IFR Asia: Let’s get started with an overview. Dafei, China is the biggest financing market in Asia, but what’s the size of the ESG component?
Dafei Huang: The ESG financing market has come a very long way since its launch in 2016. So far, the main focus has been on green finance and, in terms of instruments, green credit accounts for about 90% of China’s entire ESG finance landscape.
By the end of 2021, the outstanding balance of green loans had risen to more than Rmb15trn (approximately US$2trn), and green bonds outstanding were about Rmb1.1trn (US$165bn).
Last year alone, just over US$90bn-equivalent of green bonds were issued, representing a near 180% increase in issuance from the previous year.
On top of that, considering the 2030 emission peak and 2060 carbon zero goal announced by the Chinese president, last year the regulator launched new green debt instruments, such as carbon neutrality bonds and sustainability-linked bonds (SLB). Both types of instruments have found traction.
The introduction of a new variety of themed tools is a good thing for the market’s development and we expect the ESG market to grow to meet the huge investment needed to reach the carbon neutrality goal.
IFR Asia: Let’s look at India, the other huge market in the region. Harsha, how has ESG policy in India evolved in recent years?
Harsha Bangari: From a macro perspective, India has committed to achieve net zero by 2070 and, based on that estimate, this would require investment to the tune of US$10trn. It’s a huge amount.
In terms of policy, India has made noteworthy progress in strengthening the sustainable regulatory environment and has placed emphasis on all three pillars of development: economic, social and environmental.
Broadly, policies have been categorised as those for banks and financial institutions and those for corporates – there is a regulator for banks and financial institutions
The market is evolving. As early as 2007, guidance notes were issued around sustainable finance for banks and financial institutions. This was also followed by RBI’s decision to include lending to social infrastructure and small renewable energy projects within the priority sector lending targets.
It is a similar story in the corporate sector where the Ministry of Corporate Affairs published corporate responsibility and voluntary guidelines in 2009, but now requires a non-financial disclosure in annual accounts. Sustainability-related reporting requirements are now in place for the top 1,000 listed companies by market capitalisation.
The market is evolving. It started from the regulator providing guidance, moved to voluntary, and going forward it is likely to become mandatory for the corporate sector as well as financial institutions to start reporting on ESG.
IFR Asia: Daming, how do different types of ESG instruments suit different kinds of issuers and industries?
Daming Cheng: As the largest type of ESG bonds, green bonds are particularly important. A green bond plays several roles for issuers. Firstly, it provides funding for qualified investments in specified green projects such as infrastructure or clean energy. Secondly, it can provide cheaper financing – something we’ve seen this year. And thirdly, green bonds play a role as the verifiable conduit for the flow of the funds from the capital market to qualified projects.
In 2021, we have seen Rmb600bn of Green Bonds issued in the Chinese market by power companies, by steel companies, by a lot of issuers.
To achieve a sustainable development of the economy, the Chinese government has already mandated 45 government agencies to integrate sustainability development goals into specific economic tasks in the economic, social and environmental fields.
The market is starting to function. For example, the Asian Infrastructure Investment Bank – one of the most important multilateral development agencies, issued Rmb1.5bn of sustainability bonds in the Chinese bond market using its own framework. Many issuers from major industries, like clean energy, including wind, solar and hydropower, and the Chinese Big 5 power suppliers, have also issued this type of bond.
Even mining companies, like Shaanxi Coal and Chemical Industry, have issued SLBs, linking their energy consumption efficiency to the bond. Cement manufacturers and steel companies are also looking to use SLBs to reduce their greenhouse gas emissions.
Also, to coincide with the adoption of carbon neutrality goals, we will start to see SLBs linked to carbon neutrality being issued by the likes of state-owned enterprises (SOE).
IFR Asia: Edmund, what are you seeing in terms of issuers picking the structure that’s right for them?
Edmund Leong: There’s an increasingly wide range of ESG products for the issuer to choose.
For issuers, we advise the client to look at bonds that have specific ‘use of proceeds’, namely dedicated green and sustainability bonds. If borrowers have a specific ESG project to finance, then those instruments are the right choice. SLBs are a lot more flexible from the use of proceeds standpoint. The instrument is useful for companies linking funding costs to achieving an overall sustainability goal.
For the investor, an increasing number of products reflects the natural development of a growing market. A wider choice of instruments allows investors to better calibrate their ESG investment approach.
IFR Asia: How did Sembcorp decide which kind of ESG instrument to use?
Eugene Cheng: At Sembcorp, we set ourselves a transformation plan starting in 2021 by reshaping our strategy, focusing on transitioning our portfolio from brown to green. That entails growing our renewables portfolio significantly, from 2.5GW in 2021 to 10GW, and decarbonising our portfolio by reducing our carbon emissions intensity from 0.54 to 0.40 tonnes of carbon dioxide per megawatt hour (tCO2e/MWh) by 2025.
If we say that we are committed to decarbonisation as well as the renewables transformation strategy that underpins the very heart of our business, our financing strategy must also be aligned. As a result, we made the decision to finance our growth and transition out of ESG sources – SLBs as well as green instruments.
We use green bonds and loans for funding project costs, the equity contribution into greenfield projects or acquisitions of any portfolios of renewable businesses.
At the other end of the spectrum, we still need liquidity to support the day-to-day running of the business. In addition, when developing greenfield projects and acquisitions, we might need access to quick liquidity and, in those situations, we usually use sustainability-linked instruments. Most recently, we secured a S$1.2bn (US$869m) sustainability-linked revolving credit facility.
For sustainability-linked instruments, we have sustainability performance targets (SPT) which forms part of our strategy. If we do not meet those targets by 2025, we expect to pay a 25bp step-up in the interest rate.
We have noticed that investors look positively on our strong commitment to these targets.
IFR Asia: Harsha, India Exim has been in the ESG financing business for many years – one of the first in Asia. Can you describe your journey and explain how you decide which kind of instruments to issue?
Harsha Bangari: We’re agnostic to the type of instrument we issue; it all depends on market appetite or investor appetite. It’s also important for us to map the requirements of the investors with the assets we have. As an export credit agency, we participate in the medium to long-term borrowing market. As a result, bonds make up a large proportion of our borrowing programme.
We issued our first green bond in March 2015, and it was very well received in the market. Subsequently we have dabbled with some green private placements where we have issued India’s first socially responsible bond. Proceeds from this issue were used by the bank to fund infrastructure projects in the Mekong region. It’s an example of how we marry the requirements of investors with the end use of the funds.
Something we have done as a bank is we have tried to make our thinking more transparent. We have set up an ESG framework to issue green, social or sustainable bonds, and the framework has been confirmed as credible and impactful by a second party opinion provider. Our ESG framework is aligned with all the ICMA bond principles.
The framework covers six green categories: renewable energy, sustainable water and wastewater management, pollution prevention, clean transportation, green buildings, and energy efficiency. We also cover four social areas: access to essential services and basic infrastructure, food security and sustainable food systems, MSME financing and affordable housing. Of course in India, the Ministry of Small & Medium Enterprises (MSME) plays a big role in the economy, so we are also involved in MSME financing and financing affordable housing.
In terms of ESG instruments, we’ve found the bond markets to be most amenable, but I hope the loan markets will catch up soon.
We have also realised that having a framework in place really helps us in our negotiations and bilateral discussions with the multilateral agencies. The framework shows our commitment to sustainability financing and that strikes the right note with the multilateral world.
IFR Asia: Dafei, what are the opportunities in the China market in terms of transition financing – for companies or issuers that are not quite green yet but that want to reduce their impact?
Dafei Huang: Transition financing will be a massive market.
At the moment green finance focuses on green projects, focuses on renewable energy, low carbon transportation, green buildings, etc. However, heavy industry is not properly covered for two reasons.
One is the limitations placed on the use of proceeds for a green bond. That means carbon intensive industries have been unable to use this kind of financing to upgrade their operations.
We can’t overlook this issue.
China’s carbon intensive industry is responsible for over 80% of total carbon emissions, so decarbonising this industry is critical if China is to meet its net-zero goal. And this will require a significant amount of investment.
Taking the steel industry as an example, Climate Bonds Initiative estimates that for the industry to decarbonise in China, it requires about Rmb20trn of investment – the annual equivalent of around Rmb500bn.
Transition finance can effectively serve these industries and cover their needs. SLBs have been very good in providing some flexibility for these industries to tap into, but transition bonds will take support for the process to a whole new level.
This year the regulator launched a transition bond pilot in China. It’s extremely exciting. It covers four core elements: use of proceeds, information disclosure, third party certification and fund management. It’s a remarkable milestone, but there are still some technical gaps to fill before we see a vibrant transitional bond market take off.
At the moment, decarbonisation pathways are only being developed at the sector level and intermediate emission targets are only being set at the industry level. Most companies have not yet produced their own decarbonisation plan. There is still some understanding to be developed.
Looking ahead, companies and financial institutions need better guidance and standards to be set in terms of information disclosure. Financial institutions need better technical guidance to identify transition activity to ensure that their investments do not go to the wrong type of activity. And, given the size of the investment required and the need to attract international investors, decarbonisation pathways and targets, both at the industry level and the company level, must be Paris-aligned. This will provide international investors with the confidence they need to manage the risk of greenwashing and support the healthy development of the whole transition finance market.
IFR Asia: I’d like to ask two corporates about the benefits they found from issuing ESG transactions. Julian, what impact did you see from issuing ESG and did you attract different kinds of investors?
Julian Lee: We did. The US$4bn bonds that we issued earlier this year were divided into four tranches. We spent time to deliberate which tranche should be green before deciding that the five-year was the most suitable. That tranche performed very well. It was the most popular of all the tranches, with most of the allocation going to green investors.
The deal was launched into a tough market – the rates market had been volatile throughout the year, but we managed to get a good outcome. The timing was good, and we achieved reasonably low rates.
The green tranche was a principal factor in cementing the overall deal’s success.
If you consider carefully how to use the green tranche as part of your financing strategy, and think about how to maximise demand, then I reckon you will see a benefit across the whole financial strategy.
IFR Asia: Eugene, what benefits have you seen from issuing your sustainability-linked bond?
Eugene Cheng: For Sembcorp, the benefits are broadly in line with Julian’s experience. It broadened our investor reach. In the first tranche of green bonds we issued in June last year, we saw some less traditional names coming into the deal, including school pension funds, governmental agencies and more ESG-focused European funds.
For our SLB from October last year, we were very privileged to be supported by the International Finance Corporation, which anchored S$150m of the offering. That ultimately created confidence in the issue and drew in additional demand.
The other benefit is that we were able to issue very long tenors at competitive rates. Investors appreciated the strategies the bond was funding – building renewables and driving transition.
Issuing bonds in this format, linked to the firm’s overall strategy, allows us to lengthen the tenor of our issuance, attracts European ESG investors and ultimately reduces costs.
For example, we were delighted to see a ‘greenium’ when we issued our inaugural green bonds. The pricing advantage of these instruments was also evident when we launched our second SLB earlier this year into a tough market.
IFR Asia: Daming, are you seeing a comparable price advantage in the Chinese market?
Daming Cheng: Yes, exactly. When we were asked that question a couple of years ago, our honest answer would have been: “It’s hard to say. And at least there is no price disadvantage.”
But now we see a material advantage in financing costs for green bonds compared to regular bonds and that is thanks to the incentives provided by the Chinese financial regulators, namely the People’s Bank of China, the central bank of China.
The PBoC has encouraged Chinese financial institutions and investors to allocate more of their assets to the green sector: green assets, and in particular green bonds and loans. And with these green assets, institutions and banks enjoy extra regulatory benefits. So, because of these incentives we are seeing the investor base for green bonds grow. As a result, green bonds recently issued in the Chinese market – particularly investment grade – have been vigorously chased by investors resulting in a price advantage of somewhere between 5bp and 20bp to conventional deals.
IFR Asia: Alvin, what advantages do you see for issuers, whether it’s pricing or something else?
Alvin Yeo: Clearly pricing is one of them. Issuers are becoming increasingly smart about aligning ESG strategies at the corporate level when pursuing sustainable finance and the benefits are filtering down to transaction outcomes.
In the Airport Authority’s case, they were able to use the green tranche to the benefit of lowering the overall financing cost of what was a large transaction. And in Sembcorp’s case, they managed to bring in a very strategic investor which helped them on the deal’s ESG structure as well as helping them to secure a longer tenor for it and reduce its financing costs.
We are also seeing investors become very vocal about what structures they like. And when they do like it, they buy it, which translates into a benefit to the borrower. It helps with the overall execution.
In the secondary market, at least in the offshore US dollar bond market, there is increasing quantitative evidence to suggest that an issuer’s green bonds trade tighter than their conventional bonds. This translates into a pricing benefit in the primary market.
There are some other tangible benefits to borrowers from issuing green instruments. Some regulators, for instance, have developed schemes and subsidies as an incentive to launch green products. The Hong Kong Monetary Authority, for example, has the Green and Sustainable Finance Grant Scheme that has helped first time issuers cover some of the transaction expenses of bond issuance.
IFR Asia: Edmund, do you see any ‘buzz’ points for issuers in ESG finance?
Edmund Leong: I share the same views as Alvin and Daming, although the extent of any benefit from issuing green bonds is still going to be very dependent on prevailing market dynamics at the point of pricing. For Sembcorp, having a strategic investor like IFC will always provide pricing tension during the bookbuilding process.
There are non-financial benefits for issuers. For example, SLBs communicate targets set for internal operations to investors – how the company is improving its energy efficiency, the way it deals with waste disposal of a factory or manufacturing operation, and its performance against social issues such as employee safety.
This is important not just to investors but to all company stakeholders.
IFR Asia: You don’t get these benefits without doing a lot of work. So, Julian, how much work goes into an ESG issue? Not just at the time of issue but afterwards.
Julian Lee: Planning took almost a year, but we are fortunate to have a supportive sustainability department. The hard part is how to sync up the market need with our own corporate strategy and doing it in a dynamic manner.
We spent time to work on our framework and then the second party opinion provider, as it takes time to give their opinion. You need to do all the preparation and planning needs to be very deliberate.
But the dynamic part is when you come to market. For example, in our US$4bn deal, we initially thought the green tranche should be small – US$500m. But, by then, we were faced with increasing interest rates and volatility and, given the extent of our green assets, we decided to increase the tranche to US$1bn.
That decision helped us in raising the full US$4bn and in ensuring success with the other 10, 30 and 40-year tranches. Having a strong, well-priced five-year green bond allowed us to price through the curve out to the 40-year bond as well.
Reckoning with market dynamics, working on the corporate strategy and consulting with advisers and investors helps you decide the best way of achieving your financing target.
Yes, a lot of work goes into it. But I think the ability to issue a bond into a tough market makes all that work worthwhile.
IFR Asia: Eugene, at Sembcorp how much work went into disclosures and reporting?
Eugene Cheng: When we talk about disclosures and reporting around the issuance of green or sustainability-linked financing instruments, there isn’t much incremental work that needs doing. Once the sustainable financing framework is in place then the disclosure documentation is standard.
We have a robust sustainability report, disclosing our climate as well as social and governance performance, which is aligned with Global Reporting Initiative standards.
The game changer for us was developing a transition strategy and setting hard targets behind it. We said that by 2025, we would increase our renewables generation to 10GW from 2.5GW, reduce our carbon emissions from 0.54 tonnes of carbon dioxide emissions per megawatt hour, to 0.4 tCO2e/MWh and, by 2030, reduce Scope 1 and 2 greenhouse gas (GHG) emissions to 2.7 million tCO2e, which represents a 90% reduction from the 2020 baseline.
All these strategic targets form the sustainability performance targets in the financing frameworks and are also tied to executive compensation.
Being comfortable disclosing these targets gives investors the confidence that whatever we claim for our green and sustainability-linked instruments are underpinned by clear objectives, forms part of our remuneration and ensures that the entire organisation is focused on fulfilling the objectives that are being financed.
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