More EM sovereigns target ESG-labelled bonds in 2022
More emerging market sovereigns raised ESG-labelled bonds in 2021 despite an overall drop in EM sovereign issuance to US$145bn from US$200bn in 2020, according to research by the Institute of International Finance.
EM sovereigns issued US$23bn of ESG-labelled bonds last year, more than three times the US$7.3bn issued in 2020, and reached a record share of 15% of total EM sovereign issuance, up from 3% in 2020. Volume is expected to continue to increase this year, due to strong investor demand and countries’ growing need to attract ESG funding, according to the IIF.
Emerging markets are at greatest risk of climate change as increasing physical risks from higher temperatures and more extreme weather are impacting economic activity and public finances and could prompt sovereign debt downgrades and produce higher borrowing costs, according to a report by Fitch. It found that countries in Asia and Latin America are most exposed to climate-related natural disasters, while Middle Eastern countries are at risk of extreme high temperatures.
ESG issues are set to dominate the international policy agenda and the IIF expects ESG-labelled deals to hit US$40bn in 2022. This will be around 25% of the US$150bn–$160bn of total projected EM sovereign bonds, and will equal the US$40bn total of ESG-labelled bonds that EM sovereigns have raised since 2015.
Chile raised only ESG-labelled bonds in 2021 and is the largest ESG EM sovereign issuer to date, followed by Peru and Poland. Since late 2015, 12 EM sovereigns have raised ESG-labelled bonds, with 51% of issuance in euros, 48% in US dollars, and less than 1% in yen.
Green bond slowdown
EM sovereigns continue to show a preference for social bonds and sustainable bonds (a mix of green and social) over green bonds, which fell for the second year in a row to US$1.2bn from US$5.5bn in 2020 as social and sustainability issuance rose during the Covid-19 pandemic.
Thirteen green bonds totalling US$15.4bn have been issued since 2016 by countries including Chile, Poland, Hungary, Serbia, and Egypt, with a lower average coupon of 1.90% compared with 4.30% for non-ESG bonds and a longer average maturity of 13 years compared with 12 years for conventional deals, according to the research.
Sovereign social bond issuance rose to US$12bn in 2021, showing a strong increase from around US$1bn in 2020 as social factors like living wages and gender equality drew increased investor interest, although human rights continue to be a sticking point for many ESG investors. Chile, Guatemala, Ecuador, and Peru have issued around 10 social bonds in the last two years, with an average coupon rate of 2.70% and an average maturity of 18 years.
EM sovereigns issued a total US$10bn of sustainable deals in 2021, showing a similarly strong rise from US$0.8bn in 2020. Indonesia, Mexico, Chile, Peru, Malaysia (a sustainable sukuk), and Benin have issued nine sustainable bonds totalling US$11bn to date, with an average coupon of 2.80% and the average maturity of 21 years.
There has been no sovereign sustainability-linked bond issuance in international markets to date, despite early soundings from Chile and Uruguay, although the World Bank has proposed creating a global body to support the development and assessment of sovereign SLBs amid rising interest as governments seek to tackle high debt levels, climate change, and nature loss.
Governments are facing intensifying pressure to channel more resources towards ESG and improve debt and fiscal transparency to ensure continued access to affordable ESG financing from international investors. Many EM sovereigns lack reliable and consistent ESG reporting and are expected to prioritise climate and environmental issues in their debt management and investor relations in 2022, which should further boost ESG-labelled sovereign EM bond issuance.