Recent Developments in the Asian Green Bond Markets

In October 2015, we saw the first issue of a green bond by a Chinese bank and 94% of the US$1bn issue by the Agricultural Bank of China (ABC) was reported to have been sold to Asian investors¹. ABC will use the proceeds from the issue exclusively for lending in support of environmental protection, energy conservation and greenhouse gas emission reduction and to fund eligible green projects in China and overseas. This bond issue has been seen as a game changer in terms of issue size, issuer geography and use of proceeds and other Chinese banks (China Industrial Bank and the Shanghai Pudong Development Bank) have followed ABC’s lead with US$5bn of bonds issued in January 2016 to fund green projects². India also saw its first significant green bond issues in 2015, such as those issued by YES Bank. In addition, in December 2015 and January 2016, government-linked bodies in China and India published documents emphasising the importance of green bonds in funding environmental improvements in both countries. This article discusses the drivers of the green bond market in Asia and whether there are indications that it will be sustainable.

There is no common definition of “green” bonds and market practice has been for issuers to choose their own definition. The general idea is that the proceeds from the issue of these types of debt instruments will be used either to fund projects which have a discernible, positive environmental impact, often in the renewable energy sector, or be used to invest in generally ethically sound business lines or assets, such as green residential mortgages or low-emission vehicles. An issuer can “label” its bonds as green on the basis of its own criteria or with reference to published green principles discussed below. It is then up to investors to do the necessary due diligence to determine whether they agree with that green label on the basis of information disclosed by the issuer, which may include independent analysis given by third parties.

Without fixed criteria, there have been a few well-publicised incidents where “green money” has been used to fund controversial projects. However, there has been progress in the development of green bond guidelines. The International Capital Markets Association (ICMA), through its role as secretariat to the Executive Committee of the Green Bond Principles (GBP), has helped to formulate the GBP to help provide the market with a framework, recognised by investors, with which issuers of green bonds can agree to comply. The GBP have four components: proceeds should be used for projects which meet certain criteria, providing clear, quantifiable environmentally sustainable benefits; the issuer should have a process for evaluating the eligibility of the projects using the proceeds; the proceeds should be appropriately tracked by the issuer in a manner which links back to its green projects; and the issuer should report at least annually on the use it has made of its proceeds. One can argue the GBP are too broad to be of much comfort to some investors looking for green investments, but the counter-argument is that anything more specific would discourage issuers and the aim is to grow the market, not create barriers. Using the GBP as a starting point, regulatory bodies in China and India have issued forms of guidance for the issuance of green bonds.

At present, market practice has been not to include covenants or events of default in green bond documentation which would penalise an issuer for failing to apply the proceeds of its bond issue towards the specified green use, so documentation has not given investors much comfort that issuers will abide by their stated principles. For some investors, the GBP are only of use if someone checks whether issuers adhere to them and, in this regard, help is provided by the involvement of the big four audit firms and external, independent consultants or assessors (such as Vigeo and CICERO) which can be engaged to provide opinions certifying that certain bonds meet the GBP. These have moved the green bond market towards some form of harmonisation (often lauded as an important element for the smooth operation of the international capital markets). The opinions are usually provided annually. Making failure to comply with the GBP an event of default on the bonds, as opposed to there being a mere threat of embarrassment, could encourage more dedicated green funds to purchase green bonds. In the absence of enforcement of fixed criteria as to what constitutes a green bond, there is a limit to the efficacy of the GBP or any monitoring regime.

Until recently, green bonds were only issued by municipalities and global developmental financial institutions, such as the World Bank, European Investment Bank, Asian Development Bank.The first corporate green bonds, labelled as such, were issued in November 2013 and the market has grown rapidly since then. The value of global green bond issuances in 2015 was not as high as hoped. At the start of the year, people had talked of the possibility of US$100 billion in green bond issues in 2015, but in the end the value of the green bonds issued was US$41.8 billion³, which is still a record and the reduced volume can be partly blamed on a quiet year for the debt capital markets generally.

This is a new and fast developing market and, while Asia is definitely behind the curve, the region has seen some action in the last 18 months. In July 2014, Advanced Semiconductor Engineering (ASE), a Taiwanese company, became the first company from Asia’s private sector to issue a green bond. In India, Yes Bank issued the first Indian green bond in February 2015 and followed up with another in August with a combined issue size of over US$125m. Yes Bank’s second issue was bought by the International Finance Corporation (the IFC); a purchase the IFC financed by issuing a “Masala” green bond (an Indian Rupee denominated bond sold overseas) which was also a first. In August 2015, China’s Xinjiang Goldwind Science and Technology issued a US$300m bond which was the first labelled green bond to be issued by a Chinese corporate and in September 2015, CLP Wind Farms became the first South Asian corporate to issue a green bond with a US$90m issue. In February 2016, another issue of bonds to fund wind energy, this time by Hero Future Energies, became India’s first certified climate bond.

An environmental push from Asian governments and corporates and international organisations

When you look at Asia today, you cannot deny the need for a more sustainable approach. The forest fires in Indonesia, air pollution in China and poor waste management in India are just some of the issues which have pushed environmental topics up the Asian agenda. There is a groundswell of public opinion which will soon be hard to ignore – some supermarkets in Singapore have put up signs saying they are no longer stocking products which contribute to the haze caused by forest clearance fires. But, it is hard to argue that the sort of changes needed in Asia to meet ambitious green targets can be made without government support and, in some cases, Asian governments are considering how to fund the sustainable projects which could help to alleviate the region’s pollution and the world’s climate woes.

It is estimated that China needs US$300 billion to achieve its environmental targets under the 13th Five Year Plan (2016-2020) and the Chinese government has established the Green Financial Task Force to promote, amongst other things, green bonds. China also has plans to create a nationwide carbon market by 2017 in the hope that, by putting a price on carbon emissions, it will focus the minds of those running polluting businesses to reduce emissions. India is another significant bond market in the region and the Indian government has embarked on an ambitious target of building 175 gigawatts of renewable energy capacity by 2022, from just over 30 gigawatts now⁴. It is estimated this will require funding of US$200 billion. Raising these sorts of amounts requires the involvement of the international capital markets.

In April 2015, the Chinese Green Financial Task Force published its final report which contains a chapter recommending the promotion of the issuance of green bonds. Its suggestions include, allowing commercial banks to exclude loans backed by green bonds from their loan-deposit ratios; giving financial institutions a 75% preferential risk weighting and preferential capital regulation requirement for loans backed by green bonds; permitting banks which invest in green bonds to apply a 50% multiplier for the portion of risk asset corresponding to the green bonds they hold when calculating their capital to risk asset ratio; and making interest on green bonds tax-free for institutional investors. In addition, The Green Finance Committee of China Society of Finance and Banking published the Green Bond Endorsed Project Catalogue in December 2015, which sets criteria to be met by bonds issued with respect to green projects and businesses in China which want to be considered green. The criteria recognise the international guidelines set by ICMA and the Climate Bonds Initiative (CBI), but also notes that different countries have different problems to solve and so categories of green bonds appropriate for China may not be the same as for other countries.

In India, it is recognised that investor appetite for green bonds is unlikely to be sufficient to grow the market organically. The Nationally Determined Contribution (INDC) document, which discusses how India can meet its contribution to climate improvement agreed as part of the 21st Conference of Parties to the United Nations Framework on Climate Change (COP21), states that most of the money to adapt to, and mitigate, climate change will come from the national budget, but there are other sources too and it mentions the introduction of Tax Free Infrastructure Bonds of INR 50 billion (US$794 million) for the funding of renewable energy projects during the year 2015-16⁵. In December 2015, the Securities and Exchange Board of India (SEBI) canvassed the views of stakeholders with respect to additional disclosure, based on the GBP, which must be included in the offer document for the bonds to be designated as green bonds. Interestingly, SEBI’s concept paper takes the opportunity to list what it sees as the key benefits of green bonds: positive public relations, investor diversification and potential for pricing advantage as increasing demand drives more favourable terms and a better price for the issuer⁶. On 11 January 2016, the SEBI board meeting approved the proposed disclosure requirements and reiterated the need to explore new channels to finance India’s renewable energy sector in order to meet its INDC. The Indian government seems to be stepping away from a subsidy model and focusing more on technical support and broadening investor opportunities, such as allowing 100% foreign ownership of renewable projects.

Reputational push for companies

Outside government initiatives, there are other factors helping the green bond market to grow. Improving a company’s reputation can be an incentive to issue green bonds. The reputational risk of being associated with a heavily polluting industry or a pollution-related incident can cost a company far more than the related fines. As Benjamin Franklin said, “It takes many good deeds to build a good reputation, and only one bad one to lose it”. Reportedly, part of ASE’s motivation for its green bond issue was a desire to repair its environmental image following a fine for dumping waste water⁷. However, the flip side is that issuing a green bond and then failing to meet the green investment criteria it has set itself can damage a company’s standing, so could be seen as a risk not worth taking.

Push from international organisations and lobfby groups

There have to be global solutions to global problems and the role of international organisations has always been significant. COP21 which was held in Paris in November 2015 has been heralded as a success, in stark contrast to previous climate talks in Copenhagen 6 years previously, which ended in disarray. While the “how” will take time and each country’s INDC will need to be fleshed out, the principles were agreed, including holding increases in temperature to below 2 degrees Celsius and pursuing efforts to limit temperature increases to 1.5 degrees Celsius above pre-industrial levels, which will have a major impact on many industries, including energy, transport, mining, agribusiness and finance. This is the first time in over 20 years of UN negotiations, that a binding and universal agreement on climate has been achieved – now it just needs to be signed and we have to see if countries comply. There were several green bond panel discussions and roundtables at COP21 and, in the run-up to COP21, the United Nations Framework Convention on Climate Change (UNFCCC) emphasised its support for the green bond market in a practical way by including the CBI’s green bond data on the Non Actor State for Climate Action platform, hosted by the UNFCCC.

Lobby groups, such as the CBI and other non-government organisations, are pushing green bonds. The CBI is engaged in mobilising the debt capital markets for climate change solutions and promoting a low carbon economy through encouraging strategic issuance by public entities, an improvement in the risk-return profile of green bonds, tax incentives and demand for green investments. Amongst other initiatives, the CBI is involved in advocating the acceleration of green development through financial market regulation, the development of a climate bonds private placement market in Europe and encouraging the mobilisation of private capital through government action.

Green investor pull

An influx of capital from the more developed green markets of Europe and the US is helping the Asian green bond market. An increasingly large number of investors have cash which is earmarked for investment in sustainable businesses and some banks (particularly ones with European headquarters) are having to justify their investments on the grounds of sustainability. In the US and Europe, investors have been seeking green investments for a while. Investor demand has encouraged many pension and investment funds to adopt investment criteria which require a certain percentage to be invested in sustainable investment products or ethical businesses. According to the annual report 2014 of The US Forum for Sustainable and Responsible Investment, at the start of 2014 US$1 in every US$6 under professional management in the US (US$6.57 trillion) was invested with sustainable and responsible investment strategies in mind. In the medium term, there is no reason to suspect that the same trend will not develop in Asia, especially when people are dying from the effects of pollution.

Pricing pull

The pricing advantages (for investors or issuers) of a green bond issue have not yet been evident. From an issuer’s perspective, issuing a green bond has been seen as more expensive because of the hoops an issuer has to jump through to be able to label the security green and the costs of on-going monitoring. Larger companies with well-established compliance and reporting functions will have to do less work to comply and this partly explains the preponderance of large banks as issuers. There is little additional expenditure required to document a green bond in comparison to a vanilla issue. Potential issuers would be put off by the prospect of having to pay a pricing premium on any green bond issue in order to attract green investors, but in a currently uncrowded market, that has not been seen.

From an investor’s perspective, the pricing for green bonds looks to be broadly neutral when compared to straight issues by Asian corporates. The lack of attractive pricing for investors is at least partly because there are not enough green investors or green bonds to create the sort of supply and demand pressures necessary to push up interest rates or improve pricing in the secondary market.

There is anecdotal evidence that there are liquidity benefits to green bonds in both the primary and secondary markets. Reportedly, the Xinjiang Goldwind Science and Technology green bond was five times oversubscribed, gaining the financial backing of Bank of China, and different tranches of the ABC green bond were between four and nine times oversubscribed. Oversubscription sometimes bodes well for secondary market liquidity and pricing.

If capital adequacy and tax incentives kick-in, the secondary market will be bolstered by demand from investors fighting over the few green debt securities in the market and push up the price. Transparency as to pricing and demand is assisted by the publication of independent research which evaluates fixed income securities whose proceeds are used to fund green projects. An example is the Barclays MSCI Green Bond Indices. Without dedicated green bond indices, the issue size of many green bonds has been too small for them to be included in mainstream indices. The more information is shared, the easier it will be for issuers and investors to streamline processes and track market progress.

When we see issuers incurring the expense of cleaning up their business for the purpose of raising funds from green investors, we will know that there is a real pricing pull.

An interesting development (or anomaly) was seen in the pricing of a socially responsible Islamic bond in Malaysia in 2015. Malaysia’s state-owned sovereign wealth fund, Khazanah Nasional Bhd. issued a 150 million Ringgit (US$42 million) sukuk in June 2015 to fund 20 schools in Malaysia. The particularly interesting feature is that the investors will receive a lower return if the schools meet certain performance targets and investors even have the option of returning their sukuk to the issuer at maturity in exchange for one ringgit and a tax allowance.This pricing takes the philanthropy of socially responsible investors to a new level.