ESG-labelled bond activity gets affected by broader global slowdown
A more challenging global macroeconomic backdrop this quarter damped the sustainable debt market, which has been subject to a similar reduction in corporate bond activity. Issuance slowed in the third quarter, with about $185 billion in ESG-labelled bonds coming to market. This represents a 23% decline from both the previous quarter and year-on-year.
The downtrend is particularly notable in sustainability-linked bonds (SLB), which are most similar in nature to conventional bonds. Issuance dipped to $7.9 billion. This decline marked the lowest quarterly volume since the first quarter of 2021. The introduction of more detailed guidance on the materiality of SLB key performance indicators from the International Capital Markets Association (ICMA) in June 2022 may have also contributed to the slowdown, as issuers and advising banks evaluate the ambitions of targets before coming to the market.
Green bond issuance totalled $113 billion, down 21% from the second quarter, although there were several positive developments in the Asia Pacific region. Singapore’s Ministry of Finance issued the country’s first sovereign green bond. Meanwhile, China published its first Green Bond Principles aimed at improving standardisation and alignment with international best practices.
Sustainability bonds, which are use-of-proceeds instruments that finance a combination of green and social activities, remained roughly flat from the previous quarter. While the absence of corporates in the sustainability bond market was noticeable, this segment was largely buoyed by supranationals and agencies responsible for total issuance of $19 billion under the label. $11.5 billion were in the form of Sustainable Development Bonds from two World Bank institutions.
ESG-labelled bond issuance
Source: Sustainable Fitch, EF Data
JPMorgan served as lead manager for over $21 billion in such bonds from supranationals, agencies and sovereign issuers, according to the quarter’s lead manager league tables. The bank was also involved in several large social euro issuances from the African Development Bank and French government-related entity, Caisse d’Amortissement de la Dette Sociale.
Science-based targets expand to new sectors
Though labelled bond activity was generally weaker, positive developments were still evident in other areas. The Science-Based Targets Initiative (SBTi) added guidance for two sectors in September 2022 – cement, as well as forest, land and agriculture. These additions bring the total number of sectors with targets up to six. It is an important step in addressing the knowledge gaps for corporates and financial institutions, allowing for improved efficiency in targetting activities that can contribute the most to 2050 net zero commitments.
Fitch Ratings has identified cement as the sub-sector most vulnerable to climate risk, within building materials. Energy efficiency, material efficiency and carbon capture, and storage are the key operational changes needed to reduce emissions.
SBTi provides specific guidance on Scope 3 emissions reporting for cement companies, with near-term target requirements on emissions from purchased cement and clinker, and fuel-related emissions. A small number of cement companies have issued SLBs with KPIs related to emissions intensity. We expect the introduction of these KPIs to increase both the number of SLBs from the cement sector and the materiality of their targets.
Quantifying emissions in land- and nature-based economic activities has developed more slowly than for other carbon-intensive sectors, due to the challenges of balancing essential needs like food security with environmental protection. Agriculture was notably excluded from the first version of the EU Taxonomy only to be later added as an annex in March 2022. Agriculture is also not a specified sector under the International Energy Agency's (IEA) Net Zero by 2050 scenario, one of the most widely used scenarios by financial institutions for portfolio climate risk management.
Accounting for Scope 1 greenhouse gas (GHG) emissions from direct agricultural production and processing is relatively straightforward. The challenge, however, is in emissions related to the change in land use itself. Most of these comes from the loss of forests, peatland, and mangroves, thereby diminishing their capacity to absorb atmospheric carbon dioxide.
The World Resources Institute’s (WRI) Greenhouse Gas Protocol has proposed a method to account for emissions from land use change, which is due to be finalised in 2023. Should the introduction of a systematic emissions accounting for agriculture indicate the impact of land use change has been undercounted – either in its output or removal effect – this could support a shift in priorities for the allocation of green capital towards the sector.
Sustainable finance innovation continues in Latin America
Latin America is home to several firsts in the sustainable debt market and its positive efforts have continued to gather pace in 2022. Sovereign SLB, multicurrency sovereign Sustainable Development Goal (SDG)-focussed issuances, and a locally specific green taxonomy are among the region’s latest developments.
Despite a more challenging environment, several Latin American sovereigns and supranationals came to the market with labelled bonds in the quarter. The government of Mexico expanded its SDG bond programme into new currencies with a $2.2 billion, 11-year bond in early August, and a multi-tranche yen offering totalling JPY75.6 billion ($535 million) with maturities ranging from three to 20 years.
Elsewhere, Uruguay offered its first sovereign SLB in October 2022, following the publication of its framework in September. It has two notable differences from Chile’s March 2022 bond, which remains the only sovereign SLB to date. The first is a biodiversity KPI on maintenance of native forest area. The second is a bi-directional adjustment mechanism, where the bond’s coupon can either step up or down depending on whether key targets are reached or missed.
Colombia’s publication of its Green Taxonomy in April 2022 – the first from a Latin American country – is another step towards advancing sustainable finance goals on a national scale. As with other green taxonomies, Colombia’s is a science-based standardised framework. The goal is to articulate the country’s green finance priorities, mitigate ‘greenwashing’ risks and attract financing from a diversified pool of investors. The taxonomy classifies economic activities and financial assets based on their substantial contribution towards the environmental objectives of the SDGs.
A significant difference in Colombia’s taxonomy from that of the EU is the inclusion of land use as one of its seven environmental objectives, reflecting the contribution of natural capital to the Colombian economy. Natural resources in Colombia have historically been a source of social conflict over land use resulting in decades-long fights between the Revolutionary Armed Forces of Colombia (Farc), the government and various corporations. These can have spillover environmental and social effects such as illegal deforestation and involuntary resettlement of missions of people in rural areas. In this context, the Colombian government has aimed to design policies to address social unrest, protect biodiversity, and ultimately attract foreign investments.
Aaron Wei Director, ESG and Sustainable Finance
Business and Relationship Management
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