16 February 2022
Last year saw solid growth in the sustainable debt markets, supported by issuance related to the pandemic recovery and growing corporate interest in financing sustainability strategies with labeled bonds. Moody's believes yet another year of healthy, double-digit growth could be on the horizon. Environmental Finance speaks to Moody's ESG Solutions' Matt Kuchtyak, Amaya London and Jeffrey Lee to learn more.
Environmental Finance: Following another year of strong growth for the market, what is your forecast for sustainable bond issuance this year? Could the trillion-dollar barrier be breached again?
Matt Kuchtyak: 2021 was indeed a record year for green, social, sustainability and sustainability- linked (GSSS) bond issuance. GSSS bonds accounted for an estimated over 11% of total global bond issuance in 2021, from less than 7% in 2020.
And so, we can expect yet another record-breaking year for GSSS bonds. We believe issuance is set to pass the trillion-dollar barrier for the second consecutive year – reaching US$1.35 trillion. Of course, we must remember that this represents growth moderation towards around 36% from the 64% growth achieved last year. Of this figure, predicted green bond issuance of $775 billion globally in 2022 would represent a strong, yet moderating, 48% growth over 2021 levels.
We believe the steady growth in global green bond issuance will continue into 2022 as an increasing number of issuers seek to finance climate mitigation and adaptation efforts and advance their net zero commitments, while more sovereign issuers expand their green bond programs. Meanwhile, comprising the rest of our issuance prediction are $150 billion of social bonds, $225 billion of sustainability bonds and $200 billion of sustainability-linked bonds.
Driving these volumes is the increasing number of issuers embedding sustainability strategies into their capital market plans. Healthy, double-digit expansion is our expectation despite the market maturing in established markets and headwinds for overall debt issuance in a potentially tightening monetary policy environment. As a result, GSSS bonds will continue to rise as a share of global bond issuance, potentially reaching 15% of the total.
EF: It seems green's position as the dominant label is under no threat for the time being. So, with physical climate hazards on the rise, can we expect a shift towards the financing of climate adaptation projects?
Jeffrey Lee: The past seven years were the seven warmest on record, with devastating impacts globally ranging from record-setting wildfires and heat waves to deadly floods and hurricanes. In the near term we will continue to experience extreme climate-driven events due to carbon already in the atmosphere.These risks point to an urgent need for investment in climate adaptation and resilience. For example, based on Moody's ESG Solutions' Sovereign Climate Risk dataset, approximately $41 trillion of the world's GDP and over 2.4 billion people are projected to be highly exposed to
heat stress by 2030-2040.
While decarbonizing the global economy will inevitably remain a primary focus for these entities given the urgent climate mitigation imperative, there is also a growing need to prepare economies and communities for increasing climate extremes. Indeed, the first part of the IPCC sixth assessment report underscores the reality that the physical effects of climate change are largely locked in over the next few decades, with the effects likely to be more severe and far-reaching than previously assumed.
To date, sustainable bond proceeds allocated to adaptation and resilience projects have been limited. In 2021, for example, only 3% of green bond proceeds were allocated to climate change adaptation projects, with most proceeds instead going to climate mitigation categories such as renewable energy, green buildings, clean transportation and energy efficiency. Elevated risk exposure brings the need to invest in resilience, which presents financing opportunities, suggesting that this issuance share will grow over time as the green bond market matures and diversifies.We expect sovereigns, in particular, to lead the charge, along with other public finance entities with a broader social mandate and at the forefront of combating the effects of climate change.
Sustainable Bond issuance to hit $1.35 trillion globally in 2022 for another record year
EF: Let's drill down to the burgeoning sustainability- linked market: how might volumes fare this year?
MK: Favored largely by non-financial corporates to date, we believe volumes for sustainability-linked bonds (SLBs) will continue their rapid rise. Volumes could more than double this year to $200 billion – from $90 billion globally in 2021 and a mere $9 billion in 2020.
The advent of SLBs has opened the sustainable debt markets to a broader array of issuers with limited eligible green and social projects for a benchmark use of proceeds bond, as well as issuers in early transition sectors – such as steel, cement, aviation and shipping – focused on achieving net zero strategies and responding to the economic and financial pressures of carbon transition risk. However, investor scrutiny of SLB targets and net zero commitments is growing. Questions around the credibility of targets and the robustness of key performance indicators (KPIs) and sustainability performance targets (SPTs) embedded in SLBs has further increased as investors increasingly scrutinize these transactions to combat potential greenwashing. This may provide a headwind for the SLB market in 2022, representing a downside risk to our baseline expectations.
Corporates globally are also increasingly replacing old loan facilities with ones linked to sustainability targets that can typically trigger an increase or decrease in interest rates based on to what extent these targets are achieved. The linking of loan pricing to sustainability goals will continue as lenders aim to incentivize improvements in sustainability performance and borrowers seek to highlight their sustainability goals while lowering their borrowing costs. Sustainability-linked loan volumes surged to $189 billion in 2021, up 118% from 2020.
EF: How do you see social bond volumes evolving as issuance linked to the COVID-19 recovery wanes?
Amaya London: It's evident that pandemic-driven issuance of social bonds has begun to recede. Of course, the need to finance COVID-19 pandemic-related response efforts drove the social bond issuance surge to 199 billion in 2021, up 19% from the $168 billion issued in 2020. After totaling $146 billion through the first half of the year, social bond volumes totaled just $53 billion in the second half of 2021, however, as pandemic-related financings began to decline. We believe social bond volumes will fall approximately 25% to $150 billion in 2022 due to the decline of pandemic-driven social bond issuance.
It's important to note that social bonds were heavily concentrated among issuers responding to the pandemic, as highlighted by 57% of global volumes in 2021 coming from just three issuers – the European Union and French public finance agencies Caisse d'Amortissement de la Dette Sociale (CADES) and UNEDIC.
Nevertheless, social bonds will likely remain a market fixture. Social issues remain top of mind, with issuers focusing on a wide array of social issues, including equitable access to healthcare and housing. As such, social considerations will remain important for issuers and investors alike, contributing to not only social bond issuance, but also the more explicit consideration of social factors in other sustainable debt instruments. What's more, investor appetite to generate positive social impact will support increasing innovation in labeled social financing, including diversification of issuers, project types and bond structures.
Investors will also respond to evolving regulatory developments, such as the implementation of the Sustainable Finance Disclosure Regulation (SFDR) and the prospective creation of social taxonomies, which will necessitate better identification and measurement of social risk exposures and impacts. Issuers are also aiming to mitigate operational and reputational risks from structural social exposures, a key feature of the market that will persist in a post-pandemic world and support continued social bond issuance.
EF: How could the development of taxonomies support further market growth?
AL: Investors and other market participants are increasingly calling for clearer definitions on what constitutes credible investments as the reach and impact of the sustainable debt markets continue to grow. To this end, the formulation of sustainable finance taxonomies will play an increasingly important role in the reorientation of capital to sustainable activities.
To date, taxonomies have been instrumental in defining with greater granularity whether investments can be considered green or sustainable.The EU taxonomy, for example, will form the basis for labeling green investment funds, the classification of companies' economic activities as sustainable and the certification of green bonds issued under a proposed EU Green Bond Standard.
Nonetheless, future challenges could arise.The evolving nature of taxonomies poses one concern for investors, as does the potential fragmentation of taxonomies across different regions. Indeed, an increasing number of governments – such as Canada, Singapore and the UK – are creating their own taxonomies – thereby increasing the potential for varying definitions to arise.
Overall, it remains too early to tell exactly what impact taxonomy development across multiple jurisdictions will have on the current trajectory of sustainable bond issuance.While clearer definition of which activities are compatible with a sustainable future will likely ease the burden of investors in identifying compliant investment options, the uncertain nature of taxonomy usability may limit their uptake.
Emerging market sustainable bond issuance surged in 2021 follwing years of stagnation
EF: Similar to the more established markets, do you foresee continued growth in emerging markets' sustainable debt issuance?
JL: It's certainly the case that sustainable bond volumes from emerging market (EM) issuers surged during 2021. We saw a notable uplift following five years of relative stagnation. GSSS bond issuance originating in China, which historically has been the primary driver of EM issuance, saw a noticeable uptick last year. Volumes from China rose to $63 billion in 2021, up from $19 billion during the previous year. We are seeing a steady diversification into other emerging markets, however. Latin American GSSS bond issuance, for example, jumped to $43 billion in 2021 from just $13 billion in 2020.
In turn, global EM GSSS bond issuance, excluding supranational issuance, totaled $136 billion for the year, more than double the previous record $51 billion issued in 2020. Green bond issuance by EM issuers comprised the bulk of this global figure ($79 billion). Among EM sustainable bonds, we expect green bonds will remain the largest contributor to issuance over the next few years – much in line with the sustainable bond market globally.
Notably, last year, SLBs emerged as an instrument of choice for many EM issuers. Issuance climbed to $19 billion in 2021 from just under $2 billion in 2020.The breakout in sustainability-linked bond issuance observed in 2021 will also likely continue given the challenges that some EM issuers face in having sufficient eligible environmental or social projects to support benchmark use-of- proceeds sustainable bonds. Social bonds and sustainability bonds, meanwhile, rose to $15 billion and $24 billion, respectively.
Certainly, COP26 has provided renewed momentum towards achieving the Paris Agreement commitment of mobilizing $100 billion in annual climate financing from developed to developing economies. Latest data suggest that this level of financing has so far failed to materialize, with developed countries having provided around $80 billion to developing countries in 2019.
Even if the $100 billion annual milestone is achieved, this would only represent a tiny fraction of investment needed to meet low-carbon infrastructure needs in developing economies. According to the IEA, 70% of the $4 trillion in investment required to reach net zero must flow into emerging markets and developing economies. EM sustainable debt markets can help bridge this funding gap, although investing in capacity building, creating robust investable pipelines, and de-risking projects via blended finance mechanisms will be critical enablers. Against this backdrop, a continuation of last year's robust expansion in EM sustainable bond issuance in 2022 and beyond looks assured.
To learn more about Moody's 2022 GSSS market predictions, please visit www.moodys.com/esg-insights
Figures and statistics have been sourced from Moody's ESG and the Environmental Finance Bond Database
Matt Kuchtyak, Vice President, Outreach & Research, Moody's ESG Solutions
Jeffrey Lee, Vice President, Sustainable Finance, APAC, Moody's ESG Solutions
Amaya London, Sustainable Finance Research Manager, Moody's ESG Solutions