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An outlook for the sustainable bond market


In this article:

    After a muted year for sustainable bonds in 2022, there are indications that the outlook for 2023 is more upbeat. Malika Takhtayeva and Xuan Sheng Ou Yong discuss what the future might look like for corporate and sovereign use-of-proceeds bonds.  

    In recent years, the market for sustainable use-of-proceeds bonds has grown significantly – annual issuance of green, social and sustainable (GSS) bonds rose from USD 95 billion in 2018 to USD 735 billion in 2021, according to Bloomberg data.

    However, the sustainable labelled bond industry had a difficult 2022 amid broader macroeconomic issues, causing annual issuance of GSS bonds to fall to USD 572 billion.

    The energy crisis, COVID-19 pandemic and last year’s interest rate rises have created a challenging macroeconomic environment which has been exacerbated by the war in Ukraine. This has led to a major sell-off across bonds and equities – it has been estimated that stock and bond markets lost around USD 30 trillion in value in 2022.

    While the fixed income market as a whole suffered last year, the sustainable labelled segment dealt better with the downturn: In the first three quarters of 2022, sustainable labelled bond issuance accounted for 20.8% of total bond issuance in Europe, up from 19.9% in 2021, according to the Association for Financial Markets in Europe (AFME).

    As inflation subsides and the pace of interest rate rises moderates in the course of 2023, we expect the outlook for sustainable labelled bonds to improve.

    Sovereign issues on the rise

    The Sharm El-Sheikh Implementation Plan launched at last year’s COP27 meeting includes an estimate that the transition to a low-carbon global economy to fight climate change would need investments totalling at least USD 4-6 trillion per year.

    According to the UN, the transition will require central banks, commercial banks, institutional investors and governments to act rapidly to address the lack of funding. Sovereign GSS bonds are expected to play a large role in plugging this financing gap.

    COP27 saw a number of countries updating their nationally determined contributions (NDCs) – plans by individual countries to reduce national emissions and adapt to the impact of climate change. We believe financial tools including GSS bonds can go a long way towards meetings these targets.

    January 2023 already saw a string of sovereign GSS bond issues by Hong Kong, Slovenia, Ireland and the Philippines. Hong Kong raised USD 5.75 billion in the largest sustainable labelled bond ever issued in Asia, while Slovenia collected around USD 1.35 billion. India raised about USD 1 billion with its first sovereign green bond. The issue was largely picked up by local banks and insurance firms.

    A 2022 Moody’s report on the challenges emerging markets may face in achieving a ‘just transition’ emphasised the role sustainable labelled bonds can play in funding the gap between current government budgets and projected just transition costs. It noted emerging market governments accounted for 16% of total sustainable labelled sovereign issuance in 2022, up from just 1% in 2017.

    Countries including Thailand, Malaysia, Brazil and Columbia have been developing sustainable finance taxonomies. These classification tools can help provide guidance, frameworks and standards for investors and so increase the flow of capital towards green projects and facilitate the development of innovative investment products such as sustainable bonds.

    Corporate bonds for energy security

    As the energy transition gains traction, there are many opportunities for companies to use GSS bonds to help raise the capital needed, particularly in carbon-intensive sectors.

    The energy, building and transport sectors are large use-of-proceeds bond issuers. For example, Dutch-German grid operator Tennet launched a EUR 3 billion green bond last October for its onshore grid to increase the transmission of renewable energy.

    As part of efforts to decarbonise its corporate bond portfolio, the European Central Bank has said it would give green bonds preferential treatment in its primary market. If other central banks were to take a similar stance, this could encourage companies to issue more green bonds.

    Moody’s has said that the energy crisis has increased the prospect of greater long-term sustainable debt issuance to finance Europe’s energy transition as the region seeks to move away from reliance on Russian fossil fuels. To accelerate such a shift, significant amounts will need to be invested in infrastructure. Much of this could be financed with sustainable bonds, Moody’s said.

    Evolving regulatory landscape  

    Over the past few years, there has been extensive progress in developing standards for the GSS bond market. The leading set of standards are the Green, Social and Sustainability Bond Principles by the International Capital Markets Association. These guide issuers on how to select the right projects and set standards on post-issuance compliance and reporting.

    The European Commission has devised a European Green Bond Standard (EUGBS). Although currently voluntary, it could become mandatory for issuers in the future. Additionally, the Climate Bonds Initiative has published the Climate Bond Standard, which outlines international best practices for labelling green investments.

    More regulators are working on defining green bonds. The China Securities Regulatory Commission has introduced  green bond principles to unify the country’s domestic market. The principles reference ICMA standards. Like the ICMA framework, they provide four core components: use of proceeds, project evaluation and selection, management of proceeds and duration of information disclosure.

    Sustainable Fitch said China’s requirements on working capital are unclear since they do not specify the types of working capital and the amount of proceeds that can be used to repay an issuer’s debt.

    Last month, the Securities and Exchange Board of India approved a stronger framework for green bonds that introduced the concept of green bonds and specified the basic dos and don’ts in relation to green debt.

    As standards develop and investor confidence increases, the market for sustainable bonds can be expected to continue. Stable macroeconomic conditions would also help.


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.

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