Asia has been a laggard when it comes to the megatrend that is environmental social and governance (ESG) finance, but there are signs that it is starting to catch up and 2020 may bear witness to a step change in attitudes and issuance.
As 2020 dawns, FinanceAsia has been canvassing the sell-side for their views on the year ahead and one theme that crops up over and over again is the growing importance of ESG for issuers, intermediaries and investors alike.
Typical are the comments of Sean McNelis, HSBC’s co-head of global debt capital markets. “ESG is now always a critical part of every discussion we have with clients in the region,” he commented.
“Sovereigns and institutions have been active issuers, and we’re now starting to see increasing, encouraging participation on the corporate side too. I expect the Asia sustainable financing market to continue its growth trajectory through 2020.”
Indeed one common refrain is how ESG is a subject that issuers can no longer afford to ignore. As Derek Armstrong, head of Asia Pacific debt capital markets at Credit Suisse notes, “Regardless of where we go on a roadshow to meet investors – Asia, Europe, or the US – someone will always ask a question about green finance; normally whether a company is planning to do a green bond, or has a green framework.”
Armstrong thinks the debate has, therefore, moved on from whether the main incentive for a borrower to go green is because it is likely to be cheaper.
“It’s become a strategic issue for companies now,” he said. "It’s something they all realise they need to do. The seed was planted a few years ago and is now germinating.”
Investment bankers have historically had mixed views about whether there is a pricing benefit in going green. Most would agree with Armstrong’s view that it typically takes effect in the secondary market.
The data here is most marked in Europe, which has led the world in green financing. European investment grade issuers that have issued in conventional and green format often see their green bonds trade 5bp to 10bp tighter and even more if there is a market sell-off since ESG investors tend to be stickier.
Ernst Grabowski, head of Asia Pacific debt syndicate at Morgan Stanley, believes that ESG is “shaping up to be the biggest change to the capital markets in my life time.”
He says the next big step change will occur when the rating agencies start to assign ESG ratings in addition to their standard credit risk ratings. “This will be a real accelerator in terms of awareness and behavioural change on the part of corporates and investors,” he remarked.
Many participants believe the financial markets have an outsized role to play in helping to combat climate change. But as the ESG financing develops, it also presents its own unique set of challenges.
One of them concerns what kind of issuers should be classified as green in the first place.
As Augusto King, head of Asian debt capital markets at MUFG, elaborates, “I was discussing this with some colleagues only recently. Some Asian issuers might not meet European standards, but the region here is at a different level of development.
“So when a Chinese issuer gets a green label because it's improving the quality of its equipment, it still reflects an improvement in its environmental impact,” he commented.
King says it is noticeable that investors are making a lot more distinctions about how green a bond is: light green or dark green, for example.
He argues that this shows the market is moving to a new stage of development. “It starts with awareness and then it begins to develop better categorizations and that’s the stage we’re entering now,” he said.
Clifford Lee, global head of fixed income at DBS, adds that investors are also looking for “more flow in terms of how and when they can measure a company’s progress. An annual report is not enough any more.
HSBC’s credit analysts back this argument up. In a special ESG report, published late last year, they highlighted how disclosures have mostly been driven by regulatory requirements and investor demand rather than by the corporates themselves.
They also pointed out how there is a much greater emphasis on corporate governance in Asia (or as FinanceAsia would argue: the need to improve it) rather than environmental and social factors. The two exceptions are Hong Kong and Singapore where listed companies are required to adhere to environmental and social rules on a comply-or-explain basis.
HSBC’s credit analysts noted that Hong Kong-listed bond issuers have higher ESG-related disclosures than their peers across other Asian markets, although Indian and Thailand bond issuers intend to publish more comprehensive ESG-related information, in line with their rapidly developing ESG frameworks.
“Bond issuers in mainland China, especially Chinese private companies, have relatively lower levels of disclosure due to a lack of ESG reporting framework," they added.
A second issue concerns the methodology that second opinion providers use to evaluate green bonds. There is an argument that it is too prescriptive and overly focused on monitoring use of proceeds.
DBS’s Lee believes this debate is also a sign of how the market is evolving. He says that issuing green bonds has become almost business-as-usual.
“What’s more important for issuers now is demonstrating that the company is doing something that’s a game-changer,” he commented. “It’s about how it’s changing and investing in its business practices to become more sustainable from the short-to-long-term.”
He says this is something that, “isn’t even discussed enough in more mature markets like Europe”.
DBS has been particularly active in the ESG field and Lee highlights how the bank has started “thinking about how we can influence behaviour on the lending side”.
“We’ve done several loans whereby we’ve committed to reduce the interest rate if a borrower hits certain benchmarks and then adheres to them. So we’ve put our money where our mouth is,” he commented.
One such loan is the S$250 million three-year revolving credit facility that DBS provided to Singapore's City Developments. The company will be eligible for a discount on the interest rate if it achieves mutually agreed sustainability-related performance targets.
Lee adds that DBS is now trying to devise structures that work along similar lines on the bond side. However, this is not as straightforward.
“While the market understands that investors are keen to invest in sustainable practises, what it doesn’t know is how willing they are to pay up for it,” he explained. “For example, will they be happy to reward companies via coupon re-sets? These are all issues we need to work through.”
The reception to ENEL’s pioneering transition bond suggests that they are definitely happy to be rewarded if things go the other way. Last September, the Italian electricity giant raised $1.5 billion from a bond linked to Social Development Goals. It if fails to increase its renewable power generating capacity from 45.9% to 55% by the end of 2021, the coupon will step up by 25bp.
There is a general consensus that banks are about three to five years ahead of other market participants. But as Haitham Ghattas, head of Asia Pacific capital markets at Deutsche Bank, adds, “I don’t think it will be long before institutional investors follow suit. General partners will put increasing pressure on funds to ensure that they’re ESG-compliant.”
Another bank, which has made huge strides, is French bank, Natixis. In September, it rolled out its Green Weighting Factor, a mechanism that allocates capital to deals based on their climate impact.
The bank makes a positive or negative adjustment to all financings where green equals good and brown is bad. Risk weighted assets (RWA) are then reduced by up to 50% for green deals, or increased by up to 24% for brown ones.
These weightings are used for the bank’s internal use rather than for official reporting. Xiaofei Guo, the bank’s director of green and sustainable finance in Asia, says the methodology is embedded in the bank’s existing credit approval process and IT systems.
“All of the corporate and investment bank's transactions receive a colour weighting except for those in the financial sector,” she outlined. “The next step is to use this information to set our own targets.”
Guo also emphasises that Natixis does not intend to keep this methodology to itself.
“We want to help the market to develop,” she said. “We want to share our experience with other banks and have already started to do this.”
Guo expects more diversity of bond offerings in 2020. This might include more issuers from social sub-sectors such as disadvantaged groups, education, employment, healthcare or social housing.
This latter category is one that investors are showing a rising interest, particularly in the emerging markets according to Guo. "It would have a bigger impact in developing markets like Asia becasue there are more disadvantaged groups who need this type of help compared to Europe," she said.
The New Year may also see more sovereign green benchmarks following those from: Indonesia (2018 and 2019), Hong Kong (2019) and South Korea (also 2019).
Both Malaysia and the Philippines regularly tap the international bond markets, but neither sovereign has yet set a G3 green benchmark even though the former has developed a strong local green bond market, including sukuks, and the latter produced a number of ESG-related corporate and bank deals in 2019.
Amit Sheopuri, co-head of Asia Pacific debt capital markets at Citi is especially positive about the Philippines. “Southeast Asia will see a pick-up in issuance,” he said. “The Philippines is a growing market with issuance of US$1bn in 2019 and is expected to double to US$2bn in 2020.”
So far: so positive. But market participants also predict that “old school” industries such as coal mining will find it progressively harder to raise financing, not matter how much they are willing to pay.
One very public example of this happened earlier in 2019 when MUFG found it difficult to syndicate a $150 million three-year loan for Indonesian coal miner Bukit Mandiri Utama (Buma).
After struggling to get its international peers to sign up, the Japanese bank ended up having to offload the paper to local banks in Indonesia instead. Many predict it will not be long before the latter also follow suit.
It is, therefore, shaping up to be a green decade. As Citi's Sheopuri concludes, “We expect further issuance across the green, social and sustainability markets from the region in 2020 as more issuers and investors alike embrace the product."