Asia Pacific Head of Fixed Income, Head of SSGA Singapore
With the United Nations Climate Change Conference (COP26) having recently concluded, enthusiasm for green finance remains high. Regardless of whether this enthusiasm translates into any significant climate breakthroughs, one thing seems likely – it will boost the global sales of sovereign and supranational green bonds.
By the end of 2021, global green bond issuance is expected to reach the US$500 billion mark1. That is already an impressive number. Moreover, in 2022, investors expect this to double and hit a trillion dollars for the year2. And many are optimistic that the US$5 trillion mark could be breached by 2025.
From a total issuance perspective, Asia still lags other regions, but substantial progress is being made. Ethical bond sales in Asia Pacific touched US$185 billion as of October 2021, representing a 120% annual growth3. Approximately 60% of overall issuance in the region – almost US$110 billion – has been green bonds.
This is encouraging because studies show that Asia is most likely to bear the brunt of climate change’s impact. A McKinsey study found that Asia accounts for over two-thirds of the total global GDP at risk from climate change4. What’s more, as Asian green bonds shift ever closer to the ‘norm’, opportunities are surging.
Rising Green Bond Issuance in Asia: Support from Governments and Supranationals
Considering the risk that climate change poses to Asia, it is little surprise that green bond initiatives have garnered significant support from regional governments and supranationals.
For instance, the Bank of International Settlements (BIS) has announced an Asian Green Bond Fund, intended to channel global central bank reserves to green projects in the region5. This is on top of other green bond funds at the BIS. Similarly, the Asian Development Bank (ADB) has increased its climate financing goals. It now aims to deliver US$100 billion of funding to developing member countries6.
In late September 2021, IHS Markit amended its Asian bond indices to accommodate the growth of the ethical fixed-income market. Recognising that newly issued green bonds may be smaller in size than their ‘standard’ counterparts, and therefore ineligible for inclusion in either its iBoxx ABF Pan-Asia or iBoxx Asia ex-Japan indices, the index provider reduced the minimum qualifying size for local-currency green bonds7. In turn, this enhanced accessibility should help boost investment levels.
Government support has been highly forthcoming in China, overtaking Japan and South Korea as the region’s top ESG bond issuer. Its central bank has released multiple guidelines and incentives designed to boost ethical financing – and they appear to be working. Green-bond issuance in Asia stands at US$60.5 billion for the year till October 2021, an impressive 230% rise8.
In June 2021, the People’s Bank of China (PBoC) also stated it would begin grading financial institutions based on their green bond holdings9. These fixed-income instruments are now eligible collateral for the PBoC’s lending facilities – on top of being part of its foreign exchange reserves.
Strengthening Green Financing Opportunities
Rising issuance and institutional top-down support present exciting opportunities in the green financing space. Asia still has a significant infrastructure financing gap, which the ADB puts at US$1.7 trillion a year for developing Asia alone10 (and that was before accounting for the pandemic’s effects). Much of this needs to be green investment, as a significant portion of these funds must be funnelled toward climate-change responses.
In short, the need for green bonds is expected to accelerate. We also see participation from a growing number of non-financial corporates – and this is a positive catalyst for growth11. Furthermore, the aforementioned policy support is not just helping boost issuance and demand. It also mitigates some of the common risks associated with green fixed income.
For example, to combat “greenwashing”, China is actively strengthening its ethical bond standards, bringing them more in line with international best practices. This is especially the case for offshore bonds. There is also a uniform framework all Chinese green bond issuers must follow12. Broad policy support makes green bonds less reliant on China’s economic trajectory – again lowering the risk to investors.
Still, market participants looking toward the growing opportunities in this space should be aware of ever-present risks and trade-offs.
Uncovering the Risks in Asian Green Bonds
While concrete steps are being taken toward improving Asian green bond standards, a gap remains. For instance, China still permits 50% of green bond proceeds to replenish working capital and repay bank loans13. This “taxonomy gap” may indeed be narrowing – but it still presents a possible growth constraint.
Another risk is the question of whether ethical idealism can contend with an often-harsh economic reality. With inflation spiking, China’s green initiatives to bolster new energy sectors like electric vehicles will likely incur even higher costs. And to ease the ongoing energy crunch, the government was also forced to loosen restrictions on coal mining operators to ensure an adequate supply of raw materials14 . One future development could be an increase in demand for green energy, which should attract new entrants. In turn, this would see supply expand, which will help drive down the cost of green energy production and consumption.
Finally, there is the persistent question of whether green bonds are more expensive than their conventional counterparts – the “green premium”. Evidence has been mixed, with one explanation for any premium being that green projects are inherently more competitive and thus deserving of the additional cost15. There may be some merit to this argument, considering that having long-term green power agreements did shield some companies from the effects of the energy crunch16. Yet, the debate is far from settled.
Finding a Balance Amid the Green Financing Boom
The data is clear. Not only are green bonds here to stay in Asia, but their issuance should continue to increase. However, investors must be mindful of risks and trade-offs. Careful due diligence will be required. Alternatively, focusing on green bonds issued by sovereigns and supranationals may be an effective shortcut that bypasses much of the risk – while still capturing any upside.
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