Summary of Global Green Bond in the Context of the Initiation of the Rate Reduction Cycle

[Certified ESG Analyst Insights Sharing] Delton Lau, CESGA

Green bonds have become a viable and quantifiable fixed income option for facilitating a significant shift in the energy landscape. The willingness to engage, foster open discussions, and exchange best practices positions the green bond market as an area that governments and policymakers globally are eager to support. Following a phase of satisfactory returns and minimal volatility, sustainable bond funds faced challenges during the period of elevated interest rates. However, with major central banks such as the Federal Reserve (FED) and the European Central Bank (ECB) beginning to lower rates, the future prospects are becoming more favorable.

l What Are Green Bonds & Sustainability-linked Bonds?

Green bonds are designed to generate funds specifically for the financing of new or existing projects that yield a beneficial effect on the environment. Such projects may encompass renewable energy, energy efficiency, waste management, sustainable transportation, and various other eco-friendly initiatives. In addition to green bonds, there exist other categories of sustainable bonds; for instance, social bonds are aimed at funding new projects and refinancing existing ones that have a positive social impact. These initiatives typically focus on assisting low-income, unemployed, or otherwise marginalized segments of the population.

On the other hand, sustainability-linked bonds (SLBs) possess structural characteristics, such as interest rates, that are contingent upon the attainment of sustainability objectives. Unlike green bonds, SLBs are not tied to the execution of a specific sustainability project. The funds raised through these bonds can be allocated for general purposes that align with a broader sustainability strategy, featuring measurable targets assessed annually. This category of bonds is considered the most versatile within the ESG fixed income market, as it may encompass environmental goals, social objectives, or a combination of both.

In 2023, approximately $870 billion in new sustainable bonds were issued globally, resulting in a total outstanding amount nearing a record $4.4 trillion by year-end, across more than 43,000 individual bonds worldwide, as reported by the non-profit Climate Bonds Initiative. (1)

l Recent Funds and ETFs Exposed to Sustainable Bonds

There are approximately 300 bond funds and exchange-traded funds (ETFs) in Europe are categorized under Article 9 of the Sustainable Finance Disclosure Regulation (SFDR), which was implemented in March 2021. These funds are characterized by their focus on a “clear sustainable objective” and are commonly referred to as “dark green” strategies. (2)

The significance of Europe was reaffirmed last year, as it emerged as the largest provider of sustainable debt instruments, with a total issuance of $405 billion, accounting for 46% of the overall total in 2023. In the initial four months of the year, these funds experienced net inflows of EUR 4.2 billion, reflecting an organic growth rate of 5.4%, surpassing the 3.3% growth rate of the broader category of Europe-domiciled fixed income funds. By the end of April, the assets under management in these funds reached EUR 75 billion.

As of July 2024 (3), Germany led the issuance by country, with $24.41 billion in issuance volumes during the April to June quarter, followed closely by France at $22.65 billion and Italy at $15.54 billion. The United States ranked fourth, concluding the quarter with $14.39 billion in green debt issuance. Europe maintained its position as the largest regional issuer of green bonds, with $91.76 billion in green debt issued during the quarter, significantly outpacing the $31.24 billion issued by entities in the Asia-Pacific region and the $20.01 billion from North American entities. However, Europe’s issuance in the second quarter decreased from $108.03 billion recorded in the first quarter.

l Latest outlook of Global Green Bond

Following the Federal Reserve (Fed) has kicked off the rate reduction in September. In light of the recent rising unemployment data and slowing down inflation trend, there is now an anticipation that the Fed may potentially lowering the federal funds rate to approximately 4.4% by the end of 2024. On the European front, the European Central Bank (ECB) has not indicated a definitive strategy for rate reductions following its initial cut in June. ECB President Christine Lagarde remarked that a decision in September remains “wide open,” noting that the risks to economic growth are “tilted to the downside.” She also indicated that inflation is expected to remain at current levels for the remainder of the year before decreasing in the latter half of 2025. The interplay of robust wage growth and subdued productivity in the Eurozone suggests that services inflation will likely stay elevated throughout most of this year. The recent uptick in growth momentum diminishes the immediate need for rate cuts. It is anticipated that the ECB will reduce the benchmark rate to 3% or below at the end of 2024. Europe, which accounted for nearly half of all global green bond issuances in 2023, is at the forefront of this recovery, as recent fund flow data indicates a resurgence of investor interest in this asset class.

The IMF eLibrary indicates that green bonds exhibit a longer average maturity compared to conventional bonds, with green bonds averaging 17 years and conventional bonds averaging 12.2 years (4). This trend supports the notion that green bonds can assist countries in extending the maturity profiles of their debt. The extended maturity aligns with the long-term return expectations associated with green investments. Given that green bonds typically possess a higher duration, they are more sensitive to fluctuations in interest rates. While this sensitivity can pose challenges during periods of rising rates, it can also yield advantages when rates decline. The green bond market is anticipated to continue its growth, primarily driven by institutional investors. Furthermore, the introduction of new standards for green bond issuance in the region, set to take effect in January 2025, is expected to enhance market transparency, comparability, and credibility, thereby facilitating the evaluation of issuers’ environmental, social, and governance practices. These new regulations mandate that at least 85% of deals align with the EU’s green taxonomy.

Nevertheless, the green bond market may encounter certain obstacles. Should Donald Trump secure victory in the upcoming US presidential election, some analysts speculate that he might withdraw the United States from the Paris Agreement on climate change. Additionally, investors must remain vigilant regarding the quality of each issuance and be cautious of marketing claims. A focus on selectivity and transparency is essential to ensure that the most relevant and impactful green projects receive adequate funding. As the market is still developing and grappling with issues of greenwashing, thorough research on issuers is vital for investors. Morningstar ratings provide valuable insights into the historical performance of these strategies (Star Rating) and offer projections on their future performance (Medalist Rating) in comparison to their category peers.

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Article is written by EFFAS Certified Environmental, Social, and Governance Analyst (CESGA). CESGA is highly recognized in Europe and globally which has been steadily increasing in the worldwide. If interested in enrolling, please refer to https://bit.ly/3tFUQ1M

Published by foehk@foe.org.hk