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What’s driving this quarter’s record ESG bond issuance?

The global ESG bond market is on track to complete another impressive year in 2021, with large issue volumes and strong demand to date expected to continue.

According to Informa Global Markets (IGM) data, the volume of new environmental, social and governance (ESG) bonds issued in the primary market has continued to set new highs into 2021

At the recent IGM Credit Corner webinar, Michelle Kwek, head of research Asia at IGM, said ESG issuance volumes tracked by Informa Global Markets were still robust at US$192 billion globally. Though issuance fell over Q3, this was in line with global bond issuance and, as a percentage, ESG bond issuance has been rising consistently and is on track to end 2021 at a record level.

In Q3 2021, bonds with an ESG label represented a record 18% of total global issuance compared to 17% in the previous quarter, 12% in Q3 2020 and 4% in Q3 2019.

‘Although issuance fell, cover ratios stayed at around 4x, showing investor demand for ESG bonds remain solid,’ added Kwek.

Within ESG, green bonds remained the most popular in Q3, followed by sustainability and social bonds.

ESG bond issues were still mainly in Euros and US dollars, although other currencies have been catching up over 2021.

Also, until recently, ESG issuance was dominated by sovereigns, supranationals and agencies (SSA) but it has recently been more evenly spread between SSAs, corporates and finance.

Kwek said the UK initially stole the limelight in September, with its inaugural green gilt of $10 billion receiving over £100 billion demand coverage - a global record. However, in October, the debut NextGenerationEU (NGEU) green bond just surpassed this, at €12 billion and over €135 billion demand.

Despite the dominance of green bonds, Kwek said the biggest global growth in 2021 has been sustainability-linked bonds. IGM introduced SLBs as a separate new category in its database following the European Central Bank’s September 2020 decision to make SLBs eligible as collateral for its asset purchase programmes.

Regulation drives Europe boom

Euro-denominated ESG bond issuance continued its solid year-on-year growth, and the percentage of all Euro issuance remained around 25% in Q3.

Christopher Shiells, senior emerging markets analyst at IGM, said: ‘There was continuing interest in ESG in Europe, especially from banks. This was led by the EU’s clarification, in June, on criteria for what can be advertised as sustainable environmentally from 2022. That removed an obstacle for some green issuers.’

Shiells said IGM expects the trend towards SLBs to keep growing dramatically on the back of the ECB’s decision.

‘We expect green and SLB issuance will dominate in Europe,’ he said. ‘Social and sustainable bonds will be constrained by lack of EU eligibility criteria. The EU social taxonomy is still in draft.’

In Q3, demand in Europe remained strong with average cover around three times.

‘At the longer end of the curve, Euro rates have been stable and ECB purchases are continuing at full speed for the rest of the year,’ said Shiells. ‘This should continue to make conditions receptive for issuers.

‘ESG issuance in Europe will continue to be driven by government and regulation. Also, the COP26 summit focused attention on climate objectives. We expect corporates to increase issuance as more adopt ESG strategies.’

Is there a greenium in Europe?

Shiells said IGM expects the NGEU programme to take centre stage, contributing to an estimated €250bn of green bond issuance through to 2026.

‘The NGEU deal priced at mid-swaps -8 basis points, which starts to answer whether its green issuance will trade at a so-called greenium (premium for green issuance), and act as a barometer and steer for future green bonds in Europe,’ he said.

‘There is still huge subjectivity in this greenium debate. We viewed the pricing of the debut green bond as in line with non-green issuance. But an avalanche of these bonds is coming, so we will be able to gather more data and evidence.’

Looking at broader conditions since the end of Q3, issues are still happening despite some volatility in short-term bond markets, said Shiells. Demand has held up, but investors have exercised more pricing power due to higher yields, rising inflation, and expectations of reduced central bank support.

Corporate dollar ESG bonds surge

ESG related bond issuance in the US dollar market has been slower compared to Europe. In Q3, dollar deals accounted for around 10% of all issuance compared with around 2% in Q3 2019.

In the US, corporates overtook SSAs as the largest bond issuers in 2021.

Shankar Ramakrishnan, senior corporate bonds editor at IGM, said: ‘Many companies are motivated to invest in ESG related activities amid a growing perception that environmentally conscious companies will maintain strong corporate governance, and long-term sustainability.

‘Social and environmental factors have become essential for growth. Investors also favour the diversification these bonds bring and expect them to perform better as supply grows, improving market liquidity.

‘Companies also expect to be rewarded with a greenium. As acceptance grows, there are signs there will be exponential growth in ESG bonds and more interest from investors.’

Soaring growth in Asia Pacific

ESG bond issuance has seen spectacular growth in Asia Pacific (APAC) this year. So far, there has been US$62 billion of US dollar denominated issuance in APAC including Japan, compared to only US$19 billion in the whole of 2020.

In Q2 2020, ESG bonds represented only 2% of all issuance but that proportion has grown to 16%.

Kwek said: ‘There’s more room for upside momentum and we wouldn’t be surprised if the volume of ESG issuance nearly doubled in 2022 to around US$100 billion, ex Japan.

To date, China has been the main APAC issuer of ESG bonds, which are mainly green bonds green bonds. South Korea has been a big issuer of social bonds. However, we are also seeing more and more issuance of ESG bonds across the region due to greater adoption by issuers to meet their decarbonisation efforts with issuance from India leaping three-fold over Q3.’

In contrast to Europe, most issuers of ESG bonds are corporates, utilities, and finance.

The question of whether there is any price advantage or greenium attached to ESG bonds in APAC, like other regions, is unclear.’ said Kwek. ‘However, t from what we have seen, Asian US dollar denominated ESG bonds have generally outperformed their conventional peers this year, in part to the bonds being skewed towards more resilient banks and utilities. There is also relatively high bond holder stickiness noted amongst ESG bonds’

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