Asia’s Sovereigns to Embrace Sustainable Bonds

UN SDGs an increasing factor in government funding needs and costs.

A new Moody’s report claims “conditions are ripe” for increased issuance of sustainable bonds by sovereigns in the Asia-Pacific region. Established issuers will be the first-movers, joined by less-frequent market participants as governments look to address post-pandemic financing gaps, low-carbon transition investments and other ESG risks, the ratings agency said.

The report predicted ongoing fiscal pressures and “significant” public investment needs would spur greater debt issuance by the region’s governments across a variety of funding instruments. Moody’s cited challenges including short-term post-pandemic support for businesses and households, long-term sustainable development challenges, including climate risk mitigation, and gradual, uneven recovery in revenue streams.

It forecasted that 19 countries in the region would suffer worsening public finances over 2021-23, versus the period prior to the outbreak of the pandemic. Much of the required fund-raising will be realised through sustainable bonds, said Moody’s, due to a post-pandemic focus on investment to achieve UN Sustainable Development Goals (SDGs) and major governments’ pursuit of net zero CO2 emissions targets.

Developing economies globally need to invest as much as US$4.5 trillion annually to achieve the SDGs by their 2030 deadline, according to the UN Conference on Trade and Development. The Asian Development Bank (ADB), which estimates a US$3.1 trillion annual SDG funding gap across developing economies, says the Asia-Pacific region needs to spend 4% of its collective GDP annually (US$1.5 trillion) to reach the goals.

A recent report by Pictet Asset Management and the Institute of International Finance said “a fully-fledged sustainable debt market” would go a long way to filling the SDG financing gap, predicting sustainable bond issuance in emerging markets would grow from US$50 billion per year in 2020 to US$360 billion by 2023.

Moody’s also suggested many Asia-Pacific governments could struggle to handle the economic and social costs of decarbonisation without further capital support, noting current high levels of reliance on coal-fired power and strong predicted energy demand, especially among high-growth economies.

Expanding issuer base

Sovereign issuers with good access to funding or track records of conventional issuance, such as Hong Kong SAR, China, India, Indonesia, South Korea and Malaysia, are “increasingly integrating” sustainable bonds into their borrowing strategies. “The issuer base is likely to expand through multilateral support and as investor appetite for sustainable bonds catches up with vanilla bonds,” Moody’s added.

Global sustainable bond issuance surged in 2021, with data providers estimating total volumes just above or below US$1 trillion; green bonds accounted for roughly half. Moody’s ESG Solutions expects overall GSSS-labelled (green, social, sustainability and sustainability-linked) issuance to rise from US$992 billion last year to US$1.4 trillion by the end of 2022.

“Greater sovereign issuance may be supported by expanding demand from investors for GSSS-labelled investments and increased integration of ESG risk assessment in asset allocation,” said Moody’s.

Although social bond issuance by multilateral institutions increased during the pandemic, the agency predicted social issuance by sovereigns would remain lower than for green bonds, due to issues around standardisation and measurement of progress against objectives.

“We expect global and regional momentum supporting more stringent national targets for reducing CO2 emissions to drive sovereign GSSS bond issuance – particularly to finance projects that have discrete, measurable targets, such as land or biodiversity protected, renewable electricity capacity installed or other benchmarks that support investor confidence and reduce the risk of ‘greenwashing’.”

Transition challenges

But issuance by sovereigns will grow from a low base, especially in Asia. From 2019-21, sovereigns and local governments accounted for 14% of global green bond issuance volumes, compared with 40% for companies and 24% for financial institutions, including supranationals, with the vast amount of 2021 sovereign issuance generated by EU member states and UK.

Alongside increased GSSS issuance from the most established sovereign issuers, Moody’s said multilateral development banks could provide technical assistance to less-frequent issuers, noting the ADB’s role in a 2020 bond issued by Thailand to finance infrastructure and social spending.

Not all sovereign issuers would necessarily achieve cheaper financing via the lower premia being charged by investors for sustainable bonds, Moody’s warned, but it said the costs of monitoring ESG performance and use of proceeds would become “less onerous” over time. It also noted that sustainability-linked bonds potentially offered greater flexibility than other GSSS bonds, while tying the bond coupon rate to key performance indicators.

Moody’s acknowledged an “uneven” regulatory landscape across the Asia-Pacific region posed difficulties for investors in establishing and comparing how proceeds are used and projects identified. But it said ongoing harmonisation efforts in major markets would help address transparency concerns.

“Although the development of regulatory standards and taxonomies across the region is still at an early stage, it will gradually facilitate markets,” said Nishad Majmudar, a Moody’s Assistant Vice President and Analyst.

Reduced funding costs through SDG focus

An academic report published in January suggested that sovereign issuers would benefit from lower yields and increased proceeds over the longer term by channelling investment to projects which contribute to UN SDGs.

The findings were from a study of the relationship between countries’ progress toward SDGs and sovereign bond spreads, conducted by researchers at the Rotterdam School of Management, Erasmus University.

Using a country-level SDG measure for a global sample of 59 developed and emerging market countries, researchers identified a “significantly negative” relation between SDG performance and credit default swap (CDS) spreads, while controlling for traditional macroeconomic factors.

Previous studies linking sustainability performance to sovereign bond spreads had used ESG ratings, but the researchers wanted to use an SDG-based approach as it provides an output-driven measure of countries’ transition toward sustainable development, directly measures environmental and social pledges up to 2030 and uses all 17 SDGs, reflecting the interlinked nature of sustainability challenges.

The study mapped a recently developed SDG Index against five-year sovereign CDS data as a proxy for the credit component of sovereign bond spreads, including controls to offset bias toward countries with greater risk and political stability.

Researchers found that a standard deviation increase in performance as measured by the SDG Index was associated with a negative impact on the five-year CDS spread of 17.2 basis points, albeit decreasing slightly when controls were applied.

Further, the impact of positive SDG performance on the CDS spread widened at the longer-end of the yield curve, implying stronger positive impacts on government finances in the longer term.

Investor relations

Researchers said the evidence could be used by governments to offset short-term budget pressures and to communicate more effectively with investors as demand increased for information about sustainability risks related to sovereign bonds.

“Governments can use our results and the SDGs to provide more information on, for example, the country’s level of sustainability and its plans to reach the SDGs.”

Researchers said their results should be treated as initial rather than definitive because of the short period covered (2017-2019). Nevertheless, they said the results suggest SDGs are an additional determinant of CDS spreads and as such could be considered by investors as a risk variable.

Further, they suggested SDG performance would play a key role in the increasing levels of engagement between investors and governments “Where possible, investors can use this information to engage on sustainability with governments, pressing for improvement. As a result, besides ecological and social impact, they can benefit financially if the engagement proves successful,” they said.

A separate study by global risk analytics company Verisk Maplecroft found that social factors are now having almost as much impact on sovereign debt pricing as governance factors.

Based on six years of quarterly historical data, the study reported spread tightening of more than 4% when bonds improved their social rating by one notch in the firm’s scoring system, controlling for factors including credit rating and debt levels. This impact is “nearly equivalent in magnitude” to a similar governance rating upgrade.


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