The potential of green bonds in emerging markets

By Sarah Casey, Portfolio Director, Climate Council

Since 2011, annual global energy transition investment (renewable energy, CCS, electrified transport, hydrogen, electrified heat, energy storage) has almost doubled, from $290b to $501b. Between 2015 and 2018, emerging markets accounted for an increasingly larger share of this investment, yet high-income economies have accounted for the majority since 2018.

Clearly the green finance revolution has taken the world by storm, with investment in low-carbon energy remaining robust throughout the pandemic. A 2020 report co-authored by Amundi and the IFC pointed out that investment flows since the start of the COVID-19 crisis have proven more resilient towards green investments when compared to their traditional counterparts. This is supported by findings published in their most recent report (2021), which described a 21% increase in emerging market (ex-China) green bond issuances from 2019 and a total of $40billion emerging market green bond issuances in 2020.

Amidst this success however, there must be an acknowledgment that emerging economies will likely be disproportionally hit by the crisis as their governments cannot always provide fiscal and monetary stimulus, and many are heavily affected by the price declines in energy and raw materials, reductions in trade, tourism, and also remittances. As the world begins to recover and rebuild, there is the danger that developing nations may be left behind.

So whilst the green finance revolution is well and truly underway, it risks leaving out emerging markets, including some of the world’s most vulnerable nations to climate change.

What is the potential of green bonds to address this imbalance?

By 2019, the global green bond market had surpassed $700 billion in outstanding issues and the IFC & Amundi expect emerging market green bond issuance to double in the next three years compared to the previous three and the market to cross the US$100 billion mark of annual issuance by 2023.

The global green bond market is a crucial source of financing for positive environmental projects and enables investors to direct funding towards environmentally-friendly activities with a comparable risk-return profile to traditional bonds, in both developed and emerging nations. This market is set to continue growing as investor appetite for green bonds continues to grow, and emerging market issuers are likely to benefit from this increasing demand.

Demand for green bonds in emerging markets rose by 21% to $52bn (€54bn) in 2019, with emerging market green bond issuances in 2019 amounting to $52 billion (a 21% increase from 2018). After renewable energy, transport, followed by green buildings, waste, water, biodiversity conservation, and adaptation, comprise other areas for proceeds.

China is the leader in emerging market green bond growth, while east Asia and the Pacific region is responsible for 81% of the market. In addition to China, emerging market issuers are India, Chile, Poland, the Philippines, the UAE and Brazil. Financial institutions are the largest issuing sector in emerging markets, making up 59% of issuances, compared with 19% in developed markets, followed by non-financial corporates at 35%, sovereigns at 12%, government agencies at 5% and municipals at 0.1%.

Clearly there is positive growth, as both issuers and investors are becoming more comfortable with and recognising the benefits including stable and predictable returns, and a greater awareness of environmental, social and governance (ESG) products and strategies. Yet concerns over soft corporate and national targets remain, as some investors question how green these bonds really are. This is a rather large potential obstacle which, unless addressed, may hinder investment in emerging economies and thus stagger the current growth in clean energy projects and a green recovery post-pandemic.

What is a green project anyway?

report published by London’s Imperial College Business School in March 2021 argued that there is  too much emphasis on developed-market standards to define emerging market bond rules. The report interviewed over 40 asset managers and banks and found that whilst it’s the developing countries with the worst environmental situations and thus in greater need of capital to transition, it will be increasingly difficult for them to attract the funding required.

The pertinent issue remains: What constitutes a green project?

Indeed, what green means varies depending on context. As the report highlighted, it may be more important that an emerging market issuer has a realistic, ambitious transition goal and framework, rather than assessing opportunities through Western-built, one-size-fits-all lens.

In order to increase investment into emerging markets, the Imperial College report argues that green bonds are in fact not an appropriate vehicle for many of the heaviest emerging market polluters and instead transition bonds should be the focus.

It concludes that the need for an established taxonomy that makes funding contingent on ambitious commitments to reduce carbon emissions must be prioritised to enable polluting countries to access green finance, and sustainability-linked bonds, which tie an issuer’s borrowing rate to an environmental target.

Putting emerging markets on an even footing

Whilst the green bond market is growing in emerging economies, there is clearly a lot of work that needs to be done to encourage further investment and perhaps alternative routes do need to be considered, as the Imperial College report suggested.

One way to encourage further growth is through using both public and private capital. One real time example of this is the REGIO fund, anchored by HSBC and the IFC. It is a green bond investment fund that uses public and private capital to help businesses in developing countries transition to cleaner, more efficient energy use and invest in other climate-friendly solutions and has already raised nearly $500 million.

As always, education will be vital. In 2018 the IFC launched its Green Bond Technical Assistance Program (GB-TAP), a training course to give bankers a grounding in the Green Bond Principles and the importance of green bond issuers’ disclosures to investors, with an aim to filling a critical knowledge gap and thus growing the green bond market in developing countries.

Global collaboration will also be vital. Financing developing nations climate and sustainable development commitments is a huge task and it will undoubtedly require global investment on an unprecedented scale.

Whilst a lot has been achieved, there is still a long way to go and all possible routes should be explored to help us reach the 1.5-degree scenario. Certainly green bonds will play a major role in increasing investment into emerging economies but perhaps we will also see increased traction in transition deals as investors take a more holistic view, instead of applying a simplistic blanket approach to ESG.


About the Author

Sarah Casey has experience across both the energy and finance industries and is particularly interested in the intersection between renewable energy and investment. As Portfolio Director of the Climate Council, Sarah’s aim is to bring together renewable energy players with the finance and investment community to accelerate investment into renewables. Through technical interviews to Q&As delving into industry trends and thought pieces, Sarah sheds light on some of the ways in which the international finance community can collaborate to mobilise capital to sustainable activities. Topics of focus include ESG investing, digital finance, financing emerging economies and the just transition. You can reach her directly at: sarah.casey@climatecouncil.com

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