Explainer | What is driving an almost 200 per cent growth in sustainability-linked debt financing

Globally, green and sustainability bond and loan issuances totalled US$809.5 billion in this year’s first half, nearly tripling year on year
In China, Hong Kong and Taiwan, about 41 sustainable bond transactions worth US$19 billion were recorded in first six months of 2021, compared to 23 deals worth US$7.6 billion in all of last year

Green bonds

Eric Ng

Published: 2:00pm, 1 Aug, 2021

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Sustainable debt financing has flourished globally in the past year. Growth in green bonds, which finance projects with environmental benefits, and sustainable loans that also support social projects, has been particularly strong.

Such flows of funds from lenders and bond investors to borrowers, which are guided not only by conventional financial performance metrics such as profitability and capacity to repay, but also non-financial considerations, have been gathering momentum.

Factors such as a company’s resilience against the impact of climate change, the social impact of its activities, board diversity and governance effectiveness are important indicators of the risks and opportunities it faces. Creditors are more aware of these factors than ever, and need to take them into account systematically when assessing borrowers’ creditworthiness.

Globally, green and sustainability bond and loan issuances totalled US$809.5 billion in this year’s first half, nearly tripling from the US$286.7 billion in issuances in the same period last year, according to Refinitiv. This number also exceeded the total of US$743 billion recorded in the whole of 2020.

Here’s what debt creditors and bond investors need to know about sustainable financing.

How fast has green and sustainability debt been growing?

Globally, sustainability loans almost quintupled year on year to US$293 billion in the first half of this year, while green bonds nearly tripled and sustainable bonds grew 160 per cent.

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The Asia-Pacific region’s share of the global total edged up to 14 per cent in this period from 13.3 per cent for the whole of last year. In China, Hong Kong and Taiwan, about 41 sustainable bond transactions worth US$19 billion were recorded in the year’s first six months, compared to 23 deals worth US$7.6 billion in all of last year, according to John Lee, head of Greater China global banking at UBS.

“2021 will very likely be a milestone year for Greater China ESG [environment, social, governance] bond issuance, as we have not only seen a record number of deals and volume, but more importantly we have also seen a record number of debut borrowers, as well as innovative structures such as sustainability-linked bonds,” he said.

What is driving deals?

Government policy is one factor. In Hong Kong, the monetary authority which also acts as the city’s de facto central bank, has rolled out a three-year grant scheme that subsidises bond issuance expenses for first-time green and sustainable bond issuers. Commencing in May, the up to HK$800,000 (US$102,928) grant per transaction also covers external review and reporting fees for bond issuers and loan borrowers.

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The publication of updated standards and guidelines for the issuance of green and sustainability-linked bonds mid last year by the International Capital Markets Association (ICMA) that helps avoid “greenwashing” has also helped spur deals, said a Fitch Ratings report this month. Greenwashing refers to marketing spin aimed at giving the impression that greater environmental benefits can be achieved by companies’ products or projects than in reality.

More and better quality disclosures on non-financial performance metrics, such as ESG performance data, has also been key to the growth of sustainability-linked debt issuance.

The European Union has taken a leading role on ESG disclosure requirements and standards, issuing a directive in 2014 to its member nations to make the disclosure mandatory by 2016. A plan announced in April would more than triple the number of companies subject to ESG disclosure requirements over three years, including large privately owned firms. Such disclosure will also need to be audited.

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In the United States, a bill passed in June by the House of Representatives to make the disclosure of specific ESG data mandatory for listed firms, if replicated in the Senate, will support the growth of sustainability-linked bonds and loans in the world’s largest economy, Fitch said.

In Hong Kong, the stock exchange’s upgraded ESG disclosure requirements have come into effect in July, under which listed firms must report direct and indirect greenhouse gas emissions volumes, describe emission and energy use efficiency targets, and disclose measures to achieve them. They must also describe relevant climate issues and actions taken to manage them.

What’s the difference between sustainability-linked bonds and loans and conventional ones?

While both are fixed-income instruments from which investors can earn interest, borrowers of sustainability-linked instruments need to set predetermined sustainability performance targets that are both relevant and important. If they are not met, the debtors will have to bear a penalty in the form of a higher coupon or interest rate.

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“Here, unlike conventional instruments, a borrower is not restricted in the use of proceeds to finance a green or social project,” said Alvin Yeo, UBS’ head of sustainable finance, leveraged debt capital markets in Asia. “The focus is on the ambitiousness of the sustainability performance targets and credibility of the strategies to achieve them.”

An example is the US$500 million sustainability-linked loan facility secured in July by Budweiser Brewing Company APAC, the Asia-Pacific arm of the world’s largest brewer, AB Inbev. It featured a tiered discount on the interest rate if targets on renewable energy procurement, carbon emissions, water usage and recycled content in primary packaging are reached.

Hong Kong conglomerate New World Development in January issued the first US dollar sustainability-linked bond by a real estate developer globally, committing to use 100 per cent renewable energy by 2026 for its rental properties in the Greater Bay Area. If it fails to do so, it will pay a penalty worth 0.25 per cent of the bond per year going toward carbon offset schemes.

How can bond issuers and investors avoid greenwashing?

Issuers should explain in writing how their bond programmes directly align with principles and guidelines issued by the ICMA, Fitch said. They should also engage an external reviewer or auditor both before and after their bonds are sold, to ensure adherence to the principles and track that the proceeds are spent where they should be, it added.

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