When Green is Gold

Ashok Parameswaran, President of the Emerging Markets Investors Alliance, highlights the challenges of achieving environmental and social impact via emerging markets bonds.

The world needs “a breakthrough and a new roadmap on climate finance that can mobilise the US$1 trillion in external finance needed for emerging markets and developing countries – other than China – by 2030”.

This is the staggering figure unveiled at the COP27 Summit this week in a report commissioned by the British and Egyptian governments.

An important key to unlocking that finance lies in green and sustainable emerging market bonds, which promise lenders both returns and the opportunity to invest in projects with an ESG impact.

Appetite for emerging market green, social, sustainability and sustainability-linked (GSSS) bonds has surged since the COP26 Summit which saw some of the world’s richest countries promise US$100 billion in finance for climate mitigation in developing countries. Rich countries have since struggled to deliver on this pledge, but the private sector have begun to step in.

Data published this week from the World Bank – ‘Sovereign Green, Social and Sustainability Bonds: Unlocking the Potential for Emerging Markets and Developing Economies’ – show that total issuance reached US$3.5 trillion by September, with demand for emerging market labelled bonds far outstripping the rest of the world.

Research from Moody’s ESG Solutions in the first quarter of 2022 found issuance by emerging markets sovereigns and corporates increased by 22% from the fourth quarter of last year, while the global GSSS or ‘labelled’ bond market experienced falls of 11% over the same period.

According to the World Bank report, which surveyed 12 major international investors and intermediary banks with US$20 trillion in assets under management, their “strong interest” in emerging market thematic bonds is motivated by “achieving ESG impact, developing the thematic bond market, diversifying their portfolios, and serving the direct business interests of their investors and shareholders”.

Weak frameworks

But there are governance challenges for those keen to use emerging market GSSS bonds as a means of managing risk and delivering return while also achieving positive environmental and social impact.

The World Bank notes that emerging market bonds GSSS bonds, notably those from sovereign issuers, had “weak bond frameworks and lacked institutional capacity of the issuing governments to identify and monitor eligible projects, and limited data availability”.

Disappointment in the framework underpinning the GSSS emerging market bonds, is shared by Ashok Parameswaran, President of the Emerging Markets Investors Alliance (EMIA), an organisation made up of “emerging market insiders” including investment bankers, buyside and sellside analysts, portfolio managers, credit rating agency analysts and capital markets lawyers, who engage with corporate and sovereign issuers “to advance the adoption of ESG best practices”.

Parameswaran says: “Investors want to see that GSSS bonds make a real impact, and they have not been happy with the with the kind of issuance we’ve seen in emerging market labelled bonds. There’s a lot of greenwashing, and there are really weak standards in terms of additionality, materiality, accountability and transparency.”

The World Bank’s survey reflects Parameswaran’s views, with investors complaining it was hard to access quality data on labelled emerging market bonds.

Gold standard

In response, this October the Alliance announced “significant improvements” to its labelled bond standards in a bid to eradicate greenwashing and provide investors with a “new gold standard” for emerging market GSSS bonds.

EMIA’s labelled bond standards cover both corporate and sovereign issuers in the emerging markets, and are designed to help investors identify which bonds make a “meaningful contribution” to ESG outcomes.

Like the International Capital Markets Association Green Bond Principles, the EMIA standards set out clear guidance on how what constitutes a GSSS bond and how they should be assessed, verified and monitored. EMIA lists recipients of the gold standard on its site.

Parameswaran says: “We identified the critical opportunities to strengthen this market, and how labelled bonds should be structured in a way that investors believe will ensure meaningful impact outcomes.”

The enhanced standards include:

  • More transparency, including a description of the use of proceeds as described in the documentation at issuance, with additional disclosure requirements for sustainability-linked bonds.
  • Inclusion of a requirement that details community and grassroots-level involvement.
  • Independent oversight of the bonds, including audits by international financial institutions and annual impact reports which are made publicly available.
  • Recourse for misuse of funds. For instance, if an independent verifier finds that bonds have been spent on items not specified in the legal documentation, the issuer will be required to replenish the funds and report a failure to spend proceeds as planned or to meet KPI targets to all relevant stakeholders with possible de-labelling consequences.

Parameswaran says: “The current labelled bond market is characterised by bond issuance that often has weak provisions for transparency, additionality, materiality and oversight. Our enhanced provisions address all these areas.”

He continues: “For example, labelled bonds sometimes have infrequent checkpoints to ensure that KPIs are on target. Often the second party opinions are boilerplate, and they don’t critically assess the issuer’s performance against its covenants. The enhanced framework ensures that critical oversight.”

Parameswaran adds that the ‘recourse for misuse of funds’ is an important addition to the standards since it will incentivise issuers to take responsibility for ensuring their bonds deliver as promised.

“Having a stick is an additional incentive to issuers to meet their commitments. Any recourse would be a black mark on an issuer and would stain their perception in the market. We think that would be quite a formidable deterrent to not meeting one’s commitments.”

No excuse

At the end of last month, the Uruguay SSLB 5.750% USD bond due in 2034, which settled on 28 October, was the first emerging market labelled bond to be fully consistent with EMIA’s gold standard.

This, Parameswaran says, demonstrates the standards are achievable.

However, he concedes there are challenges in raising awareness about the new framework.

“We believe these are reasonable standards and given that Uruguay has met them, it is not unreasonable to think that others will follow suit. That said, not all issuers know about the standard, so there will be a period of education. But we believe take up will grow as awareness spreads.”

Parameswaran is optimistic that investor demand for authentic ESG investment products prompted by the EU’s Sustainable Finance Disclosure Regulation and Sustainability Disclosure Requirements in the UK, will also drive take up of the standards.

“Investors are becoming increasingly discriminating and sophisticated in their ESG allocations. Investors will reward issuers with labelled bonds with lower borrowing costs and that make a meaningful impact. Thanks to the EU regulations – and regulations and guidance coming up in different countries – investors are also being forced to be more discriminating about the kinds of labelled bonds they buy.”

Any issuer hoping to rest easy after meeting the new gold standard may be disappointed however, as Parameswaran says EMIA will be constantly reinforcing the framework.

“Going forward, we will continue to update standards to ensure that they deliver a meaningful improvement to the structure of the emerging market labelled bonds market.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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