Nine key trends for sustainability and sustainable financing
Earlier this year, S&P Global identified nine trends its analysts and researchers expect will shape the sustainability landscape during 2023. Richard Timbs, senior director and sector lead – corporate and infrastructure ratings, Pacific at S&P in Sydney, explains why these trends are so important and what they mean for financing.
With a backdrop of geopolitical turmoil, persistent inflation, looming recession and worsening impacts of climate change, new tensions are likely to emerge between managing near-term risks and making meaningful progress on longer-term sustainability goals. These trends highlight the delicate balancing act S&P sees stakeholders facing and managing – the requirement to weigh various and sometimes opposing forces. This push-and-pull dynamic could continue to be a hallmark of sustainability discussions and decisions throughout 2023.
THE NINE KEY TRENDS
In the article S&P Global Outlines Key Sustainability Trends That Will Drive Decision Making in 2023, the rating agency highlights nine trends as critical market drivers.
The trends are:
- Sustainability disclosure standards will pressure companies and investors to respond and adapt.
- Companies and investors will navigate the increasing risk of litigation related to sustainability actions and inactions.
- Climate strategies will be reconsidered in the face of energy security and affordability concerns.
- Rising costs from physical climate risk will accelerate investment in adaptation and resilience.
- Employment practices adapting to new workforce dynamics will be tested in the face of economic and labour market uncertainty.
- More resources will be devoted to managing human rights impacts in supply chains amid new sustainability regulations.
- Climate change will continue to drive drought and water scarcity, sharpening the focus on water-related risk.
- Understanding of biodiversity and nature-related risk will reach an inflection point as more data and frameworks become available.
- The global sustainable bond market will return to growth but contend with credibility challenges and market uncertainty.
S&P has also presented its outlook for sustainable bond issuance in its sustainability insights research reports, Sustainable Bond Issuance Will Return To Growth in 2023 and Asia-Pacific Sustainable Bond Issuance to Increase in 2023.
One of the primary forecasts is for global green, social, sustainability and sustainability-linked bond (GSSSB) issuance to grow by 5-17 per cent this year. We believe GSSSB issuance will return to growth in 2023, reaching US$900 billion to US$1 trillion and nearing the record US$1.1 trillion from 2021 (see chart 1). This follows a 2022 in which contractionary monetary policy and macroeconomic uncertainty curtailed global bond issuance.
Three factors could drive growth or drag it down. Broadly, these are policy initiatives, levels of investment in climate adaptation and resilience, and the ability of issuers to address concerns about the credibility of certain types of GSSSB debt.
Green bonds will likely continue to dominate. However, we expect to see sustainability bonds – where the proceeds are earmarked for environmental and social projects – become more prevalent.
Meanwhile, sustainability-linked bonds (SLBs) are at an inflection point. Skepticism and questions about the credibility of the asset class’s ability to achieve meaningful sustainability targets are increasing, weighing on the minds of investors and issuers.
In our view, total global bond issuance will grow only moderately in 2023. However, we expect faster growth for GSSSB issuance will lead to a larger market share for this asset class across all regions and sectors. We believe GSSSB issuance from nonfinancial corporates, financial services, and the US and international public finance sectors is likely to comprise 14-16 per cent of all bond issuance in 2023. In our view, issuance data are the most comparable in these sectors.
We expect the Asia-Pacific region to post 20 per cent growth in GSSSB issuance in 2023, outpacing other regional markets and reaching a total value of about US$240 billion. The steep rise in percentage terms is mainly due to a lower existing base of issuance. However, growing awareness of sustainability imperatives across the region, especially decarbonisation, will also contribute to market momentum.
Asia-Pacific GSSSB issuance maintained momentum in 2022, yet at a slower pace. It was up by 10 per cent, to US$199 billion. It proved more resilient to global macroeconomic uncertainties than other regions, as global volume contracted by 19 per cent. Green bonds dominated issuance in Asia Pacific, accounting for 55 per cent of the volume. This was followed by social bonds at 26 per cent, sustainability bonds at 14 per cent and sustainability-linked bonds at 3 per cent. Transition bond issuance remained minimal, at 2 per cent, and was limited to Japan.
We believe China, South Korea and Japan will drive volume. However, a few other countries are starting to catch up. In our opinion, the continued development of local regulations will also help instil discipline and credibility in the market, potentially unlocking additional opportunities to nurture pockets of growth.
“Three factors could drive growth or drag it down. Broadly, these are policy initiatives, levels of investment in climate adaptation and resilience, and the ability of issuers to address concerns about the credibility of certain types of GSSSB debt.”
In our view, China, South Korea and Japan are likely to remain the heavyweight GSSSB issuers in Asia Pacific primarily due to the size of their economies and their established issuer and investor bases. These countries have represented 70-80 per cent of issuance in the region for the last five years.
However, other markets are slowly catching up with North Asia. Issuance volume in Australia, India, Indonesia, and Malaysia trails that of China, Japan and South Korea, which could reflect, in part, their economies’ greater dependence on fossil fuels. Still, the situation could well change, led by commitments made to address global climate imperatives more decisively.
For instance, the Malaysia Renewable Energy Roadmap supports the decarbonisation of the electricity sector by 2035. Likewise, the Australian federal government’s Powering Australia Plan proposes A$24 billion (US$115.9 billion) of public investment by 2030. This plan aims to unlock an additional A$52 billion in private investment and achieve renewable energy penetration of 82 per cent by 2030.
GLOBAL TRENDS, LOCAL CHARACTERISTICS
Proposals for sustainability disclosures that are being developed around the globe are likely to inform reporting requirements in the Asia-Pacific region. The European Financial Reporting Advisory Group, the US Securities and Exchange Commission and the International Sustainability Standards Board are all close to finalising proposals.
Debt capital markets are cross-border in nature, and North American and European financial institutions have extensive reach. Therefore, the form of these final proposals will likely guide trends in Asia Pacific. For instance, European initiatives such as the Sustainable Finance Disclosure Regulation could push issuers outside Europe to adopt the continent’s reporting standards to attract European investment.
A few countries in Asia Pacific have used international principles as bases for developing guidelines for debt instruments. They have, in some cases, followed certain frameworks set out by the International Capital Market Association. However, countries have also kept local nuances. For example, Japan has broader definitions for social eligible categories.
Meanwhile, there are several local taxonomies – such as China’s Green Bond Endorsed Project Catalogue and the K-taxonomy for South Korea. Most use the EU taxonomy as a reference. However, coverage and requirements are driven by local economic characteristics as well.
“Investors have increasingly questioned issues about the ambitiousness of SLB targets effectively to address sustainability issues, together with the materiality of financial penalties if issuers fail to achieve them. We believe addressing concerns on the materiality of sustainability impact and coupon step-ups will be key if the market is to rebound in 2023.”
A WAVE OF NEW REGULATION
We consider the Asia-Pacific region to be most vulnerable to climate risk. Accordingly, in 2023 more countries and regions may emphasise reporting under the recommendations of the Taskforce on Climate-Related Financial Disclosures. New Zealand, Singapore and Taiwan are in the vanguard here. Meanwhile, we expect some mandatory disclosures will come into force in Hong Kong and Malaysia by 2025.
In addition, a few taxonomies are expected to roll out in the Asia-Pacific region in 2023. Hong Kong’s Green and Sustainable Finance Cross Agency Steering Group is working on a local green classification framework, following the publication of the updated Common Ground Taxonomy by the International Platform on Sustainable Finance. Likewise in Australia, market participants and regulators are developing an Australian sustainable finance taxonomy. Singapore’s Green Finance Industry Taskforce, meanwhile, aims to finalise its taxonomy in 2023 following two rounds of public consultation.
At the same time, however, regulation proliferation could also create regulation fatigue and increase compliance cost if there is not a steady convergence.
We believe more thorough climate disclosures can bring about two main benefits. First, they could pave the way for more credible climate mitigation use-of-proceeds instruments. Second, they could lead to more educated assessments of the ambitiousness of sustainability targets in other instruments.
DECARBONISATION: THE GSSSB GROWTH ENGINE
Green bonds will continue to dominate GSSSB issuance in Asia Pacific, in our view: they are likely to account for nearly half of overall volume. We expect issuance will primarily support technologies and interventions that contribute to climate mitigation.
We anticipate interest in financing adaptation and resilience actions through green bonds will increase. However, growth is likely to be slow. Typically, the benefits of adaptation finance are realised over a long-term horizon, while those of investments in climate mitigation are more immediately visible.
Within green categories, issuers have favoured climate mitigation investments in areas such as renewable energy, green buildings, and energy efficiency (see chart 2). Meanwhile, uses of funds including eco-efficient products, production technologies and processes, and terrestrial and aquatic biodiversity conservation, have received considerably less investment.
SLBs could be a source of growth in the region. These instruments provide entry to the GSSSB market for issuers that would otherwise struggle to access finance for dedicated green or social projects. However, we believe this asset class will face challenges in 2023. Beyond an unsupportive economic environment, investors have increasingly questioned issuers about the ambitiousness of SLB targets effectively to address sustainability issues, together with the materiality of financial penalties if issuers fail to achieve them. We believe addressing concerns on the materiality of sustainability impact and coupon step-ups will be key if the market is to rebound in 2023.
The reduction of greenhouse gas emissions is the most used SLB KPI in the region. More than half of instruments adopt this KPI. KPIs on greenhouse gas emission reduction predominantly come from developed economies such as Japan and Australia, whereas emerging economies have generally used KPIs based on energy efficiency and renewable energy.
An increase in absolute power consumption and historical economic dependence on fossil fuel production remain two hurdles, making carbon intensity reduction a more reasonable, yet less ambitious, metric than that of absolute emissions. We believe scope-three emissions will remain uncommon as a KPI, given the complexity of assessing and managing them.
Other areas, such as waste and water, could help broaden the market to entities that are less energy intensive. They have thus far been somewhat overlooked. However, they are highly relevant to the region. Gender equality, at 6 per cent, was the only social KPI among Asia-Pacific SLB issuance in 2022. This suggests some potential for diversification and growth in instruments with social KPIs.
While carbon will remain a central theme, diversification of KPIs would accelerate the expansion of the SLB market. Intermediaries and issuers will need to give more credence to these instruments, though, if this acceleration is to happen.
We believe the focus on reducing the carbon intensity of power generation in Asia will further support the supply of green bonds. The flexibility of sustainability-linked instruments could boost their growth, provided investors become more comfortable with their characteristics.
Local currency issuance could drive volume, even should cross-border markets remain volatile. In 2023, regulators focusing on climate-related disclosures and taxonomies will add transparency to the market.
In our opinion, this transparency should contribute to expansion in GSSSB issuance over the coming year.
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