20 February 2023

Back on an upward trajectory

As the sustainable bond market returns to growth, issuers and investors face greenwashing concerns, new regulatory developments – and the prospect of massive issuance as the net-zero transition accelerates. BNP Paribas' sustainable finance specialists review the landscape

Environmental Finance: The green bond market is widely tipped for a return to growth in 2023, but greenwashing concerns are casting a cloud. How big a threat do greenwashing and reputational risk pose to issuance?

Constance Chalchat, head of CIB company engagement and CSO global markets: We are seeing diverging trends. The first is a certain normalisation of markets after the challenging market conditions we saw last year. January has been stronger in terms of green and sustainable bond issuance, as issuers who held off last year have returned to the market to fund their continuing efforts to transition as part of their net-zero trajectories. In the green bond segment, for instance, we are forecasting volumes of at least $600 billion, up from $524 billion last year – and the risk to that forecast is to the upside.

Constance ChalcatHowever, this growth is being mitigated by the second trend, which is scrutiny around greenwashing. I'm expecting issuers who could be challenged as to whether their financing could be described as sustainable, or whose framework is not very robust, to favour conventional issuance rather than turning to the ESG bond market.

EF: Are these concerns around greenwashing justified?

CC: The way we see it, criticisms can come either from a transaction from a sector that is far from green, or from an issuer which is not very sustainable, or from the transaction itself which doesn't meet the International Capital Markets Association (ICMA) or Loan Market Association (LMA) principles.

To address each of these in turn. Take a sector that is fossil-fuel heavy. If an energy company is switching to low carbon it's entirely legitimate for this company to do a green issuance to invest in renewables, for instance, provided it is transparent about the use of proceeds.

The second type of situation is where the company itself has faced controversies. Then it is necessary for this company to evidence that it has put in place solid remediation plans and has a robust approach with material targets in a sustainability-linked bond (SLB) that address real sustainability ambitions. I've seen some transactions arranged in the market where companies are setting objectives that have already been achieved, or which are not material. We need to see public scrutiny of these deals, scrutiny from the press and, indeed, we need to see these companies' banks and advisors saying they need to respect market-established principles.

EF: To what extent do we need to see greater standardisation in the sustainable bond market? Does that provide the answer to greenwashing concerns?

Frederic Zorzi, global head of primary markets: When you speak to investors, everyone has their own methodologies. That can be a positive: after all, when you look at the 2008 crisis, you can argue that a common approach by rating agencies didn't prevent a credit collapse of one part of the market. So, having people looking at ESG from different angles is no bad thing; it can challenge issuers. But, to evolve, the market will at some stage need the equivalent of the International Financial Reporting Standards (IFRS) for accounting, and the work of the International Sustainability Standards Board (ISSB) is a very good development from that perspective. That will allow investors to compare apples with apples, so to speak.

Frederic ZorziThere is enormous work underway to address this challenge – and, as a bank, we are closely involved in the development of regulations and standards. Whether ICMA, the LMA, the EU Platform for Sustainable Finance, the Hong Kong Green Finance Association, there are a lot of very serious market bodies working with investors to set up these standards. There is real willingness among market participants – issuers, banks, investors – to see strong standards agreed.

CC: We pushed hard for standardisation of key performance indicators (KPIs), both at ICMA with sustainability-linked bonds as well as through the LMA for KPIs on the loan side. The ICMA KPI registry is a great resource. Having standard KPIs both helps ensure materiality and allows investors to compare companies in terms of their ambition. It's an important part of the answer to greenwashing.

EF: What about the market's medium-term prospects? How do you see patterns of issuance evolving?

Trevor Allen, Markets 360 head of sustainability research: The SLB market is difficult to forecast, as we've less than four years of data, and social and sustainability bonds tend to be issued in response to a particular event, so volumes tend to be a bit more volatile. But green bond issuance is about the CapEx needed for the low-carbon transition and understanding countries' policies to generate clean energy.

Trevor AllenFundamentally, green bond issuance is about the economic competitiveness of solar and wind energy, and about the extent of support for emerging clean energy technologies, like batteries, electric vehicles and the hydrogen economy.

On the former, wind and solar were economically competitive with natural gas when it was cheap. On the latter, we are seeing subsidy programmes like the Inflation Reduction Act in the US, Europe's response and, in future, I expect to see similar initiatives in Asia as well.

That is going to continue to push the green transition, and we are going to see substantial green issuance in response.

EF: Which instruments hold the best promise for financing the net-zero transition – SLBs or transition bonds?

Agnes Gourc, head of sustainable capital markets: For those sectors or companies that have CapEx that are delivering significant decarbonisation projects, but which are not yet net zero, then transition bonds can be a very useful tool. And we've seen some quite significant initiatives last year, such as Japan's plans for transition bonds and work at the G20 and the OECD around transition finance. However, it's true to say that transition bonds, as a use-of-proceeds instrument, haven't been used massively yet. I think we'll see developments in 2023 in this particular part of the market, and not only from the Asia-Pacific region.

Agnes GourcWhat we always tell issuers who are looking at ESG bonds is that there are different types of approaches, and the question to ask is, which one suits your company, and where are you in your evolution?

There can be a tendency to look at precedents in the market, and almost do a 'copy-paste': that's often not the right approach. EF: What about emerging technologies? What role can the sustainable bond market play here? TA: Certainly, there is an urgent need for capital to finance energy storage – whether utility-scale batteries to shift the energy generated from intermittent renewables like solar to better fit the daily demand curve, or hydrogen to store energy over longer time periods. We will also need blended finance to help bring down the cost of the energy transition in emerging markets: it can be extremely powerful in helping to attract foreign direct investment into countries that are higher risk and providing it at interest rates that can make renewables lower cost than coal, for example.

There's also an urgent need to simply have a lot more of existing technologies. China produces 80% of the world's solar panels. For reasons of energy security, we will need to ensure that countries have the materials and technologies they will need to meet their energy transition goals: that ranges from copper wire to power transformers to wind turbine blades to solar panels.

But I think the market will start looking beyond energy, at issues such as biodiversity. As an example, soil can act as a massive carbon sink, if it's well managed. That requires things like ensuring farmers have a more diverse group of crops, while providing them with the same level of remuneration. It's not necessarily about new technologies, but the green bond market could have a role in funding the systems we need to see to ensure that the planet's critical natural cycles stay in balance, meaning tackling mitigation, adaptation and biodiversity.

EF: How can disclosure initiatives underway in the market help accelerate sustainable bond issuance?

Franck Rizzoli, head of ESG financing advisory: Let's take the EU's Sustainable Finance Disclosure Regulation (SFDR). It's important to understand its ramifications, particularly for investors. For any fund registered as Article 8 or 9, the regulation requires them to increase ESG disclosure. To do so, they need to get the data from somewhere – this is ultimately putting the burden of disclosure on issuers. Investors are therefore increasingly looking for instruments and issuers that can provide them with higher levels of transparent data and impact for them to comply with the regulation.

Many of the conversations we are having with investors are around how use-of-proceeds bonds can help them fulfil their obligations under SFDR. These bonds typically come with impact reports that can substantially support them in this regard. So, we believe that 2023 will see a big re-focus on useof-proceeds bonds – and, by issuing them, issuers will be able to potentially tap into additional demand from investors.

In turn, we think that greater disclosure will help support the credibility of the market. Well-structured sustainability-linked bonds, with ambitious targets and robust reporting, will provide measurable impact that investors can point to.

AG: It is also important to note that, while more disclosure is important, we need high quality disclosure on material topics. It's important here that we don't see a mushrooming of disclosure initiatives that end up completely confusing issuers and investors. The ISSB disclosure initiative is doing valuable work here, in bringing together important disclosure frameworks that are already in existence.

When they think about disclosure, issuers always need to ask themselves, why would investors or broader stakeholders need that information? Is it material? Is it relevant to our business?

We would also argue it is also true the other way round. Through working on sustainable bond issuances, we have helped many of our clients, including in emerging markets, further evolve their disclosure.

EF: What about other regulatory developments? Which should sustainable bond issuers and investors be watching most closely?

Jeanne Aing, head of CIB regulatory anticipation: Probably the most important is the European Green Bond Standard (EU GBS). This was due to be agreed last year, but it has been held up by ongoing negotiations between the European Commission, Parliament and Council. It would create a 'gold standard' in terms of disclosure and external reviewers who are registered and supervised – in this case, from the European Securities and Markets Authority – and alignment with the EU Taxonomy. The Parliament wants all assets financed by GBS-certified bonds to be aligned with the Taxonomy; member states are arguing for a 20% 'flexibility pocket'. We would support this, as there a risk that, without this flexibility, it would make it very difficult to issue EU GBS-certified bonds.

Regarding the EU Taxonomy, we are also looking forward to the definition by the EU of other sustainable activities, covering the circular economy, pollution, water and biodiversity. The more activities that are defined, the better for the development of the green bond market. There are a lot of regulatory developments underway: we are seeing a lot of standards, taxonomies and disclosure requirements emerging around the world. Any regulations that help to bring greater clarity, transparency and comparability for investors will help to grow the market.

For more information about Sustainable Finance at BNP Paribas, see: https://cib.bnpparibas/low-carbon

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