ESG debt issuance holds up in emerging markets

Rising global interest rates and market volatility have weighed heavily on the supply and demand for bonds, especially from emerging markets.  In fact, the annual issuance volume has decreased slightly among emerging market sovereign issuers and sharply among supranational institutions.  On has to keep in mind that in 2021 bonds were issued to pay for the pandemic measures, now a less pressing need.

But extreme weather events, as recent heat waves and wildfires, keep climate change and the environment on the agenda of priorities around the world.  So we expect the growth of ESG labelled bonds (environmental, social and governance) in emerging markets to continue.  In fact, a study by Pictet AM and the Institute of International Finance suggests the annual issuance of ESG-labelled bonds in emerging markets could reach $360 billion by 2023, helping emerging economies to generate more capital towards United Nations Sustainable Development Goals by 2030.  The growth in this market fosters sustainable reforms and ultimately improves sovereign fundamentals.  In fact, the ESG bond segment has remained surprisingly resilient, paving the way for this asset class development.

Thus, in the first half of 2022, emerging market borrowers have issued 81.9 billion dollars in ESG bonds, 2% more than in the same period of 2021, in contrast to the emerging market fixed income universe, were issuance has fallen 48%, although local Asian currency has increased almost a quarter.  On the other hand, in this period, globally, debt issuance has come down 14% to 4.8 trillion, according to Refinitiv.  It should be noted that ESG-labelled bonds with investment grade credit ratings are particularly popular issuers, accounting for more than half of such issuance the first six months of 2022.

Specifically, emerging market corporate borrowers issued around 40% more ESG-labelled bonds the first half of the year than in the same period in 2021, totalling €56 billion, mainly financial and energy companies (54% and 7%), although the trend has widened to industrial, utilities and cyclical consumer companies. Currently, following strong issuance of last two years, ESG corporate bonds represent around 7.5% of JP Morgan's Corporate Emerging Market Bond Index (CEMBI).

As for sovereign issuers, volume of ESG issuance has decreased slightly in one year, drastically among supranational issuers.  It may be related to the pandemic, as by 2021, both countries and supranational institutions issued bonds to help pay anti-Covid measures and their effects, currently a less pressing need.  Specifically, issuance of sovereign bonds linked to social objectives has fallen sharply in relation to 2021, although green bonds have increased by almost 12% and those linked to sustainability 40%.  Chile remains one of the leaders in ESG sovereign debt, having issued green, social and sustainable bonds, an example of issuer with a focus.  We hope it will continue to reduce its carbon emissions. Some of its ESG issuance have been in local currency, in contrast to most of the rest, in dollars or euros.  It can be an interesting area of growth.

Also, emerging markets have more work to do in terms of ESG than developed ones, one of the reasons why investors have particularly welcome their issuance. Sometimes this debt benefits from investors being willingness to pay a premium, 'greenium', for such bonds, which means lower borrowing costs.  In addition, these bonds can offer yields comparable to those of high-yield developed-market debt for significantly lower credit risk, something particularly attractive given the market volatility and rising interest rates.  Perhaps, as a result of the expansion of this universe, the 'greenium' has decreased, although varies according to sector and issuer.  It is usually lower where there is more supply of ESG bonds, as between Korean utilities or Chinese financial firms. In other areas with limited options, as Indonesian green sukuk bonds, this premium can be high and persistent.

However, not all ESG bonds are the same and strict controls are needed.  Third-party supervision is very important, but investors are still obliged to do their own job assessing the credibility of sustainable bonds, as with any bond.   In addition, we should actively engage with emerging market issuers to foster a strong ESG bond issuance framework, which as investors, provides us with a better view of governments' policy priorities and reform objectives, even if issuance does not materialize, as it improves accountability, transparency and reporting,  which helps to create a virtuous circle.