The sustainable bond market will rebound from 2022 – but it faces a number of near-term headwinds, say Adriana Cruz Felix, Jeffrey Sukjoon Lee and Matthew Kuchtyak of Moody's Investors Service
Environmental Finance: What are your expectations for sustainable bond issuance in 2023? Could we see volumes return above $1 trillion?
Matthew Kuchtyak: It's a mixed picture, with the global green, social, sustainability and sustainability-linked (GSSS or sustainable) bond market facing a combination of drivers and constraints. Our forecast is for around $950 billion of sustainable bond issuance, excluding loans, or around a 10% increase from last year.
We expect about $550 billion in issuance of green bonds – the biggest individual component of the market – with a continuing focus among issuers and investors globally on climate mitigation. We expect a slight decline in social bonds to $150 billion, as many of the pandemic-response financings by governments and agencies are now in the rear-view mirror.
We predict some growth in sustainability bonds, to about $175 billion of issuance, as growing awareness of the interplay between green and social considerations takes hold, and as more issuers package green and social objectives together under sustainability-labelled frameworks and instruments.
Finally, we expect about $75 billion of sustainability-linked bonds (SLBs) globally – a very small tick-up from last year. It's still a nascent market, and it's navigating some challenges in terms of building credibility and standardising best practice. But we predict modest growth, with issuers focused on making the SLB label work effectively, particularly within transition sectors. While sustainable bond volumes will not return to 2021 peak levels, the long-term fundamental growth drivers remain in play. These include the acceleration of corporate decarbonisation plans and related financing of net-zero ambitions, growing public sector interest in financing broader sustainable development goals, and rising investor pressure on companies to enhance their sustainability disclosures.
But there are some near-term constraints that we think will limit the upside in 2023. On the macro front, a challenging economic growth and interest rate environment may dampen issuance momentum, particularly in the first half of the year. And heightened concerns over greenwashing could cause some issuers to take pause. While these drivers and constraints lead to a mixed story for 2023 issuance, what remains clear is the long-term penetration and influence of sustainability in the capital markets. Sustainable bond volumes continue to reach new highs in their share of the broader bond market, with a record 13% of global bonds being labelled as sustainable in 2022. We anticipate that sustainable bonds will reach an approximate 15% share of full-year global issuance in 2023 as market penetration deepens.
EF: How will transition finance evolve in the coming year? Could we see the transition label grow in popularity?
Jeffrey Sukjoon Lee: Transition bonds – as distinct from commonly used use-of-proceeds green bonds or sustainability-linked instruments – are not widely used by issuers globally. However, there's emerging interest in the transition label in the Asia-Pacific region, because of the carbon-intensity of many economies and strong policy support to finance decarbonisation agendas.
For example, Japan's Ministry of Economy, Trade and Industry has published guidelines on climate transition finance and a sector-specific technology roadmap over the past couple of years. The government also subsidises the assessment costs that issuers face when issuing transition debt under its guidelines and roadmap. We expect such policy momentum to help drive transition debt issuance from Japanese corporates.
Similarly, in China, the National Association of Financial Market Institutional Investors announced the launch of a low-carbon transition bond pilot programme in June 2022, to provide guidance to eight carbon-intensive industries.
Elsewhere, we are also starting to see signs of harmonisation in green and sustainable taxonomies. For example, Singapore's Green Finance Industry Taskforce has published the second version of its taxonomy, which is well-aligned with the ASEAN taxonomy and leverages a traffic light approach that classifies activities into green (environmentally sustainable), amber (transition), and red (harmful) categories. The approach will provide greater clarity to corporates issuing transition debt in the region. We expect Australia will also adopt a similar traffic light approach and include a transition category in its upcoming taxonomy.
EF: Will heightened market concerns about greenwashing weigh on investor demand this year, especially for sustainability-linked instruments?
MK: We saw a meaningful pullback in SLB volumes in the second half of last year. This was, at least in part, due to heightened scrutiny around greenwashing risks and market concerns around whether issuers are selecting credible, ambitious, and rigorous targets and financial variations in instruments (in the event that targets are missed).
Adriana Cruz Felix: In recent years, market collaboration has played an important role in developing standards and principles that ensure the integrity and credibility of thematic debt instruments. However, as the market has grown, we've seen investors apply greater scrutiny in assessing transactions, and a larger number of critics of greenwashing have emerged. Going forward, given higher potential reputational risks, issuers are likely to take more time when structuring sustainability strategies and financing frameworks to ensure alignment with international objectives.
Market standards and solutions are being developed to address the SLB market's growing pains. For example, when it comes to emissions-related key performance indicators, or KPIs, there are various initiatives that issuers can align with to demonstrate that they are following a decarbonisation pathway in line with the Paris Agreement goals, such as the utilisation of science-based targets. We expect to see this approach gain traction with a broader array of material sustainability challenges beyond greenhouse gas emissions. We also expect to see innovation around the financial variation embedded in instruments to ensure that any financial penalties for failing to achieve targets are meaningful and promote the real-world advancement of sustainability. This year, in short, the focus will be 'quality over quantity'.
EF: What steps can issuers take to allay market fears around the quality of their sustainable debt instruments?
JSL: When we speak to prospective issuers, there is generally a clear desire to align financing frameworks and related commitments with a credible and coherent sustainability strategy and transition plan.
What's more, investors don't expect companies to transition overnight. But they do want to see a credible strategy and to understand how such plans will be implemented and financed.
We expect external reviews, notably second party opinions, to gain in popularity across regions, as issuers seek to demonstrate the credibility of their sustainable financing strategies.
Moody's second party opinions assess both the contribution to the sustainability of a financing framework or instrument and its alignment to international principles. To determine contribution, we look at the relevance of financed projects or targets to the issuer's business, as well as the magnitude of expected impact. We also take into account an issuer's ESG risk management and the coherence of the framework with the issuer's overarching sustainability objectives. By setting up credible frameworks and leveraging external reviews, issuers will increasingly seek to enhance their communication and engagement with investors and mitigate potential reputational risks.
EF: How will an ever-more complex ESG regulatory and political landscape globally affect issuers' decisions to enter the sustainable bond market?
MK: It's not a uniform picture. We're seeing increasing disclosure requirements and elements of standardisation in some markets – for example via China's Green Bond Principles and the forthcoming EU Green Bond Standard – which will likely lend support to sustainable bond market activity. In some states in the US, however, companies are facing pressure to exclude or minimise the integration of ESG considerations in their business and investment decisions. This may already be having an effect in the US.
While US sustainable bond market issuance has gone up in absolute terms, its share of the global market has fallen, from 25% in 2017 to around 13% in 2022. Last year, issuance from US nonfinancial corporates fell 32%. While this trend was not entirely driven by the broader regulatory and political backdrop, it could have been a contributing factor.
EF: What are some of the emerging trends to look out for in the labelled bond space?
ACF: The market to date has been driven mainly by climate change mitigation initiatives. However, there are a number of important themes – such as climate adaptation, biodiversity protection, sustainable management of natural resources, and other social topics – that have been seen less in the market, in some cases due to challenges over financing related projects at scale. Led by the public sector, we expect to see greater diversification of use of proceeds into these other areas.
We also expect to see a much greater focus on just transition – which seeks to maximise the socio-economic benefits of decarbonisation while minimising negative impacts – and we are starting to see some examples of related projects in sustainable bond frameworks. Such initiatives are not widespread yet, but in time more companies that are transitioning towards a net-zero future will include just transition elements in their plans.
Public-private sector collaboration will be key, and international conversations both at COP27 and the biodiversity COP15 have focused on the enabling role that blended finance from multilateral banks and supranational agencies can play in directing finance from advanced to developing countries.
JSL: To put the need into context, there are 45 million people in Southeast Asia alone that still do not have access to electricity. Addressing these types of social issues is likely to involve blended finance mechanisms. Because the projects involved are typically relatively high risk, we expect to see public sector or multilateral issuers raise transition debt to finance the equity and mezzanine tranches, catalysing private players to participate in less risky parts of the capital structure. Blended finance will therefore be very important to crowd in private investment and narrow the sizeable sustainable development financing gap in emerging Asia.
Sustainable bond volumes to rebound to $950 billion in 2023 but trail record volumes
Adriana Cruz Felix, Jeffrey Sukjoon Lee and Matthew Kuchtyak are vice presidents of sustainable finance at Moody's Investors Service. They are based in Paris, Singapore and New York respectively.
For more information, see www.moodys.com/spo or email howtogetrated@moodys.com