26 April 2021
Despite the misconception, market experts explained that emerging market sustainable bonds can deliver more impact for investors than developed market paper. Ahren Lester reports
Emerging market (EM) green, social, sustainability and sustainability-linked bonds have the potential to deliver more impact for investors, according to experts, but it requires constructive investor engagement as well as sincere and substantial strategic commitments from issuers.
With forecasts that the emerging market (EM) green bond issuance alone could reach $100 billion a year by 2023, up from $40 billion in 2020, investor interest is growing in green, social, sustainability and sustainability-linked bonds from these regions. A webinar organised by Environmental Finance in partnership with the International Finance Corporation (IFC) brought together four market experts to explore how investors and issuers can build access to these markets.
PIMCO senior vice president for credit research Del Anderson said one of the "biggest misconceptions" around EM sustainable bonds is that they have less impact than developed market sustainable bonds.
"That has quite a sizable impact on climate and carbon and an also have a very positive social impact – much more so than some of the seasoned bond issuers that you see in developed markets" – Del Anderson, PIMCO
"I would disagree with that," he said. "If you have got a large developed market company with very advanced ESG – say, Apple or some REIT that is purchasing a LEED Gold or Platinum building that was built 10 years ago – the actual impact is going to be relatively small."
"However, if you have an emerging markets company that is at the beginning of their sustainability journey and building out all of the associated internal controls and infrastructure to track their own impact while they are also constructing new buildings and leading the energy transition in their local markets. Well, that has quite a sizable impact on climate and carbon and an also have a very positive social impact – much more so than some of the seasoned bond issuers that you see in developed markets."
Crédit Agricole CIB (CA-CIB) Latin America debt capital markets origination head Gordon Kingsley said the potential for delivering greater impact through EM sustainable bonds is also being felt on the origination side. He said conversations with issuers have "evolved" over the past few years.
Previously, Kingsley said conversations were primarily with treasury and finance teams about sustainable bonds being a means to diversify their investor base, and the questions centred around how much more work was involved and what level of 'greenium' or savings could be expected.
"The conversations we are having now are strategic conversations with issuers that have made commitments to sustainability, and that has transformed the market completely," he said. "We have come a long way. Emerging market issuers have, maybe, further to go. But, in some ways, the strong commitment that they bring also brings a much higher trajectory. I think that is a very positive trend. We are moving away from a kind of a financing discussion to a much more strategic discussion."
"The conversations we are having now are strategic conversations with issuers that have made commitments to sustainability, and that has transformed the market completely" – Gordon Kingsley, CA-CIB
Anderson said this shift from a finance to a strategic focus behind EM sustainable bond issuance was also being reflected in the quality of the bonds being developed. He said the "higher-quality bonds" PIMCO is seeing from the EM are those that are an "outgrowth of a strategic decision" focused on integrating sustainability into the broader business, not those focused on a way to reduce their coupon.
"And to the extent that a company has internalised that, it is much easier for them to communicate what those targets are and how they are going to get there over a three- to five-year period," he said. "As investors, it is also much clearer for us to see what it is that we are getting when we invest in a green, social or sustainability bond. And, obviously, the new sustainability-linked structures play very closely into that type of evolution."
No lowering of standards
The panellists also disagreed with a widely held belief that investing in EM green bonds requires an investor to lower their standards.
CA-CIB's Kingsley said that from the perspective of a bank originating green bonds, they are trying to deliver a product from issuers that is "consistent" with the widely used international market principles administered by the International Capital Market Association (ICMA).
"If there is a perception that there are higher risks in EM, or that investors are being asked to take a greater 'leap of faith' [by investing in EM green bonds] – I would say that is not the case. That is not the market we are trying to build."
The panel did emphasise the difference between the sustainable bonds targeting international markets and those more focused on local markets. For Kingsley, the cross-border international market tends to be driven more by market forces than by regulatory forces. In Latin America, for example, he said that local green bonds are often issued using local taxonomies that are noticeably different from the ICMA principles around which CA-CIB structure all their sustainable bond transactions.
Nonetheless, Kingsley believes that support for the market from the regulatory side is likely to grow as these local standards eventually converge with international standards.
Amundi emerging markets corporate and high yield debt co-head Maxim Vydrine said China – which is the largest EM sustainable bond market and one of the first to kickstart the market – is a good example of this trend. Regulators in the country published green bond guidelines which encouraged local participations in the market, and recent changes to these guidelines indicate greater harmonisation with international standards.
In addition, Kingsley expects to see growth in sustainable bonds that "cross-over" between local and international markets – similar to the inaugural CLP1.77 trillion ($2.3 billion) sovereign social bond from Chile in November 2020. Although denominated in Chilean pesos and securing a large local anchor investor base, the bond was offered in the international markets.
And international investors were receptive to the Chile bond. Anderson said that this bond was one that PIMCO liked and is in its portfolio. Despite reservations about the liquidity of EM bonds not issued in hard currencies – such as US dollars and euros – Anderson added that an "evolution" along the lines of the Chile bond would "welcomed" by PIMCO.
Engagement is key
Amundi's Vydrine agrees that investors "generally expect exactly the same level of standards" for EM sustainable bonds as for developed market bonds. Nonetheless, he said there is "more scope for engagement" with EM issuers where this alignment is not evident.
"We recognise that sometimes external factors make things difficult. But, to the extent that we want to make sure that the sustainability trajectory is in place, [keeping promises] is quite important for us as an institutional investor" – Celina Apóstolo Merrill, BlackRock
For example, Vydrine said Amundi recently engaged with an issuer in China over its impact report.
"Even though they reported on their commitments, the methodology was not aligned with the standards that normally would be expected in developed markets. So, we engaged with them and explained why it is important for us to report on the CO2 emission savings on a proportional basis as opposed to for the whole project."
Following this engagement, the issuer has now committed to adjust its methodology in the future. Amundi also invests a lot of time and effort into knowledge sharing with issuers, Vydrine said, for example through executive training programmes.
BlackRock emerging market corporates portfolio manager Celina Apóstolo Merrill also emphasised the importance of long-term engagement with EM issuers and regulators to promote best practice across regions with regards to reporting behaviour and information.
"Sometimes the information is quite sensitive," she said. "Sometimes you have geopolitical or process risks that you can't share with international investors. And, sometimes, we end up having that information on a private basis.
"There are other times in which we work with regulators to even out the regulation or the information that is needed on local exchanges – that means that you level the playing field for everyone."
She said, over time, this engagement has resulted in a "significant improvement" in the information provided by EM officials and company executives. This engagement helps to overcome what she described as the difficulty for large asset managers to be seen as too prescriptive with regards to the information required, when EM issuers often don't have the history of regulatory support and capital access that would have helped furnish them with this information.
Investors must be pragmatic
Amundi's Vydrine said investors need to be "pragmatic" about what they expect from EM issuers, explaining that you cannot expect a debut EM green bond issuer to be at the "same speed" as an established green bond issuer from Sweden.
"We are quite active in green and sustainable private placements. For some of the issuers in emerging markets, in particular, sometimes [this market] is a very important first step on their path to becoming regular sustainable bond issuers" – Maxim Vydrine, Amundi
For Vydrine, it is also "quite important" for Amundi to get involved in the sustainable bond journey of issuers before they hit the public markets. He argues early engagements are a key stepping stone for some issuers to develop effective frameworks and governance to support future issuances.
"We are quite active in green and sustainable private placements," he said. "For some of the issuers in emerging markets, in particular, sometimes [this market] is a very important first step on their path to becoming regular sustainable bond issuers. This is because, effectively, it allows them the time to develop and test their framework and the infrastructure for all the disclosures that they are committing to."
'Keep your promises'
So what expectations do investors have for EM sustainable bond issuers?
PIMCO's Anderson said EM issuers must ensure that the use of proceeds for a green, social and sustainability bond or target associated with a sustainability-linked bond is clearly aligned with its sustainability strategy. What is more, if the issuer has faced criticism on matters of environmental, social or governance (ESG) criteria in the past, then the bond should be clearly used to address these criticisms.
In contrast, any bond that comes across as a 'business-as-usual' bond is likely to be looked upon poorly by investors.
Vydrine and Apóstolo Merrill said EM issuers must make sure they "keep their promises" to investors – especially as long-term investors, as Apóstolo Merrill said, have "long-term institutional memories". The task is not finished once a bond is issued: commitments on disclosures, key performance indicators and that proceeds are going to appropriate investments must be delivered on.
"We recognise that sometimes external factors make things difficult," she said. "But, to the extent that we want to make sure that the sustainability trajectory is in place, [keeping promises] is quite important for us as an institutional investor."