Asian ESG debt markets take a breath after record run

Although ESG and green debt activity in Asia may have slowed somewhat in 2022, it is now an established feature of the market

Following the substantial debt activity in the Asia-Pacific (APAC) region in 2021, a slowdown was to be expected for 2022, and yet, the region fared better than many others. For example, by the end of 2022, leveraged and non-leveraged loan issuance in APAC (excl. Japan) was down just 17% year-on-year, despite the fact that Q4 2022 was one of the lowest quarters for issuance in the region on Debtwire Par record.

Asian ESG (environmental, social and governance) and green finance issuance held just as strong against the rising headwinds. Sustainability-linked financings may have trailed the record-setting pace of 2021, but, by the end of 2022, it was clear that they are now a core part of the region’s debt markets.

Green and ESG-labeled debt has experienced transformative growth in APAC in the past three years in particular, evolving from a nascent relatively niche offering to a mainstream feature of loan and bond activity.

In 2021, issuance of green and ESG high yield bonds and syndicated and club loans surged to an all-time high of US$97.7 billion in APAC, according to Debtwire Par, as issuers responded to soaring institutional and retail investor demand for investment opportunities tethered to ESG and green outcomes.

According to Debtwire Par, this surge in activity marks a five-fold increase in issuance levels observed in 2020 (US$19.6 billion). The US$92 billion in issuance for 2022 remains substantially higher than pre-pandemic levels, with the market consolidating a significant portion of the huge gains made in 2021.

Synergies promoting increased demand

Investor appetite for green and ESG-labeled debt is being driven by a growing recognition that strong financial performance and best practice in areas such as climate change, environmental stewardship, and employee health and welfare, among others, are mutually beneficial.

In addition to growth in the traditional “use of proceeds” green and ESG finance market, where debt is made available only for specific projects that meet certain green, social or other sustainable criteria, the emergence of sustainability-linked debt facilities has provided a broader range of borrowers and issuers the opportunity to raise funds through loans and bonds with an ESG overlay.

Sustainability-linked debt packages specify a set of ESG key performance indicators (KPIs) that can be connected to various targets, including everything from emissions reduction to employee diversity. If KPIs are achieved, borrowers typically receive discounts on interest rate margins. If targets are missed, interest rate margins typically ratchet up, with the degree of such discounts and ratcheting dependent on whether the KPIs are achieved or missed.

Unlike traditional green loans (or bonds) where proceeds of the financings are to be used exclusively for recognized green projects, there are no such restrictions on how proceeds from sustainability-linked financing can be used. This has allowed companies across various sectors greater flexibility to raise funds through the debt markets while still linking their capital raising plans with ESG objectives, thus, significantly expanding the pool of borrowers and issuers as well as attracting demand from ESG-minded investors.

As momentum has grown, APAC borrowers have been able to secure substantial ESG-financing packages across a variety of loan types. In the past 12 months, Hong Kong-listed agrochemicals company Syngenta has secured a US$4.5 billion three-year syndicated sustainability-linked loan and real estate investment trust Link landed the largest sustainability-linked loan in the Asian real estate industry with a HK$12 billion raise.

Issuance cools

Despite headline deals like these, activity levels cooled somewhat as 2022 progressed, with the ESG space tracking the slowdown seen in the broader debt issuance and economic growth across the region.

Green loan and bond issuance has been particularly impacted by wider market headwinds, and, in the sustainability-linked space, lenders have scaled back deployment after a frenetic period of activity. Lenders have taken the opportunity to assess sustainability-linked portfolios and re-examine the frameworks used to evaluate and measure the validity of ESG claims made by borrowers.

As has been the case in the US and Europe, an initial wave of enthusiasm among sustainability-conscious investors was a key driver of the spike in sustainability-linked debt issuance in 2021. However, as debt markets have slowed in 2022, lenders have had more time to scrutinize how ESG KPIs are set and measured, and demanded more rigorous reporting from borrowers on ESG performance.

Banks in the region have expressed concerns around transparency because issuers are not obliged to make public their targets or performance against KPIs. They also called for more standardization around what constitutes a meaningful target and how they are calculated.

Positive outlook

While slower economic growth and concerns around greenwashing posed challenges for sustainable finance in APAC, the market held up well in 2022 and is taking steps to tighten up standards. The dip in ESG “labeled” debt financings has been smaller than the drop in overall high yield bond and loan activity, with ESG-related financing accounting for a growing proportion of lending in the region.

Asian sustainable debt issuance has proven more resilient than mainstream debt markets despite macroeconomic and geopolitical headwinds. Investor appetite for sustainable (particularly green) debt remains strong, and with the key Chinese market—which has accounted for almost half of all APAC ESG debt issuance in the past five years according to Debtwire Par—subject to ambitious government pledges to reach peak carbon emissions by 2030 and carbon neutral by 2060, banks and capital markets will have to pull every lever available to them to fund the transition to net zero.

Outside of China, APAC has also seen growth in debt linked to social rather than just environmental outcomes. Debtwire Par reports that South Korea and Japan have led the way, driving an uptick in socially linked financing in 2022.

The Asian market has also made progress on efforts to foster more uniformity and comparability in ESG labeling standards adopted by sustainable finance transactions in the region. For example, the relatively recent publication in China of the China Green Bond Principles, which are designed to be substantially aligned with the ICMA Green Bond Principles, and the Sustainability Linked Loan Principles, published by the Asia Pacific Loan Market Association, in partnership with the Loan Market Association and the Loan Syndications and Trading Association, provide issuers and lenders with guidelines to help promote consistent best practices for structuring and executing these transactions.

Asian borrowers and issuers, as well as investors, are increasingly adapting their fundraising, lending and investment criteria and strategies to align with such ESG principles.

ESG and green debt issuance may have cooled toward the end of 2022, but the market has used that lull in activity to build a more stable and credible foundation.

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