bneGREEN: Clearer ESG rules needed in booming green bond market

bneGREEN: Clearer ESG rules needed in booming green bond market
ESG plays is key role in dealing with the climate emergency / Malachi Brooks. Unsplash
By Richard Lockhart in Edinburgh October 13, 2022

The global green bond market was worth $552bn in 2021, accounting for 53% of all green, social and sustainability (GSS) issuances, according to a recent report from Sustainable Fitch.

2021 saw 69% growth in GSS bonds, also termed labelled bonds, with 3,184 transactions taking place, worth $1.02 trillion, Fitch said. Corporates represented the largest category of issuers, claiming 36% of the market share, compared with 26% in 2020.

However, green bonds saw their share of the market dip in 2021 to 53% from their previous dominant position, with KPI-linked bonds showing the most dynamic growth of 9% in 2021.

The growth is being driven by investor thirst for sustainable investments, across all asset classes, which has seen fixed income, especially GSS, issuance, creation and supply skyrocket to meet the demand.

The market for GSS bonds, which are crucial to investors meeting both their own and their clients' ESG targets, is set to reach $1.35 trillion in 2022, according to Environmental Finance’s Sustainable Bond Insight 2022 report. Green bonds will account for $775bn, followed by $225bn from social bonds.

Credit: Environmental Finance


Looking ahead

However, Sustainable Fitch warned that the market boom brought with it a new set of challenges for investors and portfolio managers. That key issue is the shortage of reliable and transparent information that investors can rely on to conduct ESG due diligence. Asset managers having to rely on non-standardised company disclosures.

There are different ESG standards on the market, promoted by varying bodies such as the EU, the UN, the ICMA, as well as diverging mandatory reporting rules, such as the SFDR, the CSRD and the TCFD, all with their own levels of compulsion.

The EU’s SFDR, which it launched in March 2021, requires fund managers to provide information about the ESG risks and negative impact of their investment.

For example, the EU’s green taxonomy is part of its Action Plan on Sustainable Growth. This aims to force larger companies to report how environmentally sustainable their activities are, so investors can check their claims against performance. Brussels is also working on a European green bond standard.

Meanwhile, the EBRD, a major supporter of green bonds in emerging market, said in July that it had invested €1bn in green bonds since 2017, with €524mn allocated in 2021 alone.

Saudi Arabia's sovereign wealth fund has raised $500mn in green bonds as part of a wider recent $3bn dollar-demonated issue that marked its first foray into ethical finance. The Public Investment Fund (PIF) sold the debt in three tranches, including a world-first dollar century green bond.

Oil-rich nations are raising green debt as they diversify sources of long-term funding and reinforce commitments to environmentally-friendly projects. However, only PIF has attempted a century-long dollar green
debt, let alone in a debut sale. PIF issued $500 million from the 100-year notes.

The kingdom pledged to neutralize greenhouse gas emissions within its borders by 2060, and has earmarked billions for carbon-capture technology as part of that goal.

Credit: Sustainable Fitch

What this means is that ESG bonds still carry a large element of risk because of the lack of a single source of reference against which to judge how green they are. This can affect the appetite of fund managers to invest if there is confusion and doubt over what is green, or social or governmental, and what is not.

Sustainable Fitch’s report said that more transparent and useful information was needed by investors to address growing scrutiny of corporate activity and behaviour, regulatory and compliance requirements, and concerns about greenwashing.

A second major issue to be address is the move to a commonly accepted set of ESG standards, and how to measure progress.

However, in practice investment firms will find it difficult to manage and report data when there are a large number of against different principles, taxonomies, reporting requirements, commitments and policies.

This only leads to confusion for investment professionals and investors, and will only hold back the expansion of the ESG sector and also make it easier to make accusations of greenwashing.

Finally, the report warned that the S of ESG was proving to be most difficult to promote, with bonds covering social impact worth far less than environmental and green bonds.

However, that could change, and the report warned that social concerns will become more important for investors as they assess an investment.

“Sustainable Fitch has highlighted the importance of the social impact of issuers’ business activities and how that should contribute to higher ESG Entity Ratings. This means that for two peers with similar environmental and governance profiles, any activities serving social needs should lead to overall differentiation,” the report said.

As green bond regulation slowly evolves, it is likely to play a key role in decarbonising the economy and enabling governments to meet their net-zero targets by 2050, while at the same time setting the rules that will prevent greenwashing.

Green think-tank E3G said that found that sustainable finance regulation would play a central role in the decarbonisation of the economy and the reduction of emissions.

The paper warned that in the global economy, the creation of international standards for sustainable finance could become a contested battle, one where European, American and Chinese interests may create frictions.

With taxonomy systems, strict disclosure rule enforced by government or exchanges, or a mixture of the two available, ESG financing is still in a state of flux as new rules emerge and investors seek reliable benchmarks against which to make their decision.