Greening the Capital Markets

With climate change now firmly on the agenda of most global economies the opportunities emerging around green investment are increasing exponentially.

Aug 1, 2016 // 8:00AM

According to data published by the Climate Bonds Initiative roughly US$42bn in green bonds having been issued last year, up from US$11bn in 2013. While 2015 saw a brief slowdown in growth rates of green debt issuance globally it is clear interest in these instruments is growing in emerging markets, particularly in Latin America and Asia – the latter of which is leading the way and already accounts for just over half of all green bond issuances in 2016.

This growth has been driven mainly by new development in low-carbon projects including buildings, transportation and renewable energy infrastructure, while the creation of new climate-linked indices, the industry’s development of green bond reporting guidelines, and new regulations and frameworks deployed by governments globally have helped take green bonds from a niche product into the mainstream.

As we look to the Middle East it is interesting to note that despite renewed emphasis on the development of low carbon infrastructure in the region, the industry has yet to see a green bond issued there. But given the similarities between Islamic finance instruments and green bonds, and renewed pressure on the region’s issuers to diversify their funding sources, it is worth asking: Will 2016 be the year we see the first green sukuk? We speak with Victoria Clarke, Director of Sustainable Financing, HSBC Capital Financing and Aziz Ata, Head of Debt Financing MENA, HSBC about the outlook for green bonds in emerging markets and the development of the green sukuk segment.

Late last year HSBC announced it would inject US$1bn into high-quality green assets like green bonds. Beyond the perception of being ‘green’, how do the benefits of holding these compare to similar instruments?

Victoria Clarke: We announced the US$1bn commitment to green bonds last year to complement our existing commitments to sustainable financing, including the issuance of our own US$531mn green bond around the same time, as we have a long term interest in supporting the green bond market and helping our clients transition to a lower carbon economy. In addition to these, HSBC is already a big participant in the underwriting capacity, helping to bring new and repeat issuers to the market. We also support the sector in a multitude of other ways; both Ulrik Ross, our Global Head of Public Sector and Sustainable Finance and myself sit on the International Capital Markets Association (ICMA) Green Bond Principles Executive Committee, which essentially frame and update (on an annual basis) the principles underlying green bonds. We are also part of various working groups at ICMA, such as, the Social Bond working group – which created the Social Bond Guidance to help provide the platform for social and sustainability bonds that are now coming to sit alongside traditional green bonds. We are also co-chair of the New Markets working group – looking at global expansion for green social and sustainability bonds and the Database and Index working group – which aims to promote consistency between the external databases recording issuance volumes.

Considering the benefits, these come from both sides –issuers want to issue green bonds because it is important for their business; to diversify investor base and demonstrate sustainable strategy and investments made or in the pipeline, and investors want to demonstrate they are committed to a sustainable low carbon economy. With green bonds, we often see more engagement from investors in the build up to transactions, which help maximise orders and contribute to long term investor stickiness. For instance, our treasury team run our USD 1bn Green Bond portfolio, their additional view into the longer term sustainability strategies and profiles of the green bond investments they consider is valuable in itself because it adds a new dimension to their investment analysis. And as we are seeing an increased transition towards adopting sustainable long term, low carbon investment strategies, through green funds and similar instruments, it is definitely something we want to support and be in front of.

Aziz Ata: From an issuer perspective this is clearly a significant diversification opportunity, and a corporate social responsibility exercise. Many corporates are expanding the proportion of their budget that can be dedicated to these activities globally, but when it comes to sustainable financing via green bonds, the additional costs are marginal and in some cases issuers can get more competitive pricing, as there are examples where the new issue premium has been slightly lower when compared to a conventional bond or the instrument has priced inside the curve. Above all, it can help establish a very positive presence in the corporate world. From an investor perspective, it is a dedicated and targeted investment that is scarcely available.

Lack of standards that define what is “green” is often cited as a barrier to the development of the green bond market. What is your take on this? Should there be more stringent standards here?

VC: We are of some market participants having this view, but we don’t believe in bringing in stringent standards until the market develops sufficiently because we don’t want to impede its potential before it takes off. We may support standards  in the future if it could help lay the groundwork for global governments to incentivise the market going forwards, because then you have a classic trade-off of fiscal incentives versus meeting standard requirements.

What we’ve seen in the past six months is encouraging. India issued voluntary green bond guidelines, which are very similar to the Green Bond Principles, to promote green bond issuance and lay out more clearly the types of information that needs to be contained within the documentation or green bond framework that sits alongside the regular documentation for an Indian green bond issuer.

Similarly, this is one of the reasons why the Chinese market has taken off so quickly; in Q1, the People’s Bank of China (PBoC) issued green bond regulation which outlines the types of projects that could qualify for a green bond by a Chinese issuer. Additionally, the National Association of Financial Market Institutional Investors (NAFMII) has issued regulations covering corporate Chinese issuances, and the National Development and Reform Commission has issued Chinese regulations covering enterprise bond issuers. Across all the regulation and guidelines, you can see many similarities to the ICMA GBP, which is a very positive step as it demonstrates international harmonisation is already working without standards.

The green bond market is forecast to swell significantly this year. Where do you see the strongest demand for green bonds coming from?

VC: Lets start with thinking about where we’ve come from. We saw US$31bn of green bond issuance in 2014, and in 2015 we ended up with about US$43bn, which is significant growth. To put this in perspective, in 2013 we saw US$11bn. The industry as a whole is moving to bring issuers up the curve in terms of their understanding of the green bond market and what it takes to issue one of these instruments, but it can takea bit of time – particularly the process of reviewing assets which may be eligible.

We see a very exciting 2016 and beyond. There is estimated, by various research articles and key market participants, to be anywhere between US$50-90bn of green bonds issued in 2016, so we are looking to see a nice step up from 2015. HSBC’s recent research in this area suggests Asia will be a key driver here. In 2015 we saw US$3.3bn of green bond issuance from Asia; year to date in 2016 we have already seen US$10.2bn issued from three Chinese banks alone. So, these countries have gone from having a 7% market share in 2015 to a 51% share in 2016. That growth is predominately focused in China – there are three banks in China that account for about 47% of that, up from 3% the previous year. The potential there is enormous. The green bond market started in Europe, and has now spread out to places like China, Canada, and the US. We’re waiting for the first Middle East issuance, which could potentially come through sometime this year and which we are very excited about. There are such a vast array of potentially eligible projects to be funded in the region, it makes great sense for issuers to consider this funding strategy.

The potential for a green sukuk market is fascinating. Does the structure of these instruments lend themselves to a green format, and how will pricing play out?

AA: Philosophically, the two products are very similar in nature. Sukuk prohibits financing any activity considered non-Sharia compliant, and if you look more closely you will see that the ethical financing principles underlying both are quite similar. When you consider the issuer and investor base that would share an affinity to these kinds of products, there are many similarities as well. On the Islamic finance front, we have managed to achieve tighter pricing than conventional transactions – but it is hard to generalise about green products and whether they will trade tighter as a result of their being ‘green’. Green sukuk are something we would be very keen to explore from an issuer and investor perspective because conceptually it would make a great deal of sense to all parties involved. It’s a significant opportunity just waiting to be tapped in our view.

The GCC region has experienced significant downgrade pressure in recent months. To what extent will ratings factor into the development of the green bond market there? Will their green nature provide some immunity from these pressures?

VC: Only time will tell. We have seen some examples where green formats have worked for issuers where conventional products have not – in part because there is such a shortage of these instruments in the market compared to investor demand. I wouldn’t say that the green bond market is immune to these pressures, however. Long term investors want their returns and will naturally take into consideration ratings and ratings changes, as would non-green investors, but the green aspect could add a little bit to an issuer’s profile. It does provide additional pockets of liquidity both from within and outside the region, which is an important consideration – particularly in the current climate.


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