Stepping stones on the way to developing the green bond market in Asia

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Several Asian countries recently introduced stewardship codes to encourage investors to act responsibly and challenge companies on the sustainability of their business models. Codes in Asia, Japan, Malaysia, Taiwan, Hong Kong, South Korea and Singapore are already proving effective when it comes to a constructive dialogue about sustainability and green finance with bond issuers.

But, as I explained at a recent BNP Paribas Sustainable Future Forum in Singapore, they are just one of the elements that need to be addressed in considering how best to develop the green bond market in Asia.

Well-adapted regulation – driven by pragmatism

When it comes to regulation in the green bond market, we can learn lessons from Singapore’s ‘economic miracle’ which in the 50 years from 1965 took its nominal GDP per capita of USD 500 – about the same as Mexico’s – to USD 56 000, comparable to that of Germany or the US. But this was not actually a miracle.

Singapore’s leaders chose a combination of policies and regulation supporting a high level of public education, the concept of meritocracy and an intolerance of corruption. What drove these policies and regulations was pragmatism. As Lee Kuan Yew, the founding prime minister of Singapore, explained: “We are pragmatists… Does it work? Let’s try it and if it does, fine, let’s continue. If it doesn’t, toss it out, try another way. We are not [tied to] any [single] ideology”.

Pragmatism – not narrow ideology – is what is needed to develop the green bond market. There is no one answer – be it “the market can solve everything” or “government intervention can provide all the answers”. What is important is to try new ideas and to look at best practices around the world to see if they are adaptable to your local market.

The importance of local market appropriateness is underlined in the latest UN Environment Programme (UNEP) Inquiry report on green finance development around the world. It says that measuring the increase in green finance flows has been possible thanks to the close connection between policy and market evolution.

Each country’s approach depends on the development of its own financial markets and ‘green’ ambitions. These are not mutually exclusive. We can see examples from the UNEP’s tracking of progress on recommendations provided to the G20 last year in Hangzhou, such as:

  • Providing strategic policy signals and frameworks

This is important because strategic policy signals and frameworks can help reduce perceived uncertainties about green investments and thereby help accelerate the development of green finance. Governments set out the vision, but the financial players deliver it.

For example, Article 173-VI of France’s Law on Energy Transition for Green Growth applies the logic of ‘comply or explain’ for investors. Investors are required to report not only on how they integrate environmental, social and governance (ESG) factors into their investment decisions, but also their contribution to combating climate change.

  • Developing a local green bond market with the help of direct government intervention

A local green bond market can provide an additional source of long-term green finance to bank lending and equity finance. Governments have been playing an active role, not least through sovereign and quasi-sovereign issuance, setting an example for companies and other players. In January 2017, the French Treasury issued a green OAT (‘Obligation assimilable du Trésor’ – a fungible government bond)  and raised EUR 7 billion.

As well as being the largest issue so far in the green bond market, it has the longest maturity date (22 years). This bond also sets new standards in terms of the evaluation of projects and environmental impact reporting. But momentum is gathering in Asia Pacific, too. In July 2016, the State of Victoria became the first Australian government to issue a green bond (USD 300 million) followed by the State of Queensland this year (USD 750 million).

What is our assessment of emerging market green bonds?

We score green bonds from 0 to 100. The average score from developed issuers is 62 points, while the average emerging market issuer scores 40 points. We see clear differences in terms of the quality and transparency of green bond frameworks.

In particular, 60% of the emerging market green bonds we have assessed do not meet international standards or have a transparent framework to mitigate environmental and social risks. This is a crucial weakness in emerging countries where projects could have significant adverse impacts on the environment and local populations.

Furthermore, 45% of emerging market green bond issuers lack a clear governance structure stipulating how their green bond programme is to be implemented. The level of disclosure on the project selection process is often insufficient. This point is crucial as many emerging market countries suffer from political instability, making it more likely that the execution of ‘green’ projects could be put at risk.

We also track the UN’s 17 Sustainable Development Goals (SDGs) in relation to the green bonds we assess. As well as SDG 7 (Affordable and Clean Energy) and SDG 13 (Climate Action), we have found that 40% of emerging market green bonds support SDG 6 (Clean Water and Sanitation) and 35% support SDG 11 (Sustainable Cities and Communities).

The green bond market in APAC: issuers versus investors

Investors

Assets under management in Asian mutual funds are split fairly evenly at about one-third each between bonds, equities and other mixed assets. So there is an appetite for fixed-income products, which is good news – but not in itself enough; we need to respond and adapt to the profile and interest of those investors.

In Singapore, the investment market is 96% retail and 4% institutional, meaning that we need to raise awareness of green bonds – in particular that they are not just ethical investments: they earn similar returns to conventional bonds, but the proceeds go to assets and projects related to climate change.

A report from the Bank for International Settlements this year found that green bond indices have a similar risk-adjusted performance to that of global bond indices, with a Sharpe ratio of 0.35 versus 0.33, respectively.

Issuers

Establishing a clear case to explain the business benefits of tapping the green bond market:

  1. Green bonds can expand your investor base. For example, the investor base in Paris for conventional French government debt is 75% domestic. In contrast, for green bonds, the investor base is 75% non-residential investors against 25% French domestic buyers.
  2. Using green bonds as a tool to finance and support a more sustainable business model can yield a competitive advantage in the longer term. Environmental regulation will likely become more stringent as countries seek to fulfil their below 2ºC commitment in line with the Paris climate agreement. For example, German banks are using green bonds to increase the proportion of green buildings in their loan portfolios.
  3. The costs and fees linked to issuing a green bond are no higher than those for the issuance of  regular bonds. Indeed, the Monetary Authority of Singapore has introduced an initiative that offsets issuers’ costs by offering grants on reporting and monitoring. Under this scheme, qualified issuers can offset 100% of the costs of obtaining an external review of green bonds, up to SGD 100 000 (about USD 73 300) per issue.

Written on 08/11/2017 by Felipe Gordillo

Source: BNP Paribas Asset Management, as of 08/11/2017

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Felipe Gordillo

SRI Senior Analyst

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