20 February 2024

Taking the pulse of the sustainable bond market

While Moody's analysts aren't forecasting growth in the sustainable bond market in 2024, rising climate risk, new technologies and evolving regulatory drivers are likely to change the market's contours. Adriana Cruz Felix, Matthew Kuchtyak, Jeffrey Sukjoon Lee and Tobias Lindbergh survey the evolving landscape.

Environmental Finance: Will last year's sustainable bond market rebound extend into 2024?

Matthew KuchtyakMatthew Kuchtyak: We expect 2024 sustainable bond volumes to be roughly flat with 2023's $946 billion, despite higher-for-longer interest rates and moderating economic growth globally. Our 2024 projection of $950 billion in sustainable bond issuance includes $580 billion of green bonds, $150 billion of social bonds, $160 billion of sustainability bonds and $60 billion of sustainability-linked bonds (SLBs).

Our forecast reflects our view that the market resilience observed during the past two years will extend into 2024. We expect sustainable bonds' share of overall global issuance to remain similar to the 14% share achieved in 2022 and 2023.

Several drivers will support sustainable bond issuance this year, while others may temper growth. Accelerating investment in emerging green technologies (such as green hydrogen, biofuels, battery storage, and carbon capture, utilisation and storage) and an increased focus on transition finance will unlock issuance in new areas. Despite posing challenges for issuers, the climate finance gap in emerging markets will spur new financing approaches and continue to drive issuance from sovereigns. A gradual shift from voluntary to regulatory standards will advance this year, opening up possible avenues for growth, while potentially delaying others in the near term. Meanwhile, closer scrutiny of SLB quality may stifle growth in that segment and shift some issuance to use-of-proceeds labels. Other emerging trends, such as innovation in sustainable bond structures and use-of-proceeds categories, will sow the seeds for future market growth.

EF: What are the key trends you foresee shaping regional issuance?

MK: Europe will continue to account for the largest regional share of issuance in 2024. Sustainability issues remain top of mind for many issuers and investors in Europe, as regulations such as the EU's Green Bond Standard (EU GBS) phases in later this year. In North America, the decline in issuance in recent years may bottom out in 2024, although the outcome of the US general elections in November will generate some uncertainty. In Asia-Pacific, issuance has been growing steadily after nearly tripling in 2021 to $194 billion. A top-down focus on transition finance will be a hallmark of the region in 2024.

In the Middle East and Africa, regional issuance more than doubled last year from 2022 levels, bolstered by the presence of sovereigns – for example, the government of Sharjah issued $1 billion in green bonds. In Latin America, high-volume issuers – including sovereigns such as Colombia, Chile and Mexico – will continue to dominate activity.

Figure 1: Sixteen sectors with $4.9 trillion in rated debt have high or very high inherent exposure to carbon transition risk

Source: Moody’s Investors Service

EF: How will emerging green technologies shape the 2024 sustainable bond market?

Jeffrey Sukjoon LeeJeffrey Sukjoon Lee: The use of sustainable bonds by issuers in hard-to-abate sectors will accelerate. Sectors with elevated exposure to carbon transition risk have a total of $4.9 trillion of Moody's-rated debt outstanding, underscoring the significant potential for increases in future sustainable bond issuance (see Figure 1). In 2023, issuers in these sectors accounted for $112 billion of sustainable bond issuance, or 43% of nonfinancial corporate volumes. Around three-quarters of this issuance came from companies in the energy and utilities and automotive sectors, where scalable decarbonisation solutions generally exist today.

In hard-to-abate sectors where low-carbon technologies are largely not available at scale today – including steel, cement, shipping and aviation – the roll-out of new technologies is an important component of sectoral decarbonisation pathways. Although these sectors have been relatively minor contributors to sustainable bond volumes in recent years, the growth of emerging green technologies could incentivise companies to enter the market, diversifying sectoral issuance over time.

That said, persistent hurdles stand in the way of widespread adoption of some technologies. First, some projects continue to face challenges with respect to economic returns and scalability, even as policy support improves cost competitiveness. Furthermore, high-interest rates and slowing economic growth could impede the financing of some capital-intensive projects.

Second, technologies in several hard-to-abate sectors carry potential sustainability quality and comparability risks that may complicate their inclusion in sustainable financing frameworks. In the case of hydrogen projects, for example, carbon-intensity thresholds needed to qualify as green or clean hydrogen can vary across geographies and standards, while the use case of the hydrogen produced also has implications for how effective it is as a decarbonisation agent.

EF: Will SLB volumes continue to decline amid global market scrutiny?

Adriana Cruz FelixAdriana Cruz Felix: We expect SLB volumes to decline both in absolute terms and as a share of total sustainable bond issuance in 2024. SLBs accounted for 7% of sustainable bond issuance last year, down from 8% in 2022 and 9% in 2021, while SLB issuance volumes dropped for the second consecutive year, to $10 billion in the fourth quarter, the lowest quarterly total since the segment began its ascent.

Continued investor focus on the robustness and achievement of sustainability performance targets and the materiality of financial adjustments has discouraged some would-be issuers from entering the market. An International Capital Market Association report about greenwashing risks identified the SLB segment's lack of ambition in the early days of issuance as a contributing factor to questions about credibility. However, the report also showed that the quality of SLBs has been improving more recently.

Nevertheless, there remains a gap in quality between use-of-proceeds and sustainability-linked instruments, in part because the SLB segment remains at an early stage of development. Eighty-two percent of the financing frameworks and instruments assessed under our second-party opinion (SPO) assessment framework have received an SQS1 (excellent) or SQS2 (very good) score since October 2022. But there is a clear difference between use-of-proceeds and sustainability-linked instruments in our SPO portfolio, with 90% of use-of-proceeds frameworks or instruments receiving an SQS1 or SQS2 score, while only 56% of sustainability-linked instruments or frameworks have received one of these top two scores.

As market and regulatory scrutiny intensifies this year, the exposure to perceived greenwashing concerns could potentially drive issuers to consider the use-of-proceeds variety of instruments over SLBs, despite the latter's flexibility in terms of proceeds allocation.

Figure 2: Use-of-proceeds frameworks and instruments have received higher Sustainability Quality Scores under Moody's SPO assessment framework

Data as of 14 January 2024, includes both public and private SPOs. Source: Moody's Investors Service

EF: Any bright spots you're noticing in the SLB space? 

ACF: Issuers in the market have been significantly focused on the incorporation of key performance indicators (KPIs) that target GHG emissions. Through the end of June 2023, nearly three-quarters of SLBs by count had included a KPI focused on GHGs.We are increasingly seeing issuers with a substantial portion of their overall carbon footprint in Scope 3 emissions integrate it into their SLB frameworks as a standalone KPI.

Issuers are then challenging themselves to commit to always using together KPIs covering the same sustainability issue, such as multiple scopes of GHG emissions.

Although challenges exist for the SLB label, new issuers provide ballast to the still-developing market, drawn in some cases by the structural appeal of SLBs. About two-thirds of SLB issuers in 2023 were making their debut in the segment, accounting for around 47% of SLB volumes globally. First-time entrants represented 31% of use-of-proceeds issuers in 2023, by comparison, and accounted for just 12% of total use-of-proceeds issuance.

EF: How will the transition from voluntary to mandatory best practices impact the sustainable bond market?

Tobias LindberghTobias Lindbergh: The sustainable bond market has grown globally over the past decade, based largely on the development of market best practices that have created a common language for determining labelled bond eligibility. However, a key development to address greenwashing concerns has been an increased regulatory focus on defining which projects constitute credible sustainable investments. For example, the creation of taxonomies around the globe aims to help facilitate a common set of criteria to define eligible investments, while providing greater clarity to market participants. We expect that this gradual shift from market to regulatory standards will pick up pace this year as more initiatives take effect.

Potentially, the most consequential of these global initiatives over the next couple of years will be the phasing in of the voluntary EU GBS. A key tenet of the standard is its definition of project eligibility, for which it uses the definitions established under the EU's Taxonomy of sustainable activities. There is a flexibility pocket of 15% of the proceeds specifically for sectors not yet covered by the EU Taxonomy and other specific activities to support and promote the standard's usability.

The development of regulatory standards has potentially delayed issuance in some markets as issuers await regulatory guidance. For example, the delayed release of the US Securities and Exchange Commission's climate disclosure rule, which is now expected later this year, and its potential inclusion of Scope 3 reporting, has created some uncertainty for US companies.

Disclosure requirements and reporting standardisation should broadly help support the growth of the sustainable bond market, despite some near-term confusion over which items to disclose and how to report them hindering the ability of companies to set up sustainable bond programmes. If they are already disclosing relevant data points as part of their existing reporting obligations, however, the marginal time and financial cost of setting up a sustainable bond programme may shrink. 

Matthew Kuchtyak is a vice president and regional manager for Americas second party opinions for Moody's Investors Service, based in New York, Jeffrey Sukjoon Lee, is vice president and regional manager for APAC second party opinions, based in Singapore, and Adriana Cruz Felix is vice president and regional manager for EMEA second party opinions, and Tobias Lindbergh is senior vice president and head of second party opinions EMEA and APAC, both based in Paris.

For more information, see: https://ratings.moodys.io/products/spo

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