30 March 2022

The story of The Very Hungry Insurers - and APAC green bonds

 APAC green and thematic bond markets are still developing, but investors want more supply and the highest governance and reporting standards to meet their demand, David Walker discovers

In the picture book The Very Hungry Caterpillar one immediately sees the appetite of the green protagonist by holes through each page signifying it is consuming the paper. Insurers hungry for more paper from Asia Pacific's (APAC) burgeoning green and thematic bond markets might know just how that caterpillar feels.

But as those markets unfurl, the institutional investors are insisting on excellent standards of governance and post-issue reporting – and APAC nations are listening intently.

At Zurich, a $4bn green- social- and sustainable bonds investor, the managing director and regional investment manager for Asia-Pacific Michael Vos advises issuers to have a strong case in what [they] are actually trying to achieve.

"There needs to be a clear intention to report on the project and the impact it is having. When [issuers] report the impact, there needs to be a clear link to the projects undertaken with the funds and impact reported - for example, is there a clear ringfence of the funds being raised for the projects for a stated purpose? And can the impact be verifiably measured by a third party?"

Norbert Ling, ESG portfolio manager at Invesco fixed income Asia Pacific, summarises a green bonds investor wish-list with 'alignment, ambition and assurance'.

"Alignment is about consistency globally using science-based targets, and I usually say 'the less frameworks you have, the better', so global alignment of standards is always positive," Ling says.

It is important in Asia to seek a balance between harmonized global frameworks and frameworks adapted to the local situations, according to Mushtaq Kapasi, MD chief representative APAC at the International Capital Market Association (ICMA) - a trade association for cross-border bond markets and, since 2014, secretariat for the green bond principles.

Harmonisation and consistency of standards is important especially for large and international investors, Kapasi says. "It becomes a nightmare [for those with] global portfolios trying to conform investment criteria and reporting to different jurisdictions."

"Most people would agree it would not be feasible or politically possible to have a global standard," he says pointing at the EU taxonomy as an example of initiative which would be hard to apply in emerging markets.

Therefore it is beneficial to have local and regional standards in Asia, in addition to global guidelines.. "It shows regulators care, [that] governments care, and giving corporates, banks and local investors a sense of responsibility, and of protection that they are being supported in their sustainability involvement."

Kapasi points to the ASEAN green- and social bonds standards as "quite a political achievement" between almost a dozen different securities regulators across the region. Sell-side stakeholders "engaged with the market very early on...so they knew what they were doing would be fit for purpose within Asia, but still consistent with ICMA green and social bond principles, and they adapted that for ASEAN, for instance making it more strict taking out fossil fuels, adding some extra requirements for ASEAN external reviews, to make it more stringent than voluntary global standards – which gave them more credibility."

As a result, national regulators can now use the standards "to inform and form a basis for their national regulations - so it increased the consistency within the region, as well".

Encompassing taste

Marcin Bill, head of funding for APAC at the International Finance Corporation (IFC) Treasury, says investors interested in green, social-, sustainability and transition bonds – as public bonds or private placements - can be broadly segmented into two groups depending on what they seek in terms of liquidity and ability to access niche currencies. Public bonds offer more liquidity, private placements more specialised FX.

"With ESG investing going mainstream, it does seem portfolio managers have more choice in available currencies and maturities [and] some investors can even enjoy full green curves, in parallel to their vanilla equivalents."

Investors call for across-the-board issuance.

Invesco's Ling describes the pace of issuance of green, social and sustainability-linked instruments in Asia "incredible" - $254bn last year alone, fivefold growth in as many years – and he says the question to vanilla issuers now is, why are they not considering a label bond?

"The conversation has changed [and] is a big shift in thinking by corporate treasurers and companies. What would be really helpful would be more sovereigns taking the lead to issuing green or sustainability-labelled bonds with the appropriate framework."

Ling highlights the "positive example" of Indonesia issuing an SDG bond including social, not just green, goals, in 2021.

"Governments promote growth in sustainability bonds by taking the lead, setting the example, standards and issuance trends. In ASEAN you see Thailand coming out with an SDG framework...for corporates to follow. As an investor this is what we look for...and it increases the overall supply of good-quality sustainability bonds."

Having more sectors, and different 'impact outcomes' to pick from, helps build clients diversified portfolios, Ling explains. "We see a greater diversification by issuers and countries, and into EMs. At the moment 6% of the universe is green - too low. Globally, we need to spend $9trn [for] net zero, but total green bond issuance is only about $1trn by 2022. The market can easily expand 5-6 times."

ICMA's Kapasi says getting more diversity in impact is important: "Investors [in Asia] are digging down deeper into the investment, and where the impact is, and the potential for improvements in sustainability and actual impact of investments in Asia is much more per-dollar than in Europe or US, where sustainability practices are already more advanced in some sectors."

Zurich's Vos agrees measuring impact verifiably and reporting on it is "key to ensuring it is occurring - but we are a way off that being widespread across all corporates".

"Measurement helps us make better investment decisions [and] shows financial returns can be balanced with environmental and social returns," he says."Investing in green bonds for us is not a charity - we are looking for full financial returns from it."

In terms of highly sought-after features, besides liquidity, in green bonds, the IFC's Bill notes:

  • transparency of what they finance, via clear reporting;
  • alignment with market standards such as the ICMA Green Bond Principles;
  • second opinions by providers certifying issuers' compliance with standards; and
  • impact measurement metrics.

And investors' own motivations? Bill sees "a 'signaling effect' [to] inform their constituencies they care about the topic and are trying to support it, [and] diversification to the portfolio through [green bonds'] unique features and performance. It has been becoming more and more clear lately that green bonds outperform their vanilla equivalents in the secondary markets and are well bid, even in times of distress."

Bill says the ability to achieve a 'greenium' - tighter spreads in green and other thematic bonds – is strengthening, and in places like Scandinavia, "one could argue that issuing a vanilla bond in, say, SEK would require a concession with a limited onshore demand for that format".

Recent reports of bid/ask spreads showed, in the very volatile 2020, green bonds did better on secondary-market liquidity "due to consistent demand from...ESG investors looking or paper", Bill adds. "Even if the price tag is slightly higher [on green bonds] in the primary market, they do provide additional value in the secondary market, and currently do offer superior liquidity. That is indeed an excellent development because historically thematic bonds have been less liquid than conventional bonds."

Data shortfalls

But all the speakers mention one of the big challenges in emerging markets green bond markets is the persisting shortfalls in available data.

"It's improving, but off a very low base and we struggle to get good emissions data in a lot of EMs. The key is to keep widening coverage and encourage as many companies as possible in EMs to disclose," Vos says.

But the comparative paucity of data both from companies and ratings agencies, is understandable, Invesco's Ling adds, given the relative youth of ESG ratings (20 years) compared to credit ratings which emerged from the Great Depression in the 1920s.

Sustainalytics and MSCI cover about 60% of Ling's Asia investment universe, he says, and still-developing agency-specific methodologies mean dispersion in ratings exists.

"The 'pull factor' is investors like us talking to issuers...to improve voluntary disclosure, sharing of more data about environmental and social KPIs, and management compensation plans. Companies that want to attract in capital will have, over time, to be more transparent. The 'push factor' is government regulations to improve data quality," Ling says.

Will everything become 'green'?

The ubiquity of sustainability considerations now among investors raises the question, whether a 'green' or 'sustainable' bond will still be readily identifiable from a 'vanilla' bond, in future?

ICMA's Kapasi says: "We can all hope for a day in the medium- to near term where everything is a sustainable instrument, and the type of disclosure and impact reporting enshrined in green bond principles are expected of any kind of capital rising. That day may come and I think we are moving in that direction."

Ling says a bond documentation's handling of ESG should be in the first 10 pages, not the appendix.

"Five years ago it was in the appendix - you talked about it if you had time in the meeting, now it is the first question any investor asks, or the first message a corporate wants to bring to its investor base," he says.

Kapasi adds the sentiment has changed greatly in green bond markets over the past five years, including about whether regulating the market would help it develop.

Back then a sense pervaded regulation would "stifle innovation, cause compliance burdens and reduce freedom to grow the market in a way conducive to all participants", but then, while European and US issuance softened in 2016, the Chinese government intervened locally and "lit a rocket under issuance, in relative terms, showing that official sector action could be beneficial".

"Other Asian markets got involved - which was clearly a catalyst for market development in a way not detrimental and boosting issuance," Kapasi continues. "And now we see the EU getting very heavily involved in regulation – which I think overall is beneficial to the market.".

However he cautiones that not all Asian investors are that committed to sustainability, yet, "sometimes the market is not entirely convinced that sustainability and financial returns can go hand in hand".