20 February 2024

Taking stock as the market gears up for growth

2023 was a volatile year for both sustainable finance and fixed income. The sustainable finance teams at BNP Paribas outline the innovation and trends they are seeing in the market as the bank further refines its strategic approach to sustainable bonds.

Environmental Finance: What innovation are you seeing in the market and how has the bank adjusted its strategic approach to ESG and sustainable bonds?

Frederic ZorziFrederic Zorzi: There is a growing understanding of the complexity of the challenge. Everybody wants to be more sustainable, but the execution of any plan can have a long tail of consequences, for example on the social side. It is no different for us as a bank: it's easy to identify positive outcomes but execution is the challenging part. One of our jobs is to get to this level where we can have impact while keeping track of the needs of our clients, and having something which is sustainable over the long term.To get there you must demonstrate integrity and leadership. That's what we are trying to do. The goal is to finance a transition, supporting the journey of our clients: issuers and investors, and fix ourselves to clear targets while maintaining this balance.

Constance Chalchat: The challenge is balancing ambition and pragmatism. Whether you are too ambitious or not ambitious enough, you risk accusations of greenwashing. You need to strike the right balance, while remaining fair to the people and value chains impacted by the changes.

Constance ChalcatA key innovation to look for this year is how to introduce transition labels that value credible transition pathways of heavy-emitting companies. The question will be around how to label such transactions. Another will be linked to the financing gap in emerging markets, with innovation around sustainable outcomes for emerging market sovereign debt. Emerging market countries have a right to transition, and the world needs them to. They have the potential to be leaders in green hydrogen or provide major carbon sinks, so there is a collective focus on how we finance those projects. We have already seen innovation with sustainable outcomes bonds and debt swaps. We also expect multilateral development banks (MDBs) to continue assisting in the early retirement of coal power plants.

At COP28, we saw a real consensus that we must consider all routes to reach net zero. The energy of the future will consist of a combination of renewables, hydrogen, biofuels, sustainable fuels, nuclear, and potentially still some oil and gas combined with carbon capture and storage (CCS). We also saw at COP28 a revival of the carbon markets. They are probably the only way to finance projects that are otherwise not bankable. We are working on our carbon markets offer and potentially considering integrating a carbon credits mechanism to a bond innovation.

EF: Agnes and Franck, what issuer and investor trends are you seeing in Europe?

Agnes GourcAgnes Gourc: Green bonds continue to make up the largest share of sustainable bond issuance and this is something that should continue in 2024. Looking at overall transactions in EMEA in 2023, around 20% of transactions were labelled. In the first month of 2024, however, that rose to over 50% of corporate transactions. I don't expect that trend to necessarily continue throughout the year but it is still a sign of interesting momentum in the European segment.

When it comes to issuer diversification, there are not that many sectors left to come to the market. For industries such as cement, steel, and chemicals, the EU taxonomy and the International Capital Market Association (ICMA) have been helpful in providing guidance to the market. The new ICMA Task Force on Green Enabling Activities could further help those industries come to market.

Franck RizzoliFranck Rizzoli: The EU's Sustainable Finance Disclosure Regulation (SFDR) has driven increased demand for labelled bonds in Europe. You need to be able to demonstrate impact for Article 8 or 9 funds. Having use-of-proceeds (UoP) bonds clearly helps demonstrate that. As a result, appetite for such transactions has increased over the past 18 months. If there is more demand from investors, it makes it ieasier to convince issuers that they will be able to attract additional demand if they have a strong framework and can demonstrate impact to investors. That has clearly created momentum.

With regards to sustainability-linked bonds (SLBs), investors still want to see improvements in the quality and ambition of the KPIs and better structuring of SLBs. To deliver impact you need to have a proper plan to be able to explain how you're going to reach a KPI and how it fits within a strategy.

EF: Anne, how does that compare with the trends you are seeing across the Americas?

Anne van RielAnne van Riel: We also continue to see the majority of bonds issued with a green label. The only exception is a focus on social in Latin America. SLBs are also more popular there. Our figures show 38% of the total bonds issued in Latam are SLBs, which is in stark comparison to 8% on a global level. That's largely driven by sovereigns.

Sovereigns are really pushing the boundaries in the region: the main drive for innovation is coming from Latin American sovereigns. I think that's because there's a real need to get financing in those regions. People are coming up with innovative structures to finance things that otherwise wouldn't be.

In North America, SLBs are almost absent from the market. We've seen a few from Canadian issuers but they are very far and few between. With the huge push to make SLBs more ambitious, the commitment to a higher step up if issuers don't meet their targets has been met with some reluctance from corporate issuers.

Meanwhile, green bonds have been spurred by the Inflation Reduction Act (IRA), with investments in renewable energy, hydrogen, and other decarbonisation efforts. Investors are also telling us less is more. They want less complicated frameworks and a focus on the key categories that are relevant for a specific business strategy, so we are seeing a decluttering of labels and frameworks.

The challenge for 2024 will be to maintain momentum in North America. A lot of green bond issuers are repeat issuers, such as Real Estate Investment Trusts (REITs) and utilities. We hope to see inaugural issuers from other sectors this year.

EF: What regulatory developments are you watching?

AVR: In North America, green bond issuance is below 10% in the corporate segments, we're still in the single digits. It is still a relatively small market and that is also driven by the fact that we don't have the EU taxonomy or SFDR. Investors have ESG strategies, they use ESG in their decision making, but it doesn't necessarily translate into labelled bond funds.

We could see the US Securities and Exchange Commission (SEC) disclosure rule materialise in 2024. But even in the absence of the SEC, states can still move forward, such as with what we've seen with California. We can expect similar action from New York State. State pension funds are becoming more vocal so this may be a sign that if there is a void at the federal level it may be filled at the state level.

AG: In Europe, it will be interesting to see the impact of the application of the EU Green Bond Standard (EU GBS) towards the end of 2024. For now, the green bond market is a best-effort market, but this could change with a move to a regulated market for EU Green Bonds. For issuers, the big question will be why should they move in that direction, given the voluntary nature of the EU GBS. In other words, green bond issuers can elect to follow the new standards but won't have to. Some may want to be leaders in this market, but many may wait to see if there is additional demand for EU Green Bonds versus 'regular' green bonds aligned to ICMA Principles.

EF: How is the topic of transition going to play out in the Asia Pacific (APAC) region in 2024?

Chaoni Huang: The APAC region has quickly become a key market for issuers, governments, and investors to accelerate the low-carbon economy transition. The transition bond has become a valuable means for governments and banks across Asia to engage investment and implement decarbonisation at scale.

Chaoni HuangRegulators have made considerable effort in accelerating the development of taxonomies and frameworks – for example, the ASEAN Taxonomy Version 2 – and the education around those, to ensure stringent standards are upheld, and capital is being channelled towards credible projects that will help the region's transition. The dialogue will continue to accelerate this year and beyond.

Across China, transition finance is ramping up as a catalyst to drive the decarbonisation of carbon-intensive sectors.

For example, Bank of China's Luxembourg branch priced a €300 million ($324 million) bond in Q4 last year where the proceeds will be used to support steel projects aligned to the China-EU Common Ground Taxonomy and Climate Bonds Initiative Steel Sector criteria, leading the way for APAC issuers to conform to global best practices for transition in hard-to- abate sectors. Despite broader economic challenges, China still led the region in ESG issuances in 2023, and the sustainability sector has shown resilience. We expect investor interest to remain consistent towards high-quality issuers coming in to fund robust transition projects with transparent instruments.

In Japan, the new Green Transformation (GX) framework aims to channel households' savings into green investments and attract international institutional investment to drive economic development through emissions mitigation. Subsequently, Japan has issued its first tranche of its "Japan Climate Transition Bond" certified under the Climate Bonds Standard, with proceeds used to fund the GX framework to transition Japan's economy.

In 2023, Japan's public bodies were raising capital to finance energy transition-related spending, including the Japan Finance Organisation for Municipalities and Development Bank of Japan. We would expect this trend to continue.

EF: Where does the above leave the sustainable bond market? What are your predictions for the direction of travel?

Trevor Allen: Alongside a drive for more diverse energy stacks, as highlighted by Constance, and the ring-fenced impact of a UoP structure, the ground is set for green bonds to proliferate. We are forecasting $600 billion of green bond issuance in 2024, which is comparable to 2023. We think 2024 is going to be a transition year where interest rates will come down and market conditions will be more favourable for renewable energy and electric vehicle (EV) projects to start growing – and for corporates to continue issuing. 2030 climate targets still need more funding to ensure they are achieved, and the growth of the green bond market will help to ensure fresh capital is being issued and ring-fenced to help transition economies towards a low-carbon economy.

Trevor AllenIn 2025, we're forecasting $700 billion of issuance and $850 billion of issuance in 2026. This is because over the next three years we're going to see $660 billion of maturities from the green bond market. In 2024, 70% of these maturities alone are going to be from corporates. This sets us up for a nice push-pull scenario: there is going to be a push from corporates and governments to issue more green bonds, because they need to roll over some of that green debt, and a pull from asset managers who are going to need to replenish their green bonds that have matured. With social bonds, it's harder to predict because volumes tend to be impacted by exogenous events, such as the Covid 19 pandemic. We want to see more social bond issuance – particularly in the southern hemisphere and emerging markets – and we want to see more demand from our clients. The emergence of dedicated social bond funds has been promising in this respect.

An important theme to watch is whether the route to transition is going to come through UoP or KPI-linked structures. With SLBs, we originally predicted increasing issuance from hard-to-abate sectors. But, as Chaoni said, China and Japan are favouring the transition bond label. It will be interesting to see how the market takes to transition bonds and how countries map out their transition goals over time – especially when you consider bonds are usually quite long-dated. The market probably wants transition bonds to be 10 years at the most, otherwise, investors will find it harder to be sure you are on an effective transition pathway. 

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

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