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.
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.