sovereign green bonds, providing green bond financial incentives, setting national agendas and implementing carbon taxes.
Further, investors are increasingly asking for more transparency on the use of green bond proceeds and reporting.
So ensuring transparency is fundamental. But it is important to maintain a balance between promoting greater transparency and encouraging growth in new directions so as not to deter smaller and potential issuers.
Finally, green bonds have played an invaluable role in drawing the attention of fixed income investors to consider sustainability and focus on climate finance. In this context, incorporation of environmental, social and governance (ESG) factors through consistent scoring frameworks is the next frontier in mainstreaming sustainability across the fixed income space. This represents an opportunity for both issuers and investors in the Asian bond markets.
The idea that overall investment outcomes can be improved through active consideration of environment protection, social and community engagement, and corporate governance practices or ESG factors, has steadily gained ground in recent years.
Some leading equity investors and asset managers have successfully incorporated ESG factors as a differentiator in asset selection and portfolio allocation to drive outperformance.
While some of them have seen good outcomes, it is difficult to demonstrate similar results in the case of investment-grade fixed income. This is because risks here are inherently lower and protected by credit quality of the asset, especially over normal investment timeframes. In the long-term, of course, even investment-grade bonds that focus on ESG factors benefit from risk reduction.
Application of ESG factors to any asset class must ultimately be based on the collective value that markets and society consciously choose to place on environment protection, social and community engagement, and corporate governance. If our collective judgment assures it will improve the overall investment ecosystem - benefiting all market participants and society - responsible market players should take these factors into account.
However, methodologies and frameworks for ESG ratings need to be refined further for wider acceptance. A ratings scale for ESG scores assigned to companies could converge around a more consistent framework, even if providers of such scores have variations in their models.
Singapore, as one of Asia's leading financial centres, is well placed to play a catalytic role in strengthening the region's fixed income markets by promoting the issuance of green bonds and driving the systematic adoption of ESG factors and scoring frameworks by investors.
In Europe, for example, the Luxembourg Green Exchange already accounts for half of green bonds listed worldwide, including IFC and Amundi's Green Bond Fund.
The need of the hour is to build partnerships among multiple key stakeholders, including the private sector, governments and development institutions.
In a significant step, the International Finance Corporation, a member of the World Bank Group, signed a Memorandum of Understanding with the Monetary Authority of Singapore this week to support the growth of green bonds as an asset class. Going ahead, the aim is to work with institutions in Singapore and beyond to build a robust green finance market in Asia.
- The writer is vice-president of corporate strategy & resources at the International Finance Corporation.