Green, social and sustainable bonds set to plug climate financing gap

IN RECENT years, the market for sustainable use-of-proceeds bonds has grown significantly. Annual issuance of green, social and sustainable (GSS) bonds rose from US$95 billion in 2018 to US$735 billion in 2021, according to Bloomberg data.

However, the sustainable-labelled bond industry had a difficult 2022 amid broader macroeconomic issues, causing annual issuance of GSS bonds to fall to US$572 billion.

The energy crisis, pandemic and last year’s interest-rate hikes created a challenging macroeconomic environment, exacerbated by the war in Ukraine.

This led to a major sell-off across bonds and equities. It has been estimated that stock and bond markets lost around US$30 trillion in value in 2022.

While the fixed income market as a whole suffered last year, the sustainable segment dealt better with the downturn: In the first three quarters of 2022, sustainable-labelled bond issuance accounted for 20.8 per cent of total bond issuance in Europe, up from 19.9 per cent in 2021, according to the Association for Financial Markets in Europe (AFME).

As inflation subsides and the pace of interest rate rises moderates in the course of 2023, we expect the outlook for sustainable bonds to improve.

Sovereign issues on the rise

The Sharm El-Sheikh Implementation Plan launched at last year’s COP27 meeting estimates that the transition to a low-carbon global economy to fight climate change would need investments totalling at least US$4 trillion to US$6 trillion per year.

According to the United Nations, the transition will require central banks, commercial banks, institutional investors and governments to act rapidly to address the need for funding. Sovereign GSS bonds are expected to play a large role in plugging this financing gap.

At COP27 a number of countries updated their nationally determined contributions (NDCs), which comprise plans by individual countries to reduce national emissions and adapt to the impact of climate change. We believe financial instruments including GSS bonds can go a long way to help meet these targets.

January 2023 already saw a string of sovereign GSS bond issues by Hong Kong, Slovenia, Ireland and the Philippines. Hong Kong raised US$5.75 billion in the largest sustainable-labelled bond ever issued in Asia, while Slovenia collected around US$1.35 billion. India raised about US$1 billion in its first sovereign green bond. The issue was largely picked up by local banks and insurance firms.

A 2022 Moody’s report on the challenges that emerging markets may face in achieving a “just transition” emphasised the role sustainable-labelled bonds can play in funding the gap between current government budgets and projected just-transition costs. It noted that emerging market governments accounted for 16 per cent of total sustainable-labelled sovereign issuance in 2022, up from just 1 per cent in 2017.

Countries including Thailand, Malaysia, Brazil and Columbia have been developing sustainable-finance taxonomies. These classification tools can help provide guidance, frameworks and standards for investors, increase the flow of capital towards green projects and facilitate the development of innovative investment products.

Corporate bonds for energy security

As the energy transition gains traction, there are many opportunities for companies to use GSS bonds to help raise capital, particularly in carbon-intensive sectors.

The energy, building and transport sectors are large use-of-proceeds bond issuers. For example, Dutch-German grid operator Tennet launched a three billion euro green bond last October for its onshore grid, to increase the transmission of renewable energy.

As part of efforts to decarbonise its corporate bond portfolio, the European Central Bank has said it would give green bonds preferential treatment in its primary market. If other central banks were to take a similar stance, this could encourage companies to issue more green bonds.

Moody’s said that the energy crisis increased the prospect of greater long-term sustainable debt issuance to finance Europe’s energy transition, as the region seeks to move away from reliance on Russian fossil fuels.

To accelerate such a shift, significant amounts will need to be invested in infrastructure. Much of this could be financed with sustainable bonds, Moody’s said.

Evolving regulatory landscape

Over the past few years, there has been extensive progress in developing standards for the GSS bond market. The leading set of standards is the Green, Social and Sustainability Bond Principles by the International Capital Markets Association (ICMA). The guidelines help issuers select the right projects and set standards on post-issuance compliance and reporting.

The European Commission has devised a European Green Bond Standard (EUGBS). Although currently voluntary, it could become mandatory for issuers in the future. Additionally, the Climate Bonds Initiative has published the Climate Bond Standard, which outlines international best practices for labelling green investments.

More regulators are working on defining green bonds. The China Securities Regulatory Commission has introduced green bond principles to unify the country’s domestic market. The principles reference ICMA standards. Like the ICMA framework, they provide four core components: use of proceeds, project evaluation and selection, management of proceeds and duration of information disclosure.

Sustainable Fitch said China’s requirements on working capital are unclear since they do not specify the types of working capital and amount of proceeds that can be used to repay an issuer’s debt.

Last month, the Securities and Exchange Board of India approved a stronger framework for green bonds, specifying the basic dos and don’ts in relation to green debt.

As standards develop and investor confidence increases, the market for sustainable bonds can be expected to grow. Stable macroeconomic conditions will also help support growth.

The writer is ESG/green bond analyst, with the assistance of Malika Takhtayeva, sustainable fixed income lead (Emea), BNP Paribas Asset Management.