A Closer Look at the “Green Wave” Hitting Asian Bonds

Asia’s green bond issuance has surged in 2021, but should fixed-income investors alter their strategies to account for this new “green wave”?

Asia Pacific Head of Fixed Income, Head of SSGA Singapore

As the Earth’s temperature continues to rise, ESG (environmental, social, and governance) investing has become a hot topic, with global ESG assets now on track to surpass US$53 trillion within five years1 . While most of these inflows have been concentrated in the equity markets, the same trend is also playing out in the fixed-income space.

In the first five months of 2021 alone, total global green-bond issuance has hit US$194.8 billion – 80% of 2020’s entire amount2 . Asia Pacific accounted for US$69 billion of this figure3 , with China being the dominant player, at US$26.1 billion. Although Asia-Pacific’s share of new bonds coming to the market still lags Europe and the United States (US), its growth this year has been impressive. For instance, China’s figure has already almost matched the US$27 billion sold for the whole of 2020.

Top-Down Targets and Bottom-Up Demand

Both top-down targets and bottom-up demand are powering this growth. US President Biden has not only re-joined the Paris Agreement but also announced ambitious new carbon-emission targets4 . The European Union’s (EU’s) Sustainable Finance Disclosure Regulation has recently come into effect, making it easier for market participants to assess these green investments5 . Investors are also now much more aware of the genuine risks associated with neglecting ESG factors – especially in light of the pandemic.

Asia’s rapid growth in the ESG bond space is following these same trends. For instance, China wants to achieve carbon neutrality by 2060. Both Japan and South Korea aim to reach this goal by 20506,7. And Singapore’s is committed to cutting its peak greenhouse gas emissions (expected in 2030) in half by 20508 .

Asia is also benefitting from the additional diversification and yield pickup that its bonds provide to international investors. As foreign participants, flush with liquidity, continue to stream into the Asian bond markets9 , tapping into the region’s ESG bonds allows them to simultaneously achieve their sustainability related goals.

Both Corporates and Governments Entering the Game

While green bond issuance has primarily been associated with corporates, Asian governments are also becoming more involved. In Indonesia, for example, a government-led US$1.25 billion green Sukuk bond came to the market in 2018 – the first sovereign of its type in Asia10 . Hong Kong has issued a cumulative US$3.5 billion of green bonds, including one with a 30-year tenor11 .

Meanwhile, Singapore announced in its 2021 Budget that it would use green bonds to finance select public infrastructure projects, with up to US$14.1 billion of projects already identified12 . In June 2021, government-linked company Sembcorp Industries priced an inaugural green bond offering of US$303 million13 .

On the corporate side, we also see more innovative green bond structures enter the market. For instance, June 2021 also saw the finance subsidiary of a Chinese state-owned automaker launch a US$142.6 million green bond backed by cash flows from auto loans for new energy vehicles14 . This is a milestone issuance that could pave the way for other securitised structures in the space.

The growth in Asian green-bond issuances is certainly impressive on the surface, but there are deeper issues at play.

Green, but not Green Enough?

“Greenwashing” is the practice of making a company look sustainable purely at the surface level. And with different standards being used to determine whether a bond is “green” enough, some Asian green bonds have triggered investor scepticism.

For instance, in China, local regulations state that up to 50% of the proceeds of these green-bond issuances can be used to boost working capital or repay bank loans15 . In contrast, international guidelines stipulate this allocation to be no more than 5%. With such a large allocation permitted toward funding day-to-day operations and repaying debt, investors are asking – how green are these green bonds?

China is not the only Asian nation facing such scrutiny. In 2020, a South Korean utility raised US$500 million via green-bond issue. Later, it came to light the firm was planning to invest in new coal-fired power plants in Vietnam and Indonesia. While the proceeds from the sale were not used for said investment, the optics of the situation were clearly less than favourable16

Although the Asian green bond space may not be perfect, it is moving in the right direction. For example, from July 2021 onward, China will exclude so-called “clean coal” and secondary oil and gas extraction projects from using green bonds for financing17

However, from an investor perspective, the question is – are Asian green bonds superior to their regular counterparts?

Is the Green Juice Worth the Squeeze?

As institutional investors demand more ESG assets, there is some evidence of a “green premium” – a premium that such assets can command18 . For fixed income, this would equate to green-bond issuers offering lower coupon rates to investors.

To be sure, the evidence is mixed, with other studies questioning the existence of such a premium19 . Investors must also consider that green bonds do not necessarily equate to lower risk. For instance, in March 2020, a green bond sold by an Indian irrigation company went into default after missing an interest payment20

As green bonds share of the Asian fixed income market continues to grow, such defaults on corporate issuances may become a more familiar story. Right now, they are still a tiny part of the larger market – even in China, they only comprise under 1% of the total bond space21 .

Careful Risk Analysis Remains Necessary

As such, investors should be careful about giving green bonds favourable treatment in the due-diligence process. Riskier corporate issuers are more than eager to capitalise on the demand for ESG assets, and careful risk analysis remains necessary.

In that respect, investors may be better off investing in a broad spectrum of Asian government bonds. The default risks are much lower, while the advantages – such as a yield pickup and portfolio diversification – are still there. Furthermore, as governments step up their green bond issuances, this may also give investors the exposure to ESG assets they desire.