REPORT Emerging Market Green Bonds IFC-Amundi Joint Report JULY 2023 EMERGING MARKET GREEN BONDS Page ii About IFC About Amundi IFC — a member of the World Bank Group — is the largest Amundi, the leading European asset manager, ranking global development institution focused on the private among the top 10 global players, offers its 100 million sector in emerging markets. We work in more than 100 clients—retail, institutional and corporate—a complete range countries, using our capital, expertise, and influence to of savings and investment solutions in active and passive create markets and opportunities in developing countries. management, in traditional or real assets. This offering is In fiscal year 2022, IFC committed a record $32.8 billion to enhanced with IT tools and services to cover the entire private companies and financial institutions in developing savings value chain. A subsidiary of the Crédit Agricole group countries, leveraging the power of the private sector to end and listed on the stock exchange, Amundi currently manages extreme poverty and boost shared prosperity as economies more than €1.9 trillion of assets. With its six international grapple with the impacts of global compounding crises. For investment hubs, financial and extra-financial research more information, visit www.ifc.org. capabilities and long-standing commitment to responsible investment, Amundi is a key player in the asset management landscape. Amundi clients benefit from the expertise and advice of 5,400 employees in 35 countries. Emerging Market Green Bonds IFC-Amundi Joint Report EMERGING MARKET GREEN BONDS Page 2 Acknowledgments This report was prepared under the guidance of IFC’s Susan Lund, Vice President of Economics and Private Sector Development, and Jean Pierre Lacombe, Director, Global Macro and Market Research. José Abad, also at IFC, was the lead author. Working team members from Amundi included Quentin Albert, Angge Roncal Bazan, Eric Dussoubs, Joan Elbaz, Victor Hintzy, Timothée Jaulin, Esther Law, Victor Monteix, and Mohamed Ben Slimane. Working team members from IFC included Natalia Cristina Bailey, Samed Hysa, Selin Gonca Ozyurt, and Jessica Stallings.  The update of the GSSS database was led by Jessica Stallings and completed thanks to Phil Fu and Karlo Hainski, all from IFC, while the green bond issuance forecasts were run by Victor Hintzy from Amundi.  We thank peer reviewers Jean Pesme and Sebastien Boitreaud from the World Bank, Berit Lindholdt Lauridsen at IFC, Antonio Garcia Pascual from the International Monetary Fund, and Paolo Cei at Amundi for their insightful suggestions. We are also grateful for useful comments received from Anup Jagwani (IFC) and Haruko Koide (IFC), as well as from colleagues from IFC’s Treasury department, including Tom Ceusters, Director of Treasury Market Operations, Rabih Kanaan, and Ayelet Perlstein.  Christopher Vellacott at IFC edited the report with help from Brian Beary, and Irina Sarchenko was responsible for graphics and design.   Page 3  Table of Contents Foreword�������������������������������������������������������������������������������������������������������������������������������������������������������������������� 4 Key Messages������������������������������������������������������������������������������������������������������������������������������������������������������������ 6 Executive Summary������������������������������������������������������������������������������������������������������������������������������������������������ 8 Chapter 1: Introduction����������������������������������������������������������������������������������������������������������������������������������������10 Chapter 2: Market Analysis and Outlook������������������������������������������������������������������������������������������������������� 16 Chapter 3: Recent Global Initiatives and Implications for Emerging Markets��������������������������������� 44 Chapter 4: Central Banks, Financial Technology, and the Public Sector�������������������������������������������� 52 Chapter 5: Case Studies on Specific Emerging Market Countries������������������������������������������������������� 66 Annex�������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 71 Bibliography�������������������������������������������������������������������������������������������������������������������������������������������������������������� 73 EMERGING MARKET GREEN BONDS Page 4 Foreword T his fifth edition of the ‘Emerging Market Amundi remains committed to the development of the Green Bonds Report’ reviews key green, social, market for green bonds and other instruments of sustainable sustainability, and sustainability-linked finance. Its collaboration with IFC on both the Amundi (GSSS) bond market trends in 2022 and outlines our Planet Emerging Green One and the Build-Back-Better expectations for 2023 and beyond. It also discusses the Emerging Markets Sustainable Transaction funds (launched implications for the asset class of recent developments in 2018 and 2021, respectively) is designed to stimulate both in policy, regulation, and technology. As in the previous demand and supply for green bonds in emerging markets. four editions, this year’s report is also the result of joint However, this is not an easy time for the asset class amid work by Amundi, a leading European asset manager, economic, financial, and geopolitical instability around the and the International Finance Corporation (IFC), a world. Last year was one of just five in the last century in member of the World Bank Group. which both U.S. Treasuries and the S&P 500 declined. This Collaboration with financial institutions, the private sector, was the result of a sharp monetary tightening from major and governments is integral to IFC’s focus on mobilizing central banks in response to growing inflationary pressures. private capital for sustainable development and climate- Higher rates on a global scale alongside more restrictive focused goals. IFC was an early adopter of green bonds and funding conditions depressed bond valuations and led to has issued over $10 billion of them across 178 securities in sharp currency swings across emerging markets. This, 20 currencies. together with mounting geopolitical risk on the back of Russia’s invasion of Ukraine, translated into meaningfully In addition, IFC provides technical assistance to issuers lower fixed-income issuance, as well as the first-ever annual and investors in developed and emerging markets and decline in GSSS issuance. promotes integrity in the green bond market through its role chairing the executive committee of the Green, Social, and This was mostly driven by lower GSSS supply from Sustainability-Linked Bond Principles. supranational issuers as well as borrowers in emerging markets outside China. On the positive side, Chinese GSSS Page 5 Foreword SUSAN M. YERLAN LUND SYZDYKOV Vice President, Global Head Economics and of Emerging Private Sector Markets, Development, Amundi IFC issuance, mostly comprising green bonds, was exceptionally Over the medium term, we do expect green bond issuance in strong, overtaking the United States and Germany to make it emerging markets to continue to grow. Driving this growth the world’s largest green bond issuer for the first time. will be: (1) an acceleration in the energy transition; (2) a pricing advantage for issuers relative to developed markets; Nevertheless, geopolitical and financial pressures alongside and (3) favorable macroeconomic conditions—notably higher the corrosive influence of greenwashing risks, continue nominal yields in a context of lower growth which is often to threaten growth in the GSSS asset class. Any reversal supportive of fixed income relative to equities. in this market would be a major setback for global efforts to meet the climate goals set out in the Paris Agreements Robust investor appetite and supportive policy environments of 2015. Sustainable finance markets are pivotal in making will remain critical for green and sustainable finance to up for shortfalls in capital available for funding economic continue building on the momentum generated in recent and energy transitions in emerging markets because they years. This report discusses potential actions aimed at channel private sector investment to areas where it is increasing GSSS bond penetration in emerging markets. needed most. Therefore, considerable effort needs to be dedicated to keeping growth in the GSSS market on track, improving regulation, harmonizing best-practice guidelines, mobilizing policy, and promoting awareness. EMERGING MARKET GREEN BONDS Page 6 Key Messages • Demand for funding to finance energy transitions as income market, was the first-ever annual decline for developing-country governments and corporates pursue the asset class, highlighting the fragility of private environmental goals set by the Paris Agreement will investment flows.  drive growth in issuance of green, social, sustainability, and sustainability-linked (GSSS) bonds. Green bond • A crucial step in enhancing the credibility of the issuance will bounce back in 2023 to 14 percent growth GSSS asset class and luring more private funding in emerging markets outside China, easing to around to sustainable projects in emerging markets will be 11 percent in 2024, according to our central forecast. to address the problem of ‘greenwashing’ whereby However, new green bond deals will be markedly slower issuers misstate the extent to which an activity meets in China, largely on account of weaker-than-expected sustainability criteria. There are encouraging signs of economic recovery from the pandemic. Given the progress in addressing greenwashing across the green country’s economic weight, this will bring overall growth finance market. For example, mandatory disclosure in emerging market green bond issuance to practices related to sustainability are becoming more -1 percent in 2023, followed by a recovery to around common in different regions, while entities are using 11 percent the following year.  voluntary guidelines more. There have also been advances in developing global guidelines on common • Bolstering the GSSS bond market in developing countries definitions and methods.  should be a priority for governments, monetary policy makers, and multilateral institutions. The asset class • Fragmentation of emerging financial markets is a is crucial for channeling private investment toward hurdle for international investors because of a lack of green transitions and the need for this type of funding comparability between different countries or regions, is especially acute in emerging markets where fiscal each with their own regulations and market conditions. resources are scarcer than in developed economies. Fragmentation brings higher screening costs and Failure to underpin these markets will leave them reduces overall investment as a result. Standardization struggling to meet climate targets. As such, a 13 percent of sustainable finance taxonomies globally would reversal in global GSSS issuance in 2022, while more make comparability easier, increase transparency, modest than the 26 percent fall in the broader fixed- provide regulatory consistency, and ultimately reduce Page 7 Key Messages transaction costs for investors. A number of jurisdictions Distributed ledger technologies, or blockchains, are have already moved toward strengthening GSSS bond already being used in financial transactions as they taxonomies and are seeking to make them compatible enable more efficient monitoring and accreditation. with international peers.  Blockchain can provide a tamper proof, encrypted, and transparent system that will appeal to private investors.  • Central banks may be pivotal in making emerging market financial markets supportive of green transitions. • Synthetic securitizations, backed by public sector In terms of monetary policy, they could also face a guarantees, are also a promising solution to the challenge to price stability from ‘greenflation,’ or the challenge of attracting more private capital into riskier rising prices associated with overhauling economies and assets such as emerging market debt. The experiences of implementing green transitions. In any case, they will Italy and Greece, which used this approach to repackage need to incorporate climate risks into regulatory and non-performing loans on bank balance sheets and sell supervisory frameworks. These, in turn, could shape the them on as securities to investors, thereby successfully data disclosure and risk management practices required unlocking lending into the real economy, could be used by regulators of the financial institutions that they as models for emerging markets. Development finance supervise. In addition, they could also actively support institutions could play an active role by backstopping the greening of economies by adapting their lending riskier portions of the debt, thereby improving the operations, collateral frameworks, and asset purchase risk-reward profile of more senior tranches of the programs to favor green assets, thereby underpinning securitization and making them viable for investors.  GSSS demand.  • Financial technology can enhance the development of GSSS issuance in emerging markets by improving transparency, enhancing data collection, and enabling comparability across markets. This would increase these markets’ appeal to international money managers as they assess potential allocations for their funds. EMERGING MARKET GREEN BONDS Page 8 Executive Summary G reen bonds and other debt instruments used modest 11 percent increase in 2024. However, including to raise money for sustainable causes are key China in the outlook presents a markedly different picture to ensuring enough capital is channeled from on account of its economic weight. We expect green bond international investors toward funding the energy issuance growth for the broader emerging markets category transition in emerging markets. This burgeoning including China to see a 1 percent fall in 2023, followed by a segment of the international capital market has recovery of around 11 percent growth in 2024, bringing the achieved remarkable progress since the first green cumulative increase to around 10 percent over the next bonds were issued more than a decade ago. two years. Even so, 2022 was a troubled year for international capital Even so, setbacks to GSSS markets in developing countries markets amid growing geopolitical tensions in the wake during the past year are an ominous development, given that of Russia’s invasion of Ukraine and tightening monetary they represent a reversal of private investment flows toward policy in major economies as they wrestled with inflationary sustainable projects in economies that face difficulties pressures. All this rattled investors and global fixed-income funding their own energy transitions. issuance fell by 26 percent from a year earlier. Encouragingly, This highlights an urgent need to boost the viability of issuance of green, social, sustainability, and sustainability- the GSSS asset class in emerging markets where local linked (GSSS) bonds proved more resilient, falling a more investment is scarcer, governments’ fiscal resources are modest 13 percent. But this was still the sector’s first-ever less ample, and the proportion of GSSS bonds rated by annual fall in issuance and a significant setback in the internationally recognized rating agencies is also smaller context of the 68 percent growth seen the previous year. than in advanced economies. However, it also highlights the We do not anticipate this loss of momentum for GSSS equally urgent need to boost local fixed-income markets in issuance will last, however. We expect growth in the asset general. Failure to underpin these needs will leave emerging class to resume, driven by an acceleration in the energy market countries struggling to meet climate targets. transition reflecting a greater sense of urgency around In order to address these challenges and minimize the meeting climate targets. We also foresee growing demand risk of greenwashing, the report recommends imposing for GSSS assets given macroeconomic dynamics—notably tighter disclosure requirements and pursuing greater higher nominal yields in a context of weaker growth— homogenization of green taxonomies to reduce the supportive of the broader emerging market fixed-income fragmentation of the asset class. It also discusses ways to asset class. increase relative demand for GSSS bonds and boost their In our central scenario, we forecast green bond issuance penetration in local markets. In addition, the report examines will bounce back in 2023, growing 14 percent year-on-year the role central banks can play by “tilting” their monetary in emerging markets outside China, before easing to a more policy operations toward GSSS assets, before assessing Page 9 Executive Summary how blockchain-based and other technologies can help • As a result of this, China not only remained the largest reduce transaction costs while increasing transparency and green bond issuer in emerging markets—73 percent improving record keeping. The report also examines financial of the total—but it also became, for the first time, the instruments such as synthetic securitizations that can help largest green bond issuer globally after overtaking reduce the cost of capital for emerging market projects and Germany and the United States. increase their appeal to developed market investors. • Green bonds remained the largest GSSS sub-segment Finally, the report also looks at actions taken by select at 69 percent of total GSSS issuance in emerging emerging market governments. First of all, we discuss how markets, with sustainability bonds coming in second Brazil’s newly elected government is pursuing an ambitious with 21 percent. In emerging markets excluding China, environmental overhaul of the economy which includes however, sustainability bonds became the largest sub- plans for an inaugural green bond in 2023. A successful segment at 41 percent, ahead of green bonds with sovereign issue along these lines is likely to boost the 38 percent. broader Brazilian GSSS market. Meanwhile, Uruguay recently carried out an issuance of sustainability-linked bonds with • Unlike in the previous two years, when non-financial a coupon structure tied to performance on pre-determined corporates led emerging market green bond issuance, environmental goals. The structure incorporates a step down financial institutions took over in 2022, accounting for in interest payments if those targets are met, but a step up 52 percent of the total. otherwise. The offering was oversubscribed, attracting new investors to Uruguay for the first time and encouraging • The emerging market greenium —the lower spread on a other corporate issuers in the region to consider using green bond yield compared with that on a conventional a similar structure for issues of their own. Other recent bond from the same issuer—widened during the year, innovations include a climate budget tagging strategy from 4.2 basis points on average in 2021 to 7.2 basis adopted by Indonesia enabling the evaluation of climate- points by the end of 2022. related expenditure by the government. This has proved effective at preventing greenwashing and making Indonesian • The low proportion of emerging market green bonds GSSS assets more attractive to international fund managers. carrying internationally recognized credit ratings remained a key barrier for investing in the asset class in 2022. Only 14 percent of green bonds issued in China Highlights of GSSS Issuance in 2022: carried investment-grade ratings (by internationally recognized rating agencies) in 2022, down from • Global GSSS bond issuance fell 13 percent in 2022, 16 percent in 2021. In other emerging markets, the the first annual fall in issuance, though the sector proportion was up to 33 percent, from 30 percent the outperformed the broader fixed-income market which previous year. fell 26 percent. This drove global GSSS bond penetration up to 13.6 percent, an all-time high. • Within the GSSS segment, the setback was particularly acute among supranational issuers, which fell 38 percent year-on-year as well as across emerging markets outside China where issuance declined 30 percent. On the positive side, China’s green bond issuance was exceptionally strong, rising 61 percent. 1 Introduction T he year 2022 proved a challenging one for 13 percent from a year earlier, the first ever decline for international capital markets. For only the fifth this still nascent asset class and a sharp reversal from the time in the last 100 years, U.S. Treasuries and the 68 percent growth recorded in 2021. S&P 500 both ended the year lower than where they This represents an outperformance by GSSS bond issuance started. versus the broader fixed-income asset class. But it is, Much of the turmoil can be attributed to the sharp monetary nevertheless, an ominous development for sustainable tightening pursued by the U.S. Federal Reserve and other finance, particularly in emerging markets where the capital central banks as they grappled with the inflationary needed to fund the green transitions is most scarce. Such pressures that took hold in the wake of the COVID-19 resources are crucial to put economies on track to meet pandemic. But Russia’s invasion of Ukraine in late February international climate goals. and the resulting geopolitical frictions also dampened the Among the challenges faced by GSSS bonds we also mood, sending bond spreads wider as investors took fright acknowledge the ongoing political debate surrounding at the heightened sense of risk, making it more costly to investment decisions based on environmental, social, and borrow in financial markets. As a result, country authorities governance (ESG) factors more broadly. Specifically, we in emerging markets currently face difficult choices between highlight legislation passed in Florida (May 2023), along with sustaining financial stability and supporting growth in an other U.S. states like Kansas (July 2023) and Indiana (April environment of tighter global liquidity, increased geopolitical 2023), which prohibit the consideration of ESG factors in frictions, and slower global growth. state investments and procurement processes. This reflects Unsurprisingly, total fixed-income issuance fell by 16 percent the polarized opinions on the topic. In this context, it is from the previous year. The upheavals and primary market worth noting the concerns raised by the Glasgow Financial shutdowns did not spare the market for green, social, Alliance for Net Zero (GFANZ), a grouping of insurance sustainability, and sustainability-linked (GSSS) bonds, companies and pension funds convened by the United as defined in Box 1.1. Bond issuance in this category fell Nations. GFANZ warns that political attacks against ESG Page 11 Introduction could have negative impacts on investors, policyholders, and 11 percent. However, green bond issuance in China will be economies. slower, due to the combination of a weaker-than-expected post-COVID-19 recovery and lower attractiveness of locally However, these setbacks mask a series of encouraging issued bonds (on account of relatively low yields versus the developments. We estimate the so-called greenium in United States and Europe). Given China’s economic weight, emerging markets widened to 6.4 basis points in 2022, from this will bring overall growth in green bond issuance for 4.2 basis points in 2021. This suggests a growing imbalance emerging markets down to around 10 percent in 2023–2024, between supply and demand which continues to make the amounting to a 1 percent decline in 2023, followed by a green bond market attractive for investors, relative to the recovery back to about 11 percent growth the following year.1 conventional bond market, in emerging markets. In the medium term, we expect green bond issuance to be a Meanwhile, a significant development was that overall global key beneficiary from an acceleration in the energy transition funding via green bonds and loans to sustainable projects driven by a greater sense of urgency around tackling climate surpassed that of the fossil fuel sector for the first time in change. Most recent analyses2 point to an increase in global 2022, a sign that the market for green financing is maturing. temperatures of about 2.7 to 2.8 degrees Celsius above pre-industrial levels under current policies, well above the 1.5 degrees Celsius targeted in the Paris Agreement, adding GSSS issuance will continue to grow pressure on policy makers to act. as energy transitions accelerate, and According to Bloomberg NEF, global investment in the energy investor demand rises. transition reached $1.1 trillion in 2022, an all-time high and a 31 percent increase from 2021 (See Exhibit 1-a).3 While this is Looking ahead, we expect GSSS issuance will continue to encouraging—as it matches global fossil fuel investments for grow over time, driven by an acceleration in the energy the first time—it also falls short of the $4.55 trillion that needs transition, a wider greenium in emerging markets relative to be invested annually for the remainder of this decade to to advanced economies, and macroeconomic dynamics get on track under BNEF’s Net Zero Scenario. (high nominal rates in a context of weak economic growth) supportive of the fixed-income asset class in developing Three drivers are contributing to most of this acceleration. economies. First, the energy transition is likely to be supported by ongoing global progress at the policy level. During the Our central scenario forecasts green bond issuance to grow, last COP27 international climate summit, held in Egypt in cumulatively, by 27 percent in emerging markets excluding November 2022, governments agreed to establish a fund to China over 2023–2024, on the back of an easing of global compensate developing countries for the loss and damage inflationary pressures driven by a global slowdown and that climate change has wrought. Key details on how this weaker credit growth. In particular, we see green bond will be funded or how to deploy the financial assistance are issuance bouncing back in 2023 to grow around 14 percent, yet to be agreed and will be up for discussion at COP28 in slowing to a more normalized increase in 2024 of about Dubai, which starts in November 2023. Furthermore, the UN 1 Green bond issuance forecasts have been run by Amundi. 2 See for example, Climate Action Tracker, November 2022 or CDP and OliverWyman, 2022, “Missing the Mark Report,” 3 If we add investments in the power grid, overall energy transition investments would reach $1.4 trillion. See Bloomberg NEF, 2023, “Global Low-Carbon Energy Technology Investment Surges Past $1 Trillion for the First Time,” January 26, 2023 EMERGING MARKET GREEN BONDS Page 12 Secretary General has also called for a “Climate Ambition would expect green bond issuance to remain broadly flat, Summit” in September 2023 for governments to seek cumulatively, over the next two years, with an 11 percent year- agreement on new country pledges or nationally determined on-year decline in 2023, offset by a 12 percent rebound in 2024. contributions (NDCs).4 The Inflation Reduction Act in the United States and the REPowerEU package in the EU should also be viewed as two crucial steps in this direction. Policy action, new technology, and Second, a wider greenium will continue to make green better-aligned guidelines can help bonds more attractive to issuers than conventional bonds. deepen GSSS markets. This is particularly the case in emerging markets where the greenium is widening, as we show in Section 2 of the In 2022, GSSS bond issuance was around 0.4 percent of report, relative to developed economies where the spread China’s gross domestic product (GDP), compared with advantage appears to be shrinking.5 0.3 percent a year earlier. For the rest of the emerging market category, the proportion was equivalent to Third, high nominal rates in a context of easing inflationary 0.2 percent of GDP, falling from 0.4 percent in 2021. In light pressures and weaker growth (on a combination of a of these numbers, bond penetration as a proportion of GDP weaker-than-expected recovery in China and slacker credit seems broadly similar in China compared to the rest of the growth in developed markets reflecting events in the U.S. emerging market space. This class of bonds remains more and European banking sectors since mid-March 2023) are established in developed markets, with issuance in 2022 likely to be supportive of emerging market fixed income in equivalent to around 1.2 percent of GDP in 2022, down from 2023–2024 in absolute terms. Moreover, emerging market 1.4 percent in 2021. bonds could also outperform local equities as the cumulative rate hikes implemented so far by emerging market central Interestingly, bond penetration as a proportion of total banks feed through to the real economy, translating into debt issuance seems much lower in China than in other weaker growth and downward earnings-per-share revisions. emerging markets. China stood at 6 percent in 2022, rising from 3 percent in 2021. In other developing economies, the This is, as discussed earlier, our central scenario. However, as rate was 16 percent in 2022 and 15 percent in 2021. This puts in previous editions of the report, we also run two alternative these emerging markets excluding China ahead of developed scenarios for emerging markets. The first of these is the country levels of penetration, which were around 13 percent more optimistic (“catch-up”) scenario, defined by a faster in 2022 and 11 percent in 2021. This also highlights the normalization of inflation rates alongside higher inflows of importance of further developing local fixed-income markets funds into emerging market debt. Under these conditions, across emerging markets as a pre-condition for sustained we would expect green bond issuance to grow by close to growth of the GSSS segment going forward. 20 percent cumulatively in 2023–2024, with 8–10 percent growth in both years. Importantly, the low proportion of green bonds carrying internationally recognized credit ratings remained a key Our more pessimistic (“slowdown”) scenario is defined by barrier for investing in the asset class in 2022. Only 14 percent a global economic slump driven by much tighter financial of green bonds issued in China carried investment-grade conditions than in our central scenario. In this case, we ratings (by internationally recognized rating agencies) in 4 UN News, December 19, 2022, “Guterres announces ‘no nonsense’ climate action summit; calls for practical solutions,” 5 Financial Times, 2023, “Green Bonds: the Disappearing Greenium is a Welcome Development,” January 2, 2023. Page 13 Introduction 2022, down from 16 percent in 2021. In other emerging markets, the EXHIBIT 1-a proportion was up to 33 percent, from 30 percent the previous year. Investment in Energy Transitions Has Against this backdrop, the report Caught Up with Fossil Fuels reviews potential actions to increase Annual investments in energy transitions versus fossil fuels, 2018–2022 GSSS bond penetration across emerging markets. Energy Transition Fossil Fuel 1,200 1,110 First, the potential for reputational 1,110 damage associated with so-called 930 922 896 greenwashing, whereby an issuer 745 800 misstates the extent to which an 849 $ Million activity meets sustainability criteria, is also a significant concern for investors. 626 400 482 522 To counter this risk, the report discusses the benefit of tighter data disclosure requirements related to 0 sustainability and a potential shift from 2018 2019 2020 2021 2022 voluntary to more formal guidelines on green definitions. Source: Bloomberg NEF, "Low-Carbon Energy Technology Investment Surges Past $1 Trillion for the First Time," January 26, 2023 Second, another problem investors face is the potential fragmentation of the asset class via a lack of comparability between different countries or regions, debt to buy green bonds would increase demand for the each with their own regulations and market conditions. latter, driving down yields and eventually prompting issuers Fragmentation carries higher screening costs and reduces to sell more into a receptive market. This would ultimately overall investment as a result. In this context, the report lead to greater penetration of green bonds into local capital argues for further standardization of taxonomies globally. markets. We note, however, that we are agnostic about Furthermore, we also discuss the Assessing Sovereign whether central banks should indeed follow this path and Climate-related Opportunities and Risks (ASCOR) Project, acknowledge that there is no consensus on the question. the first coordinated investor framework to assess sovereign Fourth, we look at how new technologies could help mobilize bond issuers on climate change. savings in emerging markets. Both fintech and blockchain- Third, we discuss how central banks in developing countries based technologies could help develop local capital markets can support energy transitions, referencing the European while tilting incremental investments toward sustainable Central Bank’s proposal for greening its bond portfolios.6 assets, including GSSS bonds. In particular, we review some Clearly, any move by a central bank to sell conventional of the leading initiatives in the field. 6 Schnabel, I. 2023, “Monetary Policy Tightening and the Green Transition,” Speech to the international Symposium on Central Bank Independence,” Sveriges Riksbank, Stockholm, January 10, 2023, EMERGING MARKET GREEN BONDS Page 14 BOX 1.1 Labeled Bonds: Definitions and Guidelines Green bonds: Fixed-income instruments with proceeds measured through key performance indicators and earmarked exclusively for projects with a positive assessed against sustainability performance targets. environmental impact. The Green Bond Principles, Failure by the issuer to meet those goals may result in guidelines developed by the International Capital Market a higher coupon. These bonds can also be structured Association (ICMA), have four components: use of to reward better-than-expected performance with a proceeds, process for project evaluation and selection, lower coupon. Unlike social or green bonds, proceeds management of proceeds, and reporting. These principles are not earmarked for specific projects. In June 2020, were last updated in June 2022. Several countries and ICMA published the Sustainability-Linked Bond Principles, jurisdictions have developed guidelines for green bond providing guidelines on structuring features, disclosure, issuance, many of which align with the Green Bond and reporting. Principles. A related category, blue bonds, focuses on Climate transition bonds: This category of debt aims financing water-related sustainable projects. to finance the transition to a low-carbon economy. The Social bonds: Proceeds from social bonds are directed "Climate Transition Finance Handbook" published by toward projects that aim to achieve positive social ICMA in December 2020 recommends disclosures for outcomes, especially, but not exclusively, for a target issuers marking either use-of-proceeds or sustainability- population. ICMA's Social Bond Principles have four linked instruments with a climate transition label. There components analogous to the Green Bond Principles: are four key elements to the recommended disclosures: use of proceeds, the process for project evaluation and the issuer's climate transition strategy and governance, selection, management of proceeds, and reporting. The the environmental materiality of its business model, 2017 Social Bond Principles were updated in June 2020 the climate transition strategy that must be science- to reflect changes in the market in light of COVID-19, based and include targets, and the transparency of notably by expanding social project categories and target implementation. populations. Other labels: Some issuers have used other marketing Sustainability bonds: Sustainability bonds are debt labels for sustainable debt funding, such as adaptation, instruments that raise money to finance or refinance or SDG (Sustainable Development Goals) bonds. Most a combination of green and social projects. The of these are use-of-proceeds bonds aligned with ICMA Sustainability Bond Guidelines established by ICMA are principles, but their branding has been adapted to single aligned with the core components of both Green and out a specific feature. Some bonds labeled "sustainable Social Bond Principles. development bonds" depart from ICMA principles, as they are not "use-of-proceeds" bonds but are general purpose Sustainability-linked bonds: These instruments are securities from issuers who wish to flag that their mission performance-based bonds whereby their financial or is inherently sustainable. The proliferation of labels structural characteristics, such as the coupon rate, are requires vigilance from investors around project eligibility, adjusted depending on whether the issuer achieves allocation, and impact reporting commitments. predefined sustainability objectives. The objectives are Page 15 Introduction Fifth, a traditional challenge facing foreign investors with some exposure to emerging markets is the relatively high cost of capital associated with investing in projects in the region.7 The report looks at synthetic securitizations with some government or supranational participation as a potential way to reduce the cost of capital for projects in emerging markets and increase their appeal to developed market investors. Finally, the report reviews initiatives to deepen sustainable capital markets in three developing countries. This segment examines Brazil’s GSSS bond ambitions under the new government that assumed office at the start of 2023. It also outlines key features of Uruguay’s sustainability-linked bond, which includes an innovative step-up-down coupon structure, before assessing Colombia’s new green bond framework and Indonesia’s climate budget tagging strategy. 7 See data from International Energy Agency, 2023, “Cost of Capital Observatory Report,”January 2023 2 Market Analysis and Outlook T his section starts with a review of GSSS State of the Market in 2022 developments observed in 2022, considering regional patterns and evolving trends in market Global fixed-income issuance fell by 16 percent globally in structure while detailing the performance of sub- 2022, due to monetary tightening by core central banks, components to identify outliers. The second part covers widening spreads, financial market volatility, and primary the performance of green bonds, the direction in which market shutdowns in the wake of Russia’s invasion of yields are moving, and the implications for future Ukraine in late February. Unsurprisingly against this issuance. The final part sets out our expectations for backdrop, issuance of GSSS bonds also declined, by some short-to-medium-term issuance around three 13 percent to $877 billion, the first-ever sequential fall and alternative views, one optimistic and the other more in sharp contrast to the record 68 percent growth seen pessimistic, around the most likely central scenario. the previous year. This was well under the forecast of a 20 percent increase in 2022 detailed in last year’s report.8 While this report covers the entire market for GSSS bonds, much of the analysis of issuance trends in this Even so, global GSSS bond issuance in 2022 remained section focuses on green bonds. This reflects the fact that 46 percent higher than 2020 levels. Furthermore, market green bonds remain the best-established, largest, and penetration—its share of overall fixed-income issuance— most liquid component of the GSSS market. While their increased from less than 12 percent to almost 14 percent in dominance has been somewhat eroded, particularly in the 2022, an all-time high (See Exhibit 2-a). wake of COVID-19 when pandemic recovery spending by Focusing on emerging markets, only China posted governments led to a rise in social bond issuance, green accelerating GSSS issuance, with an advance of 53 percent bonds still account for around two-thirds of the overall over the year to $69 billion, driven mainly by green bonds GSSS market. (See Exhibit 2-c). 8 Amundi and IFC, 2022, “Emerging Market Green Bonds - Report 2021,” June 2022, Page 17 Market Analysis and Outlook EXHIBIT 2-a Issuance of GSSS Bonds Saw Its First-Ever Annual Fall in 2022 Annual Global GSSS Issuance 2012–2022 1,200 Developed Markets $1,013 1,000 $877 Emerging Markets (excluding China) 800 China $603 $ Billion 600 Supranational 400 $326 $172 $195 200 $85 $12 $37 $49 $4 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 1.6% 1.2% 1.06% Percentage of GDP 0.8% 0.72% World, 0.88% 0.38% 0.4% 0.21% 0.23% 0.07% 0.11% 0.01% 0.02% 0.05% 0.0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 90% Percentage of Overall Fixed Income Issuance 60% 30% 11.6% 13.6% 4.5% 6.8% 0.1% 0.2% 0.6% 0.8% 1.3% 2.5% 3.0% 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: Bloomberg, CBI, Environmental Finance, IFC EMERGING MARKET GREEN BONDS Page 18 Declining issuance in other emerging markets highlights the or Ukraine, higher funding costs, and lower demand, as these impact of idiosyncratic pressures that added to the global institutions tend to issue in local currency. headwinds outlined above. While failing to dampen the In terms of sectors, the fall in GSSS issuance was mostly country’s green issuance, spillovers from China’s repeated driven by lower supply from public sector entities, which COVID-19 lockdowns contributed to a 33 percent drop in declined by 24 percent. Sovereign issuance, meanwhile, green bond issuance from neighboring South and East Asian fell even further, by 46 percent, only partially offset by a countries, to $6 billion. 180 percent jump attributed to government agencies, albeit Elevated global core yields and currency volatility in some from a low base. This may be partly explained by emerging Latin American countries was a primary reason behind market governments seeking to contain fiscal deficits or a 49 percent decline for that region. At the same time, high-yielding countries finding it prohibitively expensive to Russia’s invasion of Ukraine, while unleashing global market issue. headwinds, was felt most across Eastern European and The year saw a 6 percent rise in issuance from the private Central Asian countries where issuance halved. sector in emerging markets, dominated by financial Crucially for emerging market sustainable finance, institutions that almost doubled their bond issuance. supranational issuers reduced GSSS issuance meaningfully in Financial firms surpassed non-financial corporations’ GSSS the year. GSSS issuance by multilateral institutions declined issuance accounting for 42 percent of the total versus 38 percent, with a 46 percent rise in green bond issuance 31 percent for the latter. only partially offsetting declines across other sub-segments, Most of the emerging market growth experienced by particularly social bonds, which saw a 74 percent drop. financial institutions in the GSSS segment was driven by a This was mostly driven by some de-risking on the part of 155 percent jump in green bond issuance. In addition, green supranational entities with meaningful exposures to Russia EXHIBIT 2-b Global Issuance of GSSS Bonds Remains Dominated by Developed Markets Global GSSS issuance 2012–2022 (cumulative) $ Billion Percentage of GDP Percentage of Overall Fixed Income Issuance Developed Markets $2,392 4.6% 4.1% Supranational $530 0.5% 50.2% Emerging Markets (excluding China) $250 0.9% 3.6% China $202 1.1% 2.1% $0 $3,000 0% 6% 0% 60% Source: Bloomberg, CBI, Environmental Finance, IFC Page 19 Market Analysis and Outlook EXHIBIT 2-c China Was the Only Emerging Market to Increase Green Bond Issuance in 2022 Annual green bond issuance in emerging markets 2012–2022 100 $93.1 China Sub-Saharan Africa $77.1 80 Middle East and North Africa Latin America and the Caribbean Europe and Central Asia Asia and the Pacific (excluding China) 60 $ Billion $40.0 40 $33.9 $25.1 $28.2 $20.1 20 $1.1 $0.3 $3.7 $0.0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 0.8% 0.6% Percentage of GDP 0.4% 0.18% Total, 0.2% 0.2% 0.1% 0.09% 0.06% 0.07% 0.07% 0.01% 0.0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 16% Percentage Overall Fixed Income Issuance 12% 8% Total, 6% 4% 4% 2% 2% 2% 1% 2% 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: Bloomberg, CBI, Environmental Finance, IFC EMERGING MARKET GREEN BONDS Page 20 EXHIBIT 2-d China Dominated Emerging Market Green Bond Issuance Over the Last Decade Green bond issuance in emerging markets 2012–2022 (cumulative) $ Billion Percentage of GDP Percentage of Overall Fixed Income Issuance Sub-Saharan Africa $4 18.0% 2.2% Middle East and North Africa $12 1.3% 1.7% Europe and Central Asia $35 0.6% 2.8% Asia and the Pacific (Excluding China) $38 0.3% 2.1% Latin America and the Caribbean $38 0.7% 1.3% China $195 1.1% 2.0% $0 $400 0% 20% 0% 3% Source: Bloomberg, CBI, Environmental Finance, IFC bond issuance by government agencies grew 152 percent, Indonesia grew 2.4 times to $2.6 billion. Beyond the top albeit from a relatively low level. This was, however, only six, other key emerging markets saw green bond issuance partially offset by meaningfully lower issuance by both non- decline, with Chile, Czech Republic, India, and Poland all financial corporates, down 31 percent year-on-year, and down between 60–90 percent (See Exhibit 2-e). sovereigns which were 57 percent lower (See Exhibit 2-h Cumulatively through the end of 2022, emerging market later in this section). issuers had sold green bonds worth $323 billion. China, the Around 90 percent of all 2022 emerging market green bond largest, accounts for $195 billion, or 60 percent of the total. issuance could be attributed to just six countries. China Other large developing economy issuers include India at remained the largest issuer over the year, with 73 percent of $20 billion, Chile at $15 billion, and Brazil, which had issued the total, up from 54 percent the previous year. Among the $13 billion (See Exhibit 2-f). other top five, Hungary almost doubled its tally to $3.3 billion, Among other GSSS categories, social bond issuance followed by Brazil, which saw a 65 percent increase from contracted the most in emerging markets outside China— 2021, also reaching $3.3 billion. The United Arab Emirates by 88 percent year-on-year—while sustainability bonds (UAE) saw issuance multiply 4.3 times to $3.2 billion. Saudi proved the most resilient segment with a 14 percent rise. Arabia achieved $3.1 billion from no issuance in 2021, while This implies some substitution between the two, with Page 21 Market Analysis and Outlook EXHIBIT 2-e Emerging Market Green Bond Issuance is Highly Concentrated in Six Countries Top 10 emerging market green bond issuers in 2022 $ Billion Percentage of GDP Percentage of Overall Fixed Income Issuance China $67.5 0.4% 6.0% Brazil $3.3 0.4% 12.0% Hungary $3.3 0.1% 4.0% UAE $3.2 0.2% 6.0% Saudi Arabia $3.1 0.2% 14.0% Indonesia $2.6 0.1% 8.0% India $2.2 0.2% 10.0% Chile $1.4 1.8% 42.0% Thailand $0.8 0.6% 19.0% Poland $0.6 0.3% 13.0% $0 $70 0% 2% 0% 50% Source: Bloomberg, CBI, Environmental Finance, IFC issuers swapping social for sustainability bonds because the of China’s overall GSSS issuance last year, with overall GSSS challenging market and economic outlooks made the latter issuance growing by 61 percent. For all emerging markets, more attractive to borrowers, which offer greater flexibility including China, green bonds remained the largest GSSS sub- in how proceeds can be used. segment, rising to 69 percent of total GSSS issuance in 2022 from 55 percent in 2021. Sustainability bonds were second, A key feature of sustainability bonds is that they offer more claiming 21 percent of total GSSS issuance in 2022 from flexibility than green bonds in that the proceeds can be used 18 percent a year earlier. on either green or social projects without the issuer having to pre-commit to a specific green-social split. As a result, A significant development in the market is that overall sustainability bonds became the largest GSSS sub-segment global funding via green bonds and loans to sustainable across emerging markets outside China, representing projects surpassed that of the fossil fuel sector for the first 41 percent of the total versus 25 percent in 2021. This puts it time in 2022 (See Exhibit 2-g). On the one hand, funding ahead of green bonds, which rose one percentage point in for green projects fell by 6 percent in 2022 after almost 2022 to 38 percent of the total. doubling in 2021. On the other hand, the global fossil fuel sector posted a 19 percent decline in 2022, taking the drop However, when China is included, the issuer composition since 2018 to 31 percent. This highlights the speed at which changes considerably. Green bonds accounted for 98 percent EMERGING MARKET GREEN BONDS Page 22 EXHIBIT 2-f China Accounts for 60 Percent of Emerging Market Green Bonds Since 2012 Top 10 emerging market green bond issuers in 2012–2022 (cumulative) $ Billion Percentage of GDP Percentage of Overall Fixed Income Issuance China $195 1.1% 2.0% India $20 0.6% 3.6% Chile $15 4.8% 9.3% Brazil $13 0.7% 3.3% Poland $8 1.1% 11.2% Indonesia $8 0.6% 3.5% Czech Republic $8 2.7% 17.4% Hungary $7 3.6% 15.6% UAE $6 1.1% 2.3% Saudi Arabia $4 0.4% 2.2% $0 $250 0% 5% 0% 20% Source: Bloomberg, CBI, Environmental Finance, IFC green funding—including green bonds—is fast becoming a Surprisingly, issuance of sustainability-linked bonds central component of international capital markets as green in emerging markets outside China were materially agendas take center stage and funding for conventional lower—declining 35 percent from a year earlier—despite energy sources diminishes. Indeed, when the Paris high expectations for this sub-segment. This is likely to Agreement was signed in 2015, green funding was less than reflect a combination of factors, including a lack of pricing one-tenth of the size of the market for fossil fuel-related advantage for issuers as well as investor skepticism about funding. the effectiveness of the penalties imposed on issuers for not meeting sustainability targets. At the time of writing, just Increasing investment in clean energy and the declining one issuer—Poland’s PKN Orlen, in November 2022—has paid relative importance of fossil fuels, suggest the energy sector a so-called step-up penalty, the additional interest charged is likely to remain a major driver of GSSS issuance growth in to the borrower for failing to meet sustainability goals.10 years to come.9 Box 2.1 provides an update on the sustainability-linked bond 9 According to the IEA’s 2023 World Energy Investment report, global energy investment in clean energy is expected to reach $1.7 trillion in 2023. 10 Bloomberg, 2022, “ESG Downgrade Sparks New Penalty in $200 Billion Bond Market,” November 29, 2022 Page 23 Market Analysis and Outlook EXHIBIT 2-g Funding for Sustainable Projects from Green Debt Overtook the Oil and Gas Sector in 2022 Bonds and loans for green projects versus oil and gas industry Source: Bloomberg's Green Lending Green Projects Oil & Gas Industry Tops Fossil as Big Oil Gets Cash Elsewhere, by Tim Quinson, January 1,000 862 4th, 2023. 900 Methodology: "Green Projects" data 769 737 800 732 comes from Bloomberg's "Green 665 688 658 League" tables and include bonds 700 and loans where 100 percent of the 583 581 proceeds or an amount equal to the 600 net proceeds are being used for eligible $ Million 500 620 green projects. "Oil & Gas Industry" data 400 323 531 include bonds and loans for any issuer 298 in the "Coal Operations," "Exploration & Production," "Integrated Oils," "Oil & Gas 300 199 Services & Equipment," "Pipeline," and 158 200 116 "Refining & Marketing" sectors while 48 68 excluding any green bonds they may 100 have issued (there are only 32 green loans issued out of these sectors, and 48 0 green bonds). 2014 2015 2016 2017 2018 2019 2020 2021 2022 market, including a discussion about the opportunities and a true alternative to use-of-proceeds bonds, they need to challenges it currently faces. effectively address some of the challenges highlighted in Box 2.1. An important topic to consider is the future of use-of- proceeds bonds in light of rising interest in sustainability- linked bonds and other structures. Use-of-proceeds securities still account for the bulk of GSSS issuance but concerns are mounting around areas such as how to define what constitutes an “authorized” use of proceeds and how this is monitored. This can introduce a degree of rigidity to the market by pairing specific expenditures with specific sources of funding, resulting in entities issuing a wider variety of financial instruments, thereby weakening their liquidity. On paper, sustainability-linked bonds seem to avoid these issues. However, for these instruments to become EMERGING MARKET GREEN BONDS Page 24 A Regional View BOX 2.1 China remains the biggest green bond market among developing countries, accounting for more than 60 percent Sustainability-Linked Bonds of total issuance in 2022 and 73 percent since 2012. in Emerging Markets Meanwhile, the Middle East and North Africa has become Governments and corporations are under increasing the most significant regional contributor to green bond pressure to meet climate goals. This leaves them issuance from emerging markets outside China. facing the mounting challenge of balancing these Asia and the Pacific priorities with their economic or business interests. Sustainability-linked bonds, a relatively new The dominance of China’s green bond market follows several category of debt that first emerged in 2019, can government initiatives in the country aimed at widening help organizations achieve that balance, raising the investor base and encouraging bank lending to energy fresh capital from investors while making credible transition projects. Significant developments underpinning commitments on environmental or social goals. green bond issues included publishing a second version of the Common Ground Taxonomy by the People’s Bank of Sustainability-linked bonds are distinct from other China and the European Commission in June 2022. Another GSSS categories, such as green or social bonds, boost came from China’s continued monetary easing, which because their terms do not specify how proceeds boosted the performance of onshore green bonds and put from debt issuance should be deployed. Instead, the country at odds with the monetary tightening seen in issuers commit to achieving predetermined other large economies. Furthermore, the country’s central sustainability goals by a deadline within the bond's bank has started assessing local lenders according to their term. Failure to meet that commitment can result in holdings of green bonds, an initiative known as the Green a higher coupon, or in cheaper borrowing costs if the Finance Evaluation Plan, while offering cheap funding to target is achieved. subsidize green loans from November 2021. The flexibility around how the borrower deploys the Dynamics in the rest of Asia were radically different, money they raise makes this type of debt appealing however, with green bond issuance falling 33 percent to to issuers that may not have an extensive pipeline of $6 billion in 2022, around 8 percent below the level seen green projects that would qualify for the proceeds of in 2019, before the market disruptions that came with the green or social bonds. For example, investments in COVID-19 pandemic. sectors such as housing, education, and infrastructure may not always meet the specific requirements This was explained mainly by lackluster issuance from set out in the terms of green bonds. Meanwhile, India—down 63 percent—amid poor performance of the governments can use the instrument as a source local fixed-income market related to monetary tightening, of funds for general public spending or to mitigate the government’s announcement of enhanced borrowing balance sheet risks by reducing maturity or currency plans for 2022–2023, and significant currency volatility. mismatches. Even so, India took the significant step of publishing its A weak but resilient year for sovereign green bond framework in early November 2022, issuance amid global headwinds which was followed by the country’s first-ever sovereign The significant underperformance of sustainability- Page 25 Market Analysis and Outlook linked bonds (-22 percent) relative to the broader GSSS On a regional basis, Latin America represented 71 percent asset class (-13 percent) in 2022 was driven by two of the 2022 total. Asia accounted for $1.4 billion, or factors: the instrument’s relative illiquidity—leading to 11 percent of the total, mainly from Thailand and India, higher volatility—and increasing concerns about the asset which issued $850 million and $400 million, respectively. class’s prospects. The spotlight shifted from corporate On the positive side, however, the market remained open, to sovereign borrowers. and issuers continued to issue sustainability-linked bonds throughout the 2022 turmoil, with emerging markets While sustainability-linked bonds have become popular representing 16 percent of total issuance ($11.5 billion) among corporations, they are far less established among over the year. Non-financial corporates accounted sovereign borrowers. However, the success of Chile's for 69 percent of the market, with sovereigns, led by offering in 2022, which was more than four times Chile and Uruguay, making up 30 percent. There was a oversubscribed, means more sovereign issuers are likely substantial reduction in sustainability-linked bond deals to follow. from financial institutions, down to just $130 million, from $1.85 billion in 2021. Emerging Market Sustainability-Linked Bond Issuance Global Sustainability-Linked Bond Issuance 20 100 1.7 China 18 90 Emerging 0.3 Markets 17.72 16 80 (excluding Sub-Saharan China) Africa 1.74 14 70 11.50 12 1.1 Middle East and 60 1.06 China North Africa $ Billion $ Billion 10 14.3 50 Latin America and 8 40 7.9 the Caribbean 72.38 6 30 59.16 Europe and Developed 4 Central Asia 20 Markets 0.6 1.0 2.2 2 2.5 Asia and Pacific 10 3.62 2.2 (excluding China) 1.3 4.24 6.67 0 0.5 0 2020 2021 2022 2019 2020 2021 2022 EMERGING MARKET GREEN BONDS Page 26 Indeed, Uruguay issued a sustainability-linked bond worth • The penalty in terms of stepped-up coupon $1.5 billion in October 2022. The debt, which matures in payments for failure to achieve the performance 2025, has performance targets that affect the coupon and targets is often too modest relative to the issuer's is linked to the country's contributions to battling climate overall cost of debt, thus limiting the effectiveness of change under the Paris Agreement. Notably, the Uruguay this mechanism to achieve sustainability objectives. structure includes an innovative two-way pricing feature. • The market needs a broader consensus and While failure to meet the performance targets by the standardization on structural issues such as the deadline incurs a 'step-up' penalty, rewarding investors timing of observation dates and the size of financial with higher interest payments, exceeding the targets incentives to help investors more easily assess each results in a 'step-down' in the coupon, benefiting bond and minimize worries around greenwashing. the issuer. • Many issuers cease engaging with investors Debates will inevitably arise around whether investors beyond the roadshows undertaken immediately should be willing to accept a lower coupon if a borrower prior to a bond's initial issue. This opacity and lack exceeds targets. Issuers would argue that it is only fair of communication have impacted credibility and for a product to incentivize both parties. Thus, investors lowered investor confidence. would encourage a more significant commitment to achieving broader sustainability goals by accepting a • The greenwashing risk is even higher around step-down coupon. sovereign issuers than corporates because sustainability performance targets may be The Chile and Uruguay deals marked significant progress abandoned with a change in government that brings toward demonstrating how sovereigns and quasi- a shift in policy. sovereigns can attract funding via sustainability-linked bonds aligned to NDC targets. There is now a greater Scrutiny of investors is intensifying, with a greater focus likelihood that more non-sovereign issuers from those on whether they refuse to buy bonds that do not meet markets will follow. their minimum criteria and to what extent they engage with issuers to help improve broader standards. Sovereign and corporate sustainability- linked bond issuers face several challenges • Given that proceeds can be used for general expenditures, performance indicators' clarity, robustness, ambition, and verifiability are crucial for ensuring credibility. In some cases, key performance targets may be effectively achieved, for example, by selecting backdated indicators. The availability and timely disclosure of relevant data are critical for investors to assess the issuer's progress in achieving the goals. Page 27 Market Analysis and Outlook green bond issue in January 2023.11 the year was dominated by significant currency volatility, lower international copper prices reflecting weaker demand Only Indonesia increased its green bond issuance, by from China, and concerns around government plans to push 2.4 times to $2.6 billion over the year. This was driven mainly through a tax reform bill to fund social programs. The year by the two sovereign issues worth $1.9 billion following the was also marked by political uncertainty stemming from a publication of the country’s Green Taxonomy in January government proposal to reform the constitution that was 2022.12 Indonesia operates a mechanism that enables ultimately rejected in a referendum. tracking and evaluating public expenditure from climate migration and adaption. Meanwhile, Chile’s weaker issuance was partially offset by Brazil, where green bond issuance was up 65 percent Europe and Central Asia at $3.3 billion. The flow of new bonds was diversified Green bond issuance in Europe and Central Asia more across several private-sector issuers, mostly non-financial than halved in 2022, retreating 56 percent because of corporates. These included fertilizer company Yara’s concerns around Russia’s invasion of Ukraine that began in $600 million green bond following the firm’s first Green February. Well-established issuers like the Czech Republic Financing Framework publication in July 2022. Among and Poland saw issuance of green bonds fall by 86 percent financial institutions, lender Itaú issued its first green bond in and 79 percent, respectively. The only notable exception the country, via a private placement to the IFC, and financial was Hungary, which saw issuance rise by 1.9 times to firm Sicredi’s first-ever green Tier-2 bond sold in a private $3.3 billion, driven by the sovereign’s successful $2.5 billion placement to IDB Invest. multi-currency issuance strategy. This involved a multi- Middle East and North Africa tranche Japanese yen-denominated green bond transaction in mid-February 2022, a green bond denominated in the The Middle East and North Africa region became the largest Chinese currency, and a $1 billion green euro-denominated source of new green bonds in emerging markets outside deal. We expect Russia’s invasion of Ukraine to result in China in 2022, with $7.2 billion issued, or 9.3 times the increased issuance of social bonds over green bonds in this amount sold in 2021. The region was a marginal player in the region due to the considerable funding needs for Ukraine’s asset class until 2021, printing around $1.4 billion on average reconstruction. per year between 2019 and 2021. The dramatic jump in bond issuance was attributed to just two countries, namely the Latin America and the Caribbean UAE, which saw a 4.3 times increase to $3.2 billion, and Saudi Green bond issuance in Latin America and the Caribbean Arabia, which issued $3.1 billion. The year before, Saudi Arabia also halved, falling 49 percent over the year due to increasing did not issue any green bonds. socio-economic tensions that prompted radical political UAE’s issuance came from four financial institutions and one changes in select countries. In particular, Chile’s green bond corporation. This included an inaugural $500 million green issuance fell 76 percent to $1.4 billion, bringing it down in bond by Abu Dhabi Commercial Bank and strong issuance the rankings of emerging market issuers to eighth from by well-established users of the green bond market, such as third in 2021, when it was exceeded only by China and India. First Abu Dhabi Bank, which sold $1.5 billion. In January 2022, Following the new government’s appointment in early 2022, a $700 million green project bond was sold to finance the 11 Government of India, 2022, “Framework for Sovereign Green Bonds.” 12 Sustainable Finance Indonesia, 2022, “Indonesia Green Taxonomy Edition 1.0.” EMERGING MARKET GREEN BONDS Page 28 Abu Dhabi Sweihan Photovoltaic Independent Market Trends in Emerging Market Power Project. Bond Issuance Saudi Arabia’s issuance was attributed to the state’s Public Investment Fund raising $3 billion from its debut green bond, Green bonds denominated in the Chinese currency increased including a $500 million tranche with a 100-year tenor. The 1.2 times from the previous year, reaching 61 percent of fund, which manages over $600 billion in assets, plays a total emerging market issuance, from 33 percent in 2021. central role in government moves to diversify the country’s This implies some substitution away from U.S. dollar- economy away from oil. The fund expects to invest more denominated debt that reflects relatively better funding than $10 billion in eligible green projects by 2026.13 conditions in local currency. It is indeed encouraging to see this region placing more focus Meanwhile, bond deals significant enough to qualify on green finance in response to investor demand. for inclusion in benchmark indexes, typically over $300–500 million, accounted for around 20 percent of the Sub-Saharan Africa total from emerging markets outside China, down from 23 percent in 2021. In China, the proportion was 28 percent, By far the smallest component of the emerging green bond falling from 32 percent in 2021. market, issuance of the instruments from Sub-Saharan Africa increased by 20 percent in 2022, to $600 million. Credit quality dynamics diverged, meanwhile, with the Almost all came from South Africa, where Absa Bank printed proportion of investment-grade bonds increasing from $270 million, and Redefine Properties raised $180 million. 30 percent to 33 percent in emerging markets outside Outside South Africa, there were just four other issues— China. In comparison, China fell from 16 percent to three from Namibia and one in Nigeria. 14 percent. Finally, the share of new bonds with medium- term maturities of between three and five years was little Supranational Entities changed at around 54 percent. Supranational entities skewed their GSSS issuance toward Overall green bond issuance in emerging markets was up green bonds, leading to a 46 percent increase in issuance of 21 percent in 2022, driven mainly by financial institutions, the instruments. But at the same time, they cut back across which saw a 155 percent year-on-year increase, and all other GSSS sub-segments, notably with a 74 percent drop government agencies, up 152 percent, albeit from a low level. in social bonds. All in all, supranational entities reduced their This was only partly offset by meaningfully lower issuance by GSSS issuance by 38 percent in 2022, becoming a key driver non-financial corporates, down 31 percent year-on-year, and of lower overall GSSS issuance. sovereigns which were 57 percent lower (See Exhibit 2-h). These weak dynamics in 2022 reflect a combination of Within the non-financial corporate segment, utilities and factors, including de-risking by supranational institutions energy accounted for the bulk of green bond issuance with significant assets or liabilities in Russia or Ukraine, in emerging markets in 2022, at 56 percent in China and credit rating downgrades, and broader tightening of funding 76 percent in other developing countries (See Exhibit 2-i). In conditions.14 Also, supranational entities are relevant players advanced economies, however, while these sectors generally in the local currency bond market, which was particularly hit account for a lower share of overall green bond issuance, in 2022. 13 Reuters, 2023, “Saudi Wealth Fund to Raise $5.5 Billion With Second Green Bond Sale,” Accessed March 1, 2023. 14 Standard & Poor’s, 2022, “Supranationals” report, Special Edition, October 2022. Page 29 Market Analysis and Outlook EXHIBIT 2-h A 21 Percent Rise in Green Bond Issuance Was Mostly Driven by Financial Institutions in 2022 Green bond issuance by sector Emerging Markets 100% Financial Institution 80% Government Agency 60% Sovereign 40% Municipal 20% Non-financial Corporate 0% 2015 2016 2017 2018 2019 2020 2021 2022 Developed Markets 100% 80% 60% 40% 20% 0% 2012 2013 2014 2015 2016 2017 2018 2019 Source: Bloomberg, CBI, Environmental Finance, IFC they did increase markedly in 2022 from 31 percent in 2021 to Use of Proceeds 43 percent in 2022, driven mainly by utilities. Among other Issuers of green bonds are committed to spending the developed market sectors, real estate firms cut back their money they raise on projects and investments with a positive share of green bond issuance to 13 percent, from 23 percent environmental impact. Cumulatively, the largest share of the in 2021, likely reflecting tightening funding conditions and proceeds in emerging markets outside China was designated consequently lower home sales. The auto industry saw the for spending on renewable energy, accounting for 44 percent opposite trend in developed markets, rising to 8.6 percent, in 2022. One explanation is that the average issuance size for from 5.7 percent a year earlier, reflecting economic such projects tends to be larger than other deals. recoveries as the COVID-19 pandemic receded. Low-carbon transportation projects also represented an important destination for money raised in green bond issues, EMERGING MARKET GREEN BONDS Page 30 EXHIBIT 2-i EXHIBIT 2-j Utilities and Energy Account Renewable Energy Claims for the Bulk of Emerging the Largest Share of Market Green Bond Issuance Green Bond Proceeds Emerging markets non-financial Emerging market and developing economies corporates issuance by sector 2022 green bond issuance by use of proceeds $ Billion 0 10 20 30 40 Materials 5% 2022 Technology Renewables 2020-21 annual average 8% 2016-19 annual average Transport Consumer Discretionary 11% Utilities Buildings 43% Water Industrials 18% Waste Energy 15% Land Source: Bloomberg, CBI, Environmental Finance, IFC Unallocated at 22 percent of proceeds in 2022. Other categories to Industry receive funds from green bonds included green buildings, at 11 percent, water, at 10 percent, waste, at 7 percent, while a Information and further 3 percent went toward land use. communications technology In developed markets, while the share of green bond proceeds designated for renewables and low-carbon transport was smaller, at 30 percent and 16 percent Source: Bloomberg, CBI, Environmental Finance, IFC respectively, the percentage assigned to green buildings was significantly higher, at 36 percent. Page 31 Market Analysis and Outlook EXHIBIT 2-k The Chinese Currency Accounted for 61 Percent of Emerging Green Bond Issuance Emerging market and developing economy green bond issuance by currency, 2012–2022 100 80 Chinese yuan 60 Local currency 40 20 Foreign currency 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: Bloomberg, CBI, Environmental Finance, IFC Currency of all local-currency denominated issues, excluding the Chinese yuan. Emerging market green bonds denominated in Chinese yuan increased 1.2 times in 2022, reaching 61 percent of Issue Size total developing economy issuance and almost double their The most liquid bonds, those that are sufficiently large to 33 percent share of a year earlier. With foreign currency- be considered as benchmarks by international investors, denominated issues down by 29 percent, to 31 percent of the provide greater access to external financing as they can total, from 53 percent in 2021, this implied some substitution be included in major indexes. Of the green bonds issued of foreign currency bonds for yuan debt by Chinese issuers, in emerging markets other than China in 2022, there were primarily motivated by relatively better funding conditions 29 benchmark-size bonds of more than $300 million, in local currency. Interestingly, local currency-denominated representing 20 percent of the total, with half exceeding green bonds also fell by 30 percent to reach 8 percent of the $500 million. A year earlier, there were 45 benchmark bonds, total. A year earlier, the share was 14 percent. representing 23 percent. The proportion of benchmark-size U.S. dollar-denominated green bonds from emerging bonds was larger in China, 28 percent, versus 32 percent in market issuers lost market share, sinking to 25 percent from 2021, likely reflecting borrowing for large renewable projects 39 percent. Emerging market euro bonds also retreated to in the country. 6 percent from 17 percent. Ratings The Brazilian real was the next most common currency used by emerging market green bond issuers, losing a percentage A key barrier to investing in green bonds issued by emerging point to account for 3 percent of issuance in 2022, followed market borrowers is the low proportion of debt securities by the Indonesian rupiah, which represented 1 percent carrying internationally recognized credit ratings. In fact, only of the market. The Hungarian forint and the Thai baht 14 percent of green bonds sold by Chinese issuers carried claimed similar shares. These four accounted for 5 percent investment-grade ratings in 2022, down from 16 percent in EMERGING MARKET GREEN BONDS Page 32 EXHIBIT 2-l COP IDR The Brazilian Real Was the RUB 4% 4% BRL Most Common Local Currency MXN 5% 21% Emerging Green Bond, 5% INR Excluding the Chinese Yuan 7% Emerging market and developing economy local currency green issuance by currency MYR THB excluding the Chinese yuan, 2012–2022 8% 13% HUF Note: BRL is the Brazilian real, THB refers to the Thai baht, ZAR the 9% Others South African rand, HUF the Hungarian forint, MYR the Malaysian ZAR 13% ringgit, INR the Indian rupee, MXN the Mexican peso, RUB the Russian 11% ruble, IDR the Indonesian rupiah and COP the Colombian peso Source: Bloomberg, CBI, Environmental Finance, IFC 2021. The remaining 86 percent were unrated, as many issuers in China rely EXHIBIT 2-m on local credit assessments, which makes their valuation difficult for The Most Common Issue Size for Emerging international investors. However, Green Bonds Was Under $50 Million dynamics are different in other Emerging market and developing economy green bond issuance size emerging markets, with 33 percent of newly issued green bonds rated 200 180 at least 500 investment grade, up from 30 percent 160 300 to 500 the previous year. 140 200 to 300 120 $ Million Defaults have been rare in the green 100 100 to 200 bond market as a whole. Among 80 50 to 100 60 emerging markets, there have been 0 to 50 40 three defaults on bonds within the 20 category: two in 2021 by a Chinese 0 solar power firm and a property 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 developer, and one in 2020 by an Indian irrigation firm. Source: Bloomberg, CBI, Environmental Finance, IFC Tenor new entrants came to market including a larger number of Through 2019, most emerging market green bonds were non-financial corporates and sovereigns. This illustrates the medium-term instruments issued by financial institutions, extent to which the green bond market is deepening as it with the majority maturing in three-to-five years. Over the matures, attracting a broader range of both issuers past three years, however, the range of tenors widened as and investors. Page 33 Market Analysis and Outlook In 2022, 54 percent of issuance was medium-term, while another EXHIBIT 2-n 27 percent was in the range of five to 10 years. Meanwhile, 12 percent were Green Bonds Underperformed longer dated, at over 10 years, and the Fixed Income Globally remaining 7 percent were for less than Total return of green bonds versus the global aggregates index three years. 105 2 Market Performance 85 0 In 2022, green bond performance was diametrically different in developed 65 -2 and emerging markets. Green bonds underperformed the broader fixed- 45 -4 income asset class by around 600 basis points globally (See Exhibit 2-n). At the same, however, green bonds from 25 Green Bond Index Over(under) performance, RHS -6 emerging market issuers outperformed Bloomberg MSCI Global Green Bond Index, $ the broader asset class in developing 5 -8 economies by around 450 basis points Bloomberg Global Aggregate Bond Index, $ (See Exhibit 2-o). This is likely to reflect -15 -10 a combination of strong demand for Jan 2021 Jan 2022 Jan 2023 emerging market green bonds on the back of much lower penetration and Source: Bloomberg, CBI, Environmental Finance, IFC weak supply. Green bonds and other sustainable The average greenium represents 6.4 percent of the securities have enjoyed rising demand from investors average spread of bonds in the sample, up from 4.2 percent in recent years, amid an ongoing proliferation of funds previously, as shown in the table below (See Table 2.1). dedicated to environmental, social, and governance goals. Meanwhile, the average greenium widened during 2022 from This is reflected in downward pressure on green bond -4.6 basis points to -7.2 basis points at the end of the year, on yields, opening up a yield gap, or spread, between green a rolling average basis. Compared to the benchmark average, bonds and equivalent conventional bonds from the same greenium widened, according to Amundi’s calculations, to issuer, commonly referred to as a ‘greenium.’ A negative -6.8 basis points in 2022, from -3.4 basis points in 2021. greenium means that a green bond is trading at a lower It is worth noting that this reflects secondary market data, yield compared to a conventional bond with similar or yields on existing bonds as they are traded, rather than characteristics. This implies a lower cost of raising capital for the pricing of newly issued debt. However, secondary market issuers of green bonds, but also lower cash flows paid to the movements act as an indicator of investor sentiment and debt investors. influence the pricing of new bonds in the primary market. This does not capture, however, other costs faced by issuers, including administrative expenses (See Box 2.1) or even the EMERGING MARKET GREEN BONDS Page 34 capacity-building costs of regulators EXHIBIT 2-o and supervisors, who may not be familiar with these instruments. Emerging Market Green Bonds A widening greenium (See Outperformed Conventional Peers Exhibit 2-p) bodes well for issuance Total return of emerging market green bonds versus across international capital markets the emerging markets aggregates index as it indicates robust investor demand 105 12 and incentivizes borrowers, including those in emerging markets, to consider 10 green bonds for future debt issues. 100 Several economic studies have 8 95 Emerging Markets Green Bond Index examined the extent to which investor Over(under) performance, RHS preference for assets that meet 6 Bloomberg MSCI Emerging Markets Green economic, social, and governance 90 Bond Index, $ criteria drives yields lower on green Bloomberg Emerging Markets Aggregate 4 bonds, in both primary and secondary 85 Bond Index, $ markets.15 One analysis, comparing 2 yields on green bonds with those 80 of equivalent conventional debt, 0 finds that demand is higher among euro-area investors for bonds that 75 -2 Jan 2021 Jan 2022 Jan 2023 are credibly green because they are Source: Bloomberg, CBI, Environmental Finance, IFC certified, either officially or with a second-party opinion. Euro area green bonds, where the issuers are certifiably committed to environmental TABLE 2.1 programs or are categorized within Emerging Market Green Premium Statistics, 2022 environmentally sound sectors, trade at a greater and statistically more significant greenium.16 Median Average Number of Average Average premium premium observations spread premium (basis points) (basis points) (basis points) versus average spread (%) -3.4 -6.8 37 106 -6.4 15 See, for example, Zerbib, O., 2019, “The effect of Pro-Environmental Preferences on Bond Prices: Evidence from Green Bonds,” Journal of Banking & Finance vol. 98, issue C. 16 Pietsch, A., Salakhova, D., 2022, “Pricing of Green Bonds: Drivers and Dynamics of the Greenium,” Source: Amundi calculations based on CBI, IFC, Enivronmental Finance, Amundi, MSCI European Central Bank Working Paper No. 2728. Page 35 Market Analysis and Outlook EXHIBIT 2-p The Emerging Market Greenium Continues to Widen (i.e. green bonds becoming richer versus conventional) A widening greenium indicates rising investor demand and incentivizes borrowers 2 0 Weekly Average Green Premium -2 -4 -6 -8 Average Green Premium Smoothed -10 -12 Oct 2019 Oct 2020 Oct 2021 Oct 2022 Apr 2019 Apr 2020 Apr 2021 Apr 2022 Source: Amundi calculations based on CBI, IFC, Environmental Finance, Amundi, MSCI In developing countries, the “longer-holding” behavior of In general, without standardized guidelines and a global green bond investors compared to non-green bondholders quality control system, potential buyers of emerging may provide an important financial advantage to issuers market green bonds are forced to carry out additional due during financial shocks. Similarly, from an investor diligence to safeguard against exposure to greenwashing, perspective, green bonds may help to preserve the portfolio thereby raising the transaction costs of buying green bonds. value by being resilient to market sentiment shifts.17 Issuers Establishing unified regulatory standards is key to channeling from developing countries may face more challenging more investor capital into emerging market green bonds. market terms from investors. This highlights the importance, discussed later in this report, of implementing credible global standards for green bonds and considering synthetic securitizations in the context of public-private partnerships. 17 See Ramos, E., 2022, “Green Bond Behavior and Greenium During a shock,” December 13, 2022. BOX 2.2 Green Bond Issuance Costs: The Case of Municipalities in Latin America The uptake of green and sustainable bonds at a municipal the government’s debt management capacity and its level has been limited in emerging markets, with only ability to reduce the cost of debt. Therefore, despite $4 billion in cumulative issuance since 2014. In Latin an investment pipeline that could potentially meet the America in particular, the use of green bonds has been requirements to be financed with green bonds, the constrained by shallow capital markets and regulatory Mexico City government has stayed away from the bond frameworks addressed at controlling subnational debt. market since 2019. Mexico City is one of the few subnational governments Colombia’s case is similar, as subnational authorities have to have issued green bonds, selling three between 2016 also shied away from green bonds. The city of Bogota and 2019. However, despite high demand, the green bond issued a social bond in 2021 , but the experience was market is yet to scale. While local authorities would like to mixed. Despite high demand (presenting a bid-to-cover tap this market as early as 2023, they find that the costs ratio of 1.97), the fact that resources were earmarked for outweigh the benefits. specific uses led to financial management challenges. The rates on green bonds have not proven significantly The disbursement of resources didn’t necessarily coincide lower than those of regular bonds. Meanwhile, with project pace of execution, leading to resources being transaction costs related to external verification and parked for prolonged periods of time. Regular bonds reporting are significantly greater. Data is not available or debt represent a more efficient option. Particularly, on the average greenium in the emerging primary bond because the national government only allows regional markets. In the secondary market, however, the average authorities to issue debt to cover cashflow imbalances. greenium among developing country green bond issues An alternative is to link the issuance with a portfolio in 2022 was 6.8 basis points (See Table 2.1). Meanwhile, of projects, rather than a single project, following additional costs associated with structuring and the national government’s example with its green registering green bonds can vary considerably, with some bond issuance in 2021. This, however, requires greater estimates ranging from $10,000 to $500,000. structuring and execution capacity. In the case of Mexico City, subnational debt is regulated Higher transaction costs, the inflexibility in the use of by the Financial Discipline Law, which forces governments green bond proceeds, and more attractive local debt to always choose the least expensive financing financing terms have led the city of Bogota to rely mostly alternative. It has been increasingly difficult for green on loans, although more recently it has increased its bonds to pass this test, particularly when compared issuance of regular bonds. to loans which offer more competitive terms. In this Although there is appetite for green bonds from investors, context, municipalities would need to be allowed to pay and certain large municipalities seem to have eligible a premium, in the short term, to develop the green bond projects and interest in financing through green bonds, market, in order to benefit from any greenium in the these are still not competitive in comparison with long run. However, given municipalities’ current fiscal local debt markets. This is particularly the case given constraints, this seems unlikely. regulatory frameworks that limit municipalities’ financial Additional challenges for the Mexican municipal bond management capacity. Given subnational governments’ market include the fact that investors in municipal bonds limited fiscal capacity and lack of incentives to pay the prefer short-term issuances (3–5 years), which are not a price of developing the green bond market, blended good fit for financing needs, as the government requires finance could represent a way to unlock the green bond longer maturities, which is why it has relied on loans since market and allow it to achieve the required scale for it 2019. to be a competitive source of financing at the municipal level in the medium term. In addition to greater transaction costs and a lengthier process, bonds include a no-prepayment clause, limiting Page 37 Market Analysis and Outlook Emerging Market Green Bond Holder 16 percent, and insurance companies 6 percent. We believe, however, that governments (including sovereign Profile and their Relative Volatility wealth funds) and pension funds are also likely to be major holders of emerging market green bonds, despite not Detailed data on the holders of green bonds is scarce. being accounted for in the Bloomberg data set. By region, Bloomberg does provide information on bond holders, Bloomberg’s data suggest the bulk of emerging market though it only captures around 20 percent of outstanding green bond holders reside in the United States and Europe emerging market green bonds. Nevertheless, it shows that (Ireland, Luxemburg, United Kingdom), with China in institutional investors hold the bulk of emerging market fifth place. green bonds. Within that broad category, investment managers account for 78 percent, banks represent EXHIBIT 2-q Emerging Market Green Bonds Frequently Fare Better Than Conventional Securities During Risk-off Episodes Performance of JPM Green bond index vs EMBI and CEMBI CEMBI D index (HC Corporate) EMBI GD index (HC Sov) JP EM Genie index 390 140 1050 380 135 1000 370 130 950 360 CEMBI D index (HC Corporate) 125 EMBI GD index (HC Sov) JP EM Genie index 350 900 120 340 850 115 330 800 110 320 750 310 105 300 100 700 2018 2019 2020 2021 2022 2023 Note: CEMBI D refers to the Corporate Emerging Markets Bond Index Diversified while EMBI GD is the Emerging Markets Bond Index Global Diversified Source: Bloomberg and authors' calculations EMERGING MARKET GREEN BONDS Page 38 While emerging market green bonds are still subject to Market Outlook underlying country and global risks, they also tend to have longer-term holders, as opposed to speculative investors Although 2022 witnessed a fall in GSSS bond issuance who trade more tactically in response to market conditions. compared to 2021, this was mainly due to ongoing market This means that emerging market green bonds often display fallout from Russia’s invasion of Ukraine and rising interest lower volatility than conventional debt during times of rates globally. This decline in emerging market debt issuance market stress. This was evident during the 2020 pandemic was also evident in conventional emerging market debt year when a number of emerging market debt indices with a drop in sovereign debt sales from $182.5 billion in outperformed conventional bond gauges. 2021 to $97 billion the following year, according to J.P. Morgan data. Country authorities in emerging markets Another reason emerging market green bonds frequently face difficult choices between sustaining financial stability fare better than conventional securities during risk-off and supporting growth in an environment of tighter global episodes is that they are often issued by borrowers located liquidity, increased geopolitical frictions, and slower global in developing countries that have high credit ratings such as growth. Notwithstanding the continuing headwinds Chile, Hungary, Poland, and South Korea. A case in point was affecting the broader bond market, GSSS bonds will likely the relative performance of emerging market green bonds in continue to increase their market share amid rising demand the context of the COVID-19 outbreak in 2020 (See for sustainable investment. China will remain the most Exhibit 2-q). significant contributor to green debt issuance in emerging One more variable to consider when looking at emerging markets, but at lower volumes. market green bond performance is duration. As it takes In our central scenario, we expect an easing of global time to complete a green project, green bonds tend to have inflationary pressures driven by a global slowdown and longer-dated maturities compared to both emerging market weaker credit growth. This, despite China’s widely expected corporates and high-yield sovereigns. Therefore, at times economic rebound, may hinder emerging market fixed of duration sell-offs like in 2022, green bond performance income in 2023 in absolute terms, as risk aversion increases. is negatively impacted as core yields increase. With the Fed Still, emerging market bonds could outperform local equities approaching the end of its hiking cycle, we expect pressure as the cumulative rate hikes implemented so far feed through from duration should ease, which is supportive for fixed to the real economy, translating into downward earnings- income in general, but green bonds in particular. per-share revisions. In this central scenario, GSSS bonds Finally, a very important driver of allocations toward as a proportion of total issuance will continue to increase. green bonds over the last few years has been regulatory In a context of slow growth, sovereign issuers, including requirements. This has been especially true for European sub-sovereigns and agencies, will dominate the market. investors since the implementation of Sustainable Finance When it comes to the fundamentals, we expect emerging Disclosure Regulation. This means that investors will markets excluding China to benefit from being more continue to demand high quality and reliable information on advanced in the tightening cycle and the fight against how green bond proceeds are used. inflation relative to developed markets (with Brazil being a good example in this regard). More modest stimulus programs during the COVID-19 shock and Europe’s recent energy crisis will also translate into lighter fiscal headwinds for emerging economies compared with their developed counterparts. This should translate into growth as high Page 39 Market Analysis and Outlook EXHIBIT 2-r Emerging Market Green Bond Issuance Under Three Global Economic Scenarios Emerging market and developing economies green bond issuance forecasts for 2023 120,000 Catchup Scenario $111,209 100,000 Central Scenario $102,284 Slowdown Scenario $93,359 80,000 $ Million 60,000 40,000 20,000 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Amundi calculations based on CBI, IFC, Environmental Finance, Amundi as 27 percent in green bond issuance cumulatively over to overall green bond issuance in emerging markets from 2023–2024. 73 percent in 2022 to 68 percent in 2023–2024. At the same time, we expect green bond issuance to fall Importantly, our expectations for the full year are consistent around 7 percent in China during 2023, mostly due to with recent trends. While fixed-income issuance had a the relatively unattractive yields of Chinese local bonds very strong start to the year (driven by higher yields), it versus the United States and Europe, and the strength has since stalled due to uncertainty around a number of of the country’s post-COVID-19 recovery falling short of factors, including the U.S. Federal Reserve’s terminal rate, expectations last year. In fact, a relatively high U.S. dollar ongoing financial stability concerns in developed markets, funding rate is the main driver of the observed decline and concerns around the strength of China’s post-COVID-19 in dollar-denominated green bonds in China, as onshore recovery. companies can finance themselves at much lower rates in As in previous editions of the report, however, we also local currency. Also, weaker-than-expected growth in China run two alternative scenarios. The first of these is a more in 2023 will be due to a combination of COVID-19 restrictions optimistic outlook, where a faster-than-expected decline and a potentially severe correction in the domestic real in inflation is accompanied by an earlier completion of the estate sector. As a result, China will reduce its contribution tightening cycle at a lower terminal rate. In parallel, an EMERGING MARKET GREEN BONDS Page 40 EXHIBIT 2-s Chinese Green Bond Issuance Under Three Global Economic Scenarios China green bond growth forecast 80,000 Catchup Scenario $75,823 70,000 Central Scenario $69,944 Slowdown Scenario $64,065 60,000 50,000 $ Million 40,000 30,000 20,000 10,000 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Amundi calculations based on CBI, IFC, Environmental Finance, Amundi earlier-than-expected resolution of Russia’s invasion of increase of close to 20 percent, partly due to the relatively Ukraine reduces uncertainty, eases supply-side pressures, unattractive yields of Chinese local bonds. and boosts global trade. In this case, recession is avoided and Our pessimistic scenario is defined by a global economic growth returns to its pre-pandemic trend. Financial stability slump driven primarily by tighter-than-expected financial concerns ease, bond prices recover on the expectation conditions. Two potential paths could take us there. On the of lower rates, and credit quality stops deteriorating. The one hand, this could be the result of persistent inflationary combination of higher risk appetite and rates peaking in the pressures keeping interest rates high. On the other, this United States would translate into higher capital flows into could also be the result of a credit crunch, with banks rapidly emerging markets, which offer higher growth rates (roughly reducing exposures to assets that will underperform in a 3 percentage points on average, according the Amundi high-rate environment such as commercial real estate and Institute) relative to developed markets. Higher asset prices leveraged loans. Recent events in the financial sector such and stronger emerging market currencies would result in as the stresses experienced by U.S. regional banks and the higher foreign exchange-adjusted returns. Under these rescue of Credit Suisse could also contribute to this scenario. conditions, we would expect green bond issuance to grow by Either way, tighter financial conditions would weigh close to 40 percent cumulatively in 2023–2024 in emerging negatively on both private consumption and investment, markets excluding China. Including China, we see a smaller Page 41 Market Analysis and Outlook ultimately leading to weaker economic growth and a broad- Asia and the Pacific based deterioration in credit quality. This alternative scenario China is expected to remain the largest single contributor to could be compounded by higher geopolitical tensions around overall green bond issuance in emerging markets over the Ukraine (but also Taiwan) and a further fragmentation next two years. Its weight, however, is expected to fall from of global trade. Higher risk aversion would put additional 73 percent in 2022 to 68 percent in 2023–2024 on the back upward pressure on borrowing costs as well as downward of weaker-than-expected growth in 2023 and disappointing pressure on emerging market currencies. Overall, this would yields on China’s onshore bonds. translate into lower capital inflows (or even net outflows) and lower asset values, particularly when measured in The China Green Bond Principles released in July 2022 now foreign currency. In this scenario, we would expect green require that 100 percent of the money raised through green bond issuance in emerging markets (including China) to be bonds is directed toward green projects rather than the 50 flat cumulatively over the next two years, with an 11 percent to 70 percent requirement under the previous guidelines. decline in 2023 followed by a 12 percent rebound in 2024. Not all issuers are currently applying these principles, however, because of fragmentation in the governance of China’s green bond market. In a context of growing concerns Opportunities for Green Bond around potential greenwashing, uncertainty over the Market Growth proportion of funds effectively allocated to green projects may further reduce the attractiveness of green bonds issued Issuance patterns reflect the prevailing economic, in China. environmental and structural issues in individual markets. As mentioned earlier in this section, uncertainty around Outside China, the pickup in green and sustainability markets geopolitics and the interest rate outlook feed into demand in Asian countries is likely to be further strengthened for green bonds. Political factors shaping sustainable by recent policy efforts. Following the publication of a finance policies and frameworks also play a part, as does taxonomy for the region, several countries are in advanced the institutional makeup of individual countries. For many stages of developing their own guidelines or classification developing economies, limited capital market depth and systems detailing which economic activities qualify for underdeveloped financial infrastructure contribute to environmental or sustainable investment. Indonesia and keeping green bond issuance below potential. Later sections Malaysia published taxonomies in 2022, while both Thailand of this report (See Chapters 3 and 4 in particular) highlight and Vietnam have produced draft frameworks which are the importance of sound governance and consistent closely aligned with those of regional peers. Efforts to regulation for healthy financial markets. These, in turn, improve data and information disclosure and reporting depend on political stability. frameworks will be key to ensuring these voluntary taxonomies support the development of GSSS markets Table 2.2 illustrates how individual countries perform across in the region. Additionally, Malaysia and Indonesia have these factors and indicates whether there has been a opportunities to grow Islamic sustainable finance markets notable change from 2021 to 2022. Some members of the through the use of green and social sukuks. IFC-initiated Sustainable Banking and Finance Network have not yet issued green bonds. Nevertheless, they demonstrate In South Asia, Indian policymakers are spurring further potential based on their commitment to national sustainable development of the green bond market, which has mostly finance initiatives. Market prospects for each region are been concentrated in issuance by renewable firms. The discussed in the remainder of this section. government published its sovereign green framework in October 2022 as well as additional criteria for green bond EMERGING MARKET GREEN BONDS Page 42 TABLE 2.2 Determinants of Green Bond Market Potential Volume of Cumulative Sustainable Green Bond Momentum Capital Market Development Governance Green Bonds Volume of Banking and Issued in Green Bonds Network 2022, $Million Issued in 2012- Score 22, $Billion Overall Green Bond Green Bonds Domestic Market EMBI Spreads, Regulatory Rule of Law Issuance in Issuance Credit to Capitalization March 2023 Quality Index 2022 Relative to Private Sector as a % of GDP Total Debt as a % of GDP Issuance in 2018-22, % China 67.56 163.9 5 3 3 5 5 3 3 3 Fiji 3 0 5 0 0 3 3 Indonesia 2.58 8.0 5 3 3 3 4 4 3 3 Lao PDR 2 0 0 0 0 0 2 2 Malaysia 0.25 1.3 1 3 3 5 5 3 4 4 Mongolia 4 0 0 3 0 3 3 3 Philippines 0.23 2.8 3 3 3 4 5 4 3 2 Samoa 1 0 0 1 0 0 3 3 Thailand 0.81 3.6 3 3 3 5 5 0 3 3 Vietnam 0.04 0.2 4 5 5 5 5 5 3 3 Armenia 0.1 1 3 3 5 1 3 3 3 Czech Republic 0.55 7.9 1 5 5 4 2 3 5 4 Estonia 0.17 0.2 1 3 3 4 0 0 5 5 Georgia 0.8 4 5 5 5 1 3 4 3 Hungary 3.31 6.7 1 5 5 3 2 0 3 4 Kazakhstan 2 0 1 3 3 4 3 3 Kyrgyz Republic 1 0 0 1 0 0 3 3 Latvia 0.11 0.3 1 3 3 3 0 0 4 4 Lithuania 0.02 0.5 1 3 3 3 0 0 5 4 Poland 0.58 7.0 1 5 5 3 3 4 4 3 Romania 0.82 2.8 1 3 3 3 2 3 3 3 Russia 2.5 1 3 3 4 4 5 2 2 Serbia 1.2 2 4 4 3 0 3 3 3 Slovenia 0.1 1 2 2 3 2 0 4 4 Slovakia 0.82 1.3 1 4 4 4 0 0 4 4 Türkiye 0.11 4 3 3 5 3 3 3 3 Ukraine 1.2 3 4 4 3 0 1 3 2 Argentina 0.35 1.0 3 3 3 0 0 1 2 3 Barbados 0.0 1 3 3 5 5 0 4 3 Brazil 3.27 9.4 4 3 3 5 5 3 3 3 Chile 1.36 14.1 3 5 5 5 5 4 4 4 Colombia 0.03 0.8 5 3 3 4 3 3 3 3 Costa Rica 3 0 4 2 3 3 3 Dominican Republic 0.0 3 1 1 3 0 3 3 3 Ecuador 0.09 0.2 3 3 3 3 0 1 2 3 Guatemala 0.7 1 4 4 3 1 3 3 2 Honduras 3 0 0 4 0 2 2 2 Mexico 2.9 4 3 3 3 3 3 3 2 Panama 0.3 3 3 3 5 3 3 3 3 Paraguay 3 0 0 4 1 3 3 2 Peru 0.03 1.5 3 3 3 4 4 3 3 2 Uruguay 0.4 1 3 3 3 0 4 4 4 Egypt 0.9 3 3 3 3 2 5 2 3 Iraq 3 0 0 2 0 3 2 2 Jordan 3 0 0 5 4 3 3 3 Lebanon 0.1 1 5 0 0 1 2 2 Morocco 0.09 0.1 4 3 3 5 5 3 3 3 Tunisia 2 0 0 0 3 1 3 3 Saudi Arabia 3.06 4.4 1 3 3 0 5 4 3 3 United Arab Emirates 3.18 5.1 1 3 3 5 5 4 4 4 Bangladesh 4 3 3 0 2 2 India 2.17 12.9 3 3 3 4 5 3 3 3 Nepal 1 0 0 1 0 0 3 3 Pakistan 0.5 3 5 5 2 0 1 2 2 Sri Lanka 3 0 0 0 2 1 3 3 Cote d'Ivoire 0.0 1 2 2 3 2 3 3 2 Ghana - 3 0 0 2 2 1 3 3 Kenya 0.1 4 3 3 3 3 2 3 3 Maldives 2 0 0 4 0 4 2 3 Namibia 1 5 2 3 3 3 Nigeria 0.05 0.2 4 3 3 2 2 1 2 2 Seychelles 1 1 1 1 0 0 3 3 South Africa 0.55 2.0 4 3 3 5 5 3 3 3 Notes: Countries included are those that are Sustainable Banking and Finance Network (SBFN) members or green bond issuers. Countries are scored from 0 to 5 on each of the components, with 5 being the highest on a relative basis, according to available data. The SBFN Score is based on the Sustainable Banking and Finance Network measurement framework assessing national sustainable finance policies. Countries that are not SBFN members are indicated in gray. Sovereign Green Bond Issuance is based on whether the sovereign has already issued green bonds and whether it has announced plans to do so. Relative Green Bond Issuance measures the share of green bond issuance relative to total bond issuance from 2017–21. Domestic Credit to Private Sector is based on the percent of gross domestic product and refers to financial resources provided to the private sector by financial institutions. The data source is the World Bank. Market Capitalization data is based on the percent of GDP and are sourced from the World Bank and World Federation of Exchanges. J.P. Morgan Emerging Market Bond Index spreads are measured in basis points and are from May 2022. Lower spreads are scored as a 5, while higher spreads are scored as a 1. The Regulatory Quality and Rule of Law Index indicators are sourced from the World Bank. Page 43 Market Analysis and Outlook issuers. The landmark issuance of two sovereign green bonds Chile. Mexico and Peru are also developing frameworks of in early 2023 raised 160 billion Indian rupees, nearly $2 billion, their own though they have made less progress than some which is likely to foster momentum in the broader domestic regional peers. bond market. Elsewhere, Bangladesh’s central bank recently published its taxonomy, setting out guidelines for eight Middle East and North Africa sectors with a particular focus on solar facilities, while Sri Led by Saudi Arabia and the UAE, the momentum generated Lanka launched its green framework in May 2022. in 2022 for green bond issuance in the Middle East and North Africa has carried over into the early part of 2023. The Saudi Europe and Central Asia sovereign wealth fund placed its second bond in February While the rollout and implementation of EU-level standards 2023, raising $5.5 billion and generating considerable interest and policies related to GSSS bonds have implications for from institutional investors, including from Asia. Financial global markets, they are particularly significant for issuers institutions in the UAE have been regular issuers, with Dubai and investors in EU member and accession countries. Islamic Bank selling a second sustainable sukuk in early 2023. Egypt has announced plans to issue $500 million in green Hungary plans to update its green bond framework to align bonds within the year to finance water, renewable energy, with the EU Taxonomy, and Romania is working to finalize and electric mobility. its green bond rules. Issuances in 2022 such as Hungary’s repeat sovereign panda green bond, as well as an expansion Sub-Saharan Africa of product offerings to include covered green bond issuance in Poland, demonstrated the region’s potential to tap a Although GSSS markets are nascent in Sub-Saharan Africa, broader investor base by using alternative currencies and developments in 2022 have been encouraging. Signs of structures. The region has strong prospects for further progress include Kenya’s draft green fiscal incentives policy sovereign issuance in 2023, with Slovenia having already framework which is intended to encourage private sector issued its second sustainability bond early in the year, Türkiye investment in green projects. At the COP27 summit, Namibia issuing a $2.5 billion green sovereign bond in April, and and the EU announced a partnership to develop renewable Romania indicating it plans to issue a sovereign green bond. hydrogen supply, which included plans to mobilize funding to support infrastructure needs. Identifying a pipeline of green Latin America and the Caribbean assets is essential to the growth of markets in Sub-Saharan Africa, as is strengthening market infrastructure. Financial Issuance of sustainability and sustainability-linked bonds regulators in Ghana unveiled new guidelines for listing continues to be a strong thematic focus in Latin America and trading green and sustainable bonds, while Nigeria’s and the Caribbean. The landmark issuances of sovereign stock exchange aims to deepen the country’s market for sustainability-linked bonds in Chile and Uruguay provided a sustainable products. significant boost to the broader markets in these countries which are likely to see further growth. Green bond markets, however, still have significant potential, as demonstrated by a deal from a renewable energy firm in Argentina early in 2023. Brazil plans to issue a sovereign bond in either a green or sustainable format later this year. Efforts toward strengthening market infrastructure continue, with the development of national taxonomies underway in Brazil and 3 Recent Global Initiatives and Implications for Emerging Markets T he following section starts by examining the fragmentation of international capital markets. Different issue of “greenwashing” whereby an issuer rules in different markets make it difficult to compare them, makes misleading claims about a project’s which acts as a major hindrance to cross-border investors. environmental credentials to qualify for sustainable Furthermore, it also raises the risk of greenwashing by funds. This is an important problem that is drawing the enabling issuers to choose the least onerous rules when attention from regulators and investors alike. Failure to seeking to issue debt that is eligible for sustainable tackle this challenge could make investors increasingly investment. reluctant to deploy funds in emerging markets because Here we outline efforts to achieve better coordination of the heightened reputational and compliance risk that between markets, such as a joint initiative between the EU comes with greenwashing. and China, which should unlock greater potential in GSSS A related obstacle that international investors face when markets. We also include a box outlining a project by a group deciding how to allocate resources to green investments of international investors to assess sovereign issuers from a in emerging markets, addressed throughout this report, is climate perspective. underdeveloped regulatory structures. In particular, multiple jurisdictions are embarking on initiatives to develop green finance taxonomies to enshrine best practice and set up Greenwashing, addressing a parameters for investment. Another issue is the application legitimate concern of developed markets standards to emerging market countries, which could put emerging market countries Growing demand for sustainability-related assets, expanding in a disadvantageous position as they start from a lower product offerings, and rapidly changing regulations raise base than their developed market peers. However, a lack the risk of unscrupulous issuers misstating the extent to of coordination between countries risks exacerbating the which bond proceeds fund environmentally or socially sound Page 45 Recent Global Initiatives and Implications for Emerging Markets projects, a practice commonly referred to as greenwashing.18 They outlined market participants’ roles in greenwashing, False or misleading sustainability claims include exaggerating including acting as trigger, spreader, and receiver of a or obfuscating elements of issuers’ sustainability profile as sustainability-related claim. They also spelled out areas on well as vague, immaterial, or unambitious sustainability which sustainability-related claims can be made. These commitments. include an entity’s governance, sustainability strategy, objectives, qualifications in relation to a bond’s issuer, the Greenwashing can occur at different phases of the green project it finances or the controls in place, and claims about bond life cycle due to weak monitoring and enforcement as metrics based on historical data or future targets. well as failures in reporting the intended use of proceeds. This brings an additional element of risk to the GSSS bond Another area the regulators identified concerns the market that threatens to dissuade ESG investors from misleading qualities of a sustainability-related claim. This deploying funds in emerging markets. Solutions to address can include selective disclosure (cherry-picking positive these challenges include robust third-party certifications information), omissions, or vagueness and ambiguity. Finally, and monitoring, mandatory disclosures, the development the regulators highlighted the channels through which and adoption of voluntary guidelines, and harmonized sustainability-related claims are communicated to other taxonomies (as detailed in Chapter 4). Improvements participants, including regulatory documents, ratings and in instrument design could also alleviate greenwashing benchmarks, project information, and marketing materials. concerns by ensuring financial penalties are sufficiently large They also outlined the various stages of the green bond’s life to motivate issuers, embedding sustainability targets that cycle where these issues can arise. are both material and ambitious, and eliminating loopholes These areas offer guidance on minimizing the risk of that minimize penalty pay-outs.19 Nevertheless, regulatory greenwashing and maintaining the integrity of sustainable and other reforms aimed at improving transparency and finance. There are encouraging signs of progress in countering greenwashing must be balanced against the need addressing greenwashing across the green finance market. for flexibility while containing costs. Failure to achieve that For example, mandatory disclosure practices related to balance could be counterproductive and dissuade smaller sustainability are becoming more common in different issuers. regions, while entities are using voluntary guidelines Regulators are focusing on greenwashing claims more. There have also been advances in developing global guidelines on common definitions and methods. Financial authorities are taking some steps to address this. At the end of 2022, three European supervisory authorities— Calls for mandatory sustainability the European Banking Authority, European Insurance disclosure are getting louder. and Occupational Pensions Authority, and the European Securities and Markets Authority—launched a public Data disclosure requirements enable investors to price risks consultation, seeking insights on analyzing greenwashing appropriately and develop a sustainable finance sector in claims.20 emerging markets. Some countries like India have launched 18 See for example, Curtis, Q., Weidemaier, M., and Gulati, M., 2023, “Green Bonds, Empty Promises,” Virginia Public Law and Legal Theory Research Paper, No. 2023-14, February 2023. 19 See Ul Haq, I., and Doumbia, D., 2022, “Structural Loopholes in Sustainability-Linked Bonds,” Policy Research Working Paper, No. 10200, October 2022. 20 European Securities and Markets Authority, 2022, “ESAs Launch Joint Call for Evidence on Greenwashing,” Press Release, November 15, 2022. EMERGING MARKET GREEN BONDS Page 46 new guidelines to make these disclosures mandatory.21 requirements. Company disclosures will also lead to an expansion of policy Efforts on sustainable regulatory disclosures and common and research analysis. In the EU, the Corporate Sustainability guidelines or taxonomies on best practices for green Reporting Directive entered into force at the start of 2023 definitions are indications that the global market is and was set up to ensure that companies report reliable mobilizing to minimize the risk of greenwashing into the and comparable sustainability information. In Singapore, future. The importance of this cannot be overstated. The climate disclosures are mandatory for financial companies.22 prevention and identification of greenwashing must be Meanwhile, climate disclosure rules proposed by the clearly defined to ensure issuers and investors redress this Securities and Exchange Commission in the United States issue. This would be a major step in preventing the green are still under development.23 bond market from suffering reputational damage that A shift is underway from voluntary to more chokes off flows of much-needed investment in sustainable formal guidelines on green principles. projects across emerging markets. Adherence to the ICMA’s green bond principles can help strengthen investor confidence in green bond instruments Toward Standardization of Taxonomies and support establishing local green bond markets. While voluntary market principles have proven effective in many To achieve goals set out in the Paris Agreements, significant areas, formal measures enshrined within regulation could resources must be deployed globally to build resilient further support and incite green bond issuers to define clear economies in light of the challenges posed by climate objectives and performance indicators while producing clear change. For renewable energy alone, investments amounting impact reporting. to $1 trillion per year are necessary between now and 2030 to reach net zero objectives by 2050, according to the Developing global sustainability disclosure International Energy Agency.25 standards will foster integrity in sustainable In emerging markets, adapting to a carbon-neutral global markets and avoid fragmentation in global economy will be especially challenging, given a relative capital markets and regulatory approaches. scarcity of capital compared with developed countries. Plugging this financing gap will become harder still amid The International Sustainability Standards Board at the IFRS multiple challenges and economic distortions associated Foundation—a public body overseeing financial reporting with climate change. Governments will face simultaneous standards—has recently outlined the steps required to demands to contain energy prices, maintain economic establish a comprehensive global baseline of sustainability growth and create jobs, amid ever rising costs from more disclosures.24 It intends to serve as a global baseline to frequent extreme weather events associated with climate reduce further fragmentation of sustainability disclosure 21 SEBI has prescribed additional disclosures in offer documents for issuance of green debt securities (including the environmental objectives of the issuance and details of the project where proceeds are to be deployed), as well as post-listing continuous disclosures in relation to the utilization of the proceeds, details of unallocated proceeds and performance of the project. Source: https://www.lexology.com/library/detail.aspx?g=954cd74b-bf66-4ec6-a2c3-45cd2fa5c547 22 See https://www.sgx.com/sustainable-finance/sustainability-knowledge-hub 23 Federal Register, 2022. “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” Proposed Rule by the SEC. 24 IFRS, 2022, “ISSB Delivers Proposals That Create Comprehensive Global Baseline of Sustainability Disclosures,” Press Release, March 31, 2022. 25 International Energy Agency, 2021, “Financing Clean Energy Transitions in Emerging and Developing Economies Report.” Page 47 Recent Global Initiatives and Implications for Emerging Markets EXHIBIT 3-a An International Overview Progress toward sustainable finance taxonomies varies internationally In place High-level guidance in place Under development In discussion Source: FoSDA Workstream on Taxonomies change. Therefore, ensuring that policy and regulatory Indonesia, South Africa, and Georgia. frameworks on sustainable finance are robust will be These green taxonomies define environmentally sustainable critical for mobilizing financial resources and attracting the economic activities or investments that can help countries investment needed to close financing shortfalls. progress toward meeting targets related to priority Progress in closing financing gaps in emerging markets environmental objectives.26 They seek to address the risk of has been slow thus far, in large part due to the absence or greenwashing around corporate and sovereign borrowing deficiency of public policy on funding economic and energy while promoting the development of green finance by transitions. A lack of standardized regulatory frameworks for helping companies, investors, and policy makers to make sustainable finance is keeping flows of investment capital better-informed decisions. below their potential. To address this deficiency, a number The number of emerging market countries considering of developing country governments have taken steps since setting up green taxonomies is rising around the world. 2022 to introduce green classification frameworks, including Regulatory frameworks are already under development in 26 World Bank, 2020, “Developing a National Green Taxonomy.” EMERGING MARKET GREEN BONDS Page 48 However, this expansion of taxonomies around the world raises issues of comparability, interoperability, and credibility, BOX 3.1 a significant problem for potential investors seeking to Indonesian and South allocate funds in multiple jurisdictions. African Taxonomies For example, Indonesia relies on qualitative assessments Launched on January 20, 2022 by President Joko to evaluate economic activities, whereas the EU uses Widodo, the Indonesian taxonomy is based on the quantitative measures, making the two systems evaluation of sectors and sub-sectors of the economy incompatible from international investors’ perspective. in terms of their impact on the environment and Another notable example is the EU’s system for rating society. It introduces a classification system which green buildings based on its Energy Performance Certificate divides sectors into three categories. These are: and Near Zero Energy Building definition. Neither of these • Green: The activity has a positive impact on are applicable outside Europe, though the EU has recently the environment and is aligned with national communicated its intention to standardize these two environmental objectives. measures globally. • Yellow: The activity does not have a significantly Part of the problem of comparability relates to the existence negative impact on the environment but needs of two alternative approaches to establishing national to adapt for transitional purposes to align with taxonomies. The first of these, a whitelist-based approach, national environmental objectives. relies on the identification of projects or economic activities that have an environmental or social impact in each sector • Red: The activity has a negative impact on the of an economy. China, Mongolia, and Russia are among the environment. countries with taxonomies modeled around this system. Similarly, South Africa published a Green Finance The second method focuses on technical screening criteria Taxonomy in April 2022. This encompasses a and thresholds which are specific to each economic activity, classification system that maps the sectors and without assessing them at the level of technologies or sub- activities that need to contribute to tackling sectoral activities. Chile, Colombia, the EU, South Africa, and climate change and informs companies of areas for South Korea have opted for this approach. improvement and their associated screening criteria. The South African taxonomy initially focuses on But the existence of more than one model makes climate change but is expected to be extended to comparisons between markets difficult for international other areas such as biodiversity and land use. investors, undermining the appeal of green finance as an asset class and contributing to market fragmentation. Harmonizing taxonomies would the Dominican Republic, Kazakhstan, India, Thailand, and the help reduce greenwashing. UAE, while other jurisdictions including Costa Rica, Egypt, and Mexico, are preparing similar steps.27 Standardization would make it possible to provide a common definition of the procedures for assessing economic 27 Future of Sustainable Finance Alliance, 2022, “Taxomania! International Overview Update 2022,” accessed on February 26, 2023. Page 49 Recent Global Initiatives and Implications for Emerging Markets activities. This would prevent issuers referring to the least onerous standard available to EXHIBIT 3-b them, thereby undermining the effectiveness of climate finance instruments in channeling Building Blocks for Bridging capital to areas where it can have a meaningful Climate Data Gaps impact on sustainability. In emerging markets, in addition to data gaps and statistical challenges, the lack of clarity CONSISTENT METRICS, about which activities and assets can be defined LABELS AND as green has hindered the scaling up of green METHODOLOGICAL STANDARDS finance. The development of harmonized Development and transparent use of labels and methodological standards. Work toward a classification definitions and methodological common set of well-defined and standards would help ensure the availability, decision-useful metrics. comparability, and reliability of climate- related data (See Exhibit 3-b). To support environmentally sustainable investments, Available, there is a need to set up a widely accepted reliable and comparable data global taxonomy and sustainable finance TAXONOMIES DISCLOSURES classifications. Efforts toward a minimally Rapid convergence toward a accepted global taxonomy. common and consistent set of The convergence of different taxonomies over global disclosure standards. time will be important in ensuring consistency in climate-related disclosures but will also improve the comparability of credit ratings across markets. It is in this spirit that the International Platform on Sustainable Finance was developed. Co-developed by the People’s Bank of China and the European Commission, a comparison Source: NGFS between the Chinese and European taxonomies was established in 2021 and revised in 2022 For example, the EU taxonomy includes nuclear energy and under the “Common Ground Taxonomy” (CGT). natural gas in its “sustainable investment” category, which Other taxonomy standardization processes are currently may not be applicable in other countries or regions. being planned or are already under development. The Another issue limiting the applicability of the European first version of the ASEAN Taxonomy was published in system to emerging markets is its binary assessment of November 2021. July 2022 saw the launch of the Working which economic activities are sustainable and which ones Group on Sustainable Finance Taxonomies in Latin America are not. It does not consider efforts made by companies and the Caribbean. More emerging market authorities may toward embarking on a transition. If these initial steps are be tempted to turn to the EU Taxonomy as a standard. not taken into account by local taxonomies, companies However, the European model does have its limitations as an cannot access funding from private firms to finance their example for developing countries amid significant differences transition efforts. in production methods and levels of economic development. EMERGING MARKET GREEN BONDS Page 50 On top of this, local economic and social realities in developing countries BOX 3.2 require transitions to be more gradual The Common Ground Taxonomy for emerging market companies than for their European counterparts. Taxonomies should, therefore, take The CGT aims to help reduce The CGT was greeted with local conditions into account, adapting transaction costs and facilitate enthusiasm by market participants as sustainable activity thresholds and international green capital flows by well as policy makers. Indeed, Chinese granting more flexibility to transitional strengthening market confidence and financial institutions welcomed activities. To this end, the EU reducing fragmentation. Based on the ability to label bonds as CGT- Platform on Sustainable Finance has the International Standard Industrial aligned. Internationally, the Bank of recommended mapping EU Taxonomy Classification guidelines for the China branch in Frankfurt issued the activities, comparing them to well- categorization of sectors, the CGT is first-ever green bond aligned with known industry classifications, in order designed to promote cross-border the CGT, a $500 million three-year to facilitate the alignment of non-EU economic activity while taking into senior unsecured fixed -rate offering. entities.28 consideration national and regional In addition, Deutsche Bank signed in specificities. To harmonize the two June 2022 the first transaction aligned To conclude, the challenges faced by taxonomies, when they diverge on with the CGT, earmarking proceeds various emerging market jurisdictions a particular issue, the CGT adopts to finance Huaneng Leasing’s in establishing their taxonomies are whichever criteria are more stringent. direct leasing for two wind power considerable. Comparability, the development projects in China. categorization of activities, and the The CGT covers 72 activities and six subjectivity of classifications are sectors including: There are signs that the CGT is being just some of the problems faced by examined in other emerging market authorities seeking to make their • Agriculture, forestry, and fishing jurisdictions as a potential model for markets more attractive to investors. • Manufacturing international alignment of their own However, addressing these challenges taxonomies. Indeed, Sri Lanka drew is crucial for strengthening the role • Electricity, gas, steam, and air on the CGT as an example when of private capital in emerging market conditioning supply developing its system. climate finance and ensuring the green • Water supply, sewage, waste bond market maintains momentum management, and remediation in these vulnerable economies. activities Harmonization of classification systems around the world will be key. • Construction But local conditions will also need to • Transportation and storage be considered in order to encourage effective transitions in emerging markets. 28 https://finance.ec.europa.eu/system/files/2022-03/ sustainable-finance-taxonomy-nace-alternate-clas- sification-mapping_en.xlsx BOX 3.3 The ASCOR Project–the first public investor framework to assess sovereign risks1 The Assessing Sovereign Climate- ASCOR has the principle of fairness information, so that investors can Related Opportunities and Risks at the core of its framework with more effectively support country (ASCOR) Project, an initiative set the aim of encouraging financial transition plans. The framework will up by a coalition of international flows to support a just and resilient enable scrutiny of country climate investors, seeks to establish a low-carbon transition, especially policies both in terms of their coherent framework for assessing in countries that are least able to contribution to mitigating climate sovereign bond issuers from the finance it themselves. change as well as building resilience perspective of climate change. The to its impact. It sets out a common basis to analyze aim is to provide an independent individual country approaches and and publicly available tool to help will reinforce public disclosures to investors engage with issuers while help investors understand sovereign giving governments the opportunity actions and progress. It builds on to showcase their progress in existing data but will also further addressing climate change. enable issuers to detail material 1 The framework is still to be finalized and subject to changes. An updated framework will be published in autumn 2023 based on the feedback received during ASCOR’s consultation process in Q1 2023. The Three Pillars of the ASCOR Framework: PERFORMANCE OF COUNTRY ON MANAGING LANDSCAPE OF COUNTRY’S CLIMATE CHANGE RISKS AND OPPORTUNITIES PILLAR 3: PILLAR 1: PILLAR 2: Opportunities to finance the Emissions pathways Climate policies transition • Financing to mitigate • Emissions trends • Mitigation • Financing to adapt • 2030 targets • Adaptation • Financing to harness • Net zero targets • Just transition opportunities 4 Central Banks, Financial Technology, and the Public Sector T he following section outlines three areas that Monetary Policy Implications of Climate Change will play a crucial role in deepening capital Climate change and the transition toward cleaner energies markets in emerging markets so that more entail significant risks for economic and financial systems. funding can be channeled toward financing green They also represent a sizeable challenge for central banks transitions at a lower cost. The first of these relates to because of their direct impact on macroeconomic and central banks. Debt markets are shaped by monetary financial stability. policy as this has a direct impact on how bonds and loans are priced. Therefore, central banks will play an Rising prices associated with the cost of green transitions, important role in energy transitions on account of their known as “greenflation,” and the risk of de-anchoring influence on international financial markets. inflation expectations could result in some central banks rethinking their monetary policy strategies. As well as their The second segment focuses on how financial technology day-to-day responsibility for ensuring price stability, the companies, commonly known as “fintech,” and blockchain- critical nexus of climate change and the financial system based solutions can aid domestic resource mobilization for could make it increasingly necessary to incorporate climate sustainable investments. risks into regulatory and supervisory frameworks. These, in Next, we examine what role public sector actors can play turn, could shape the data disclosure and risk management in reducing the cost of capital in emerging markets while practices required by authorities of the financial institutions increasing the availability of funds for the energy transition. that they supervise. In particular, we address how energy transitions in emerging Furthermore, central banks could actively support the markets would benefit from using synthetic securitizations— greening of economies by potentially adapting their lending repackaging risky debt into new securities with the backing operations, collateral frameworks, and asset purchases. This of government or multilateral agencies— to attract more would present some risks, however. In doing so, central private investment into emerging market green bonds. Page 53 Central Banks, Financial Technology, and the Public Sector banks would need to monitor whether active involvement in economies, the declining profitability of high-emission climate policy undermines their independence, leaving them activities, higher exposure to physical risks, and a broader open to accusations of stepping beyond their mandates and preference for greener investments could all cause sharp thereby weakening their credibility. selloffs of emerging market assets. To counter these external shocks, central banks would need to act by adapting their Climate-related macroeconomic stabilization foreign exchange reserve management, for instance, by challenges for central banks. shifting to a flexible exchange rate regime to preserve cost- competitiveness. The interactions of climate change and monetary policy may significantly influence macroeconomic outcomes and Greenflation may require central bank action but represent sizeable challenges for central banks. Transition also rethinking the monetary policy strategy. policy uncertainty, increased volatility, and damage to production from climate shocks can destabilize economic The primary mandate of most (orthodox) central banks is to systems, forcing central banks to step in and stabilize price keep inflation low, stable, and predictable. Climate change and output fluctuations. represents a sizeable challenge to central banks because of its direct impact on inflation and output. The materialization Extreme weather and other physical risks linked to climate of climate-related risks could significantly increase price change may result in significant output losses, requiring volatility over extended periods and potentially de-anchor central bank action to smooth the economic cycle or inflation expectations. spur growth. The challenges are particularly acute for emerging markets, especially in Africa, where monetary The materialization of physical risks could trigger similar authorities typically have fewer financial resources than dynamics to negative supply shocks, such as the surging their developed country counterparts, and exposure to food prices often seen in the wake of floods or droughts. extreme weather events such as droughts and floods is These might be difficult to counter with the traditional greater. Transition policies in advanced economies could also monetary policy toolbox, as evidenced by the food and generate undesired spillovers to developing countries and energy price spikes seen after Russia’s invasion of Ukraine. cause serious balance-of-payment challenges. For example, Climate-related upheavals will present central bankers implementing a carbon tax on goods entering the EU with a complex trade-off between inflation stabilization would harm the price competitiveness of emerging market and economic growth.29 While an interest rate hike would exporters to Europe, particularly in neighboring North Africa. partially contain supply-driven inflation, it may seriously After a radical policy shift, such as introducing carbon pricing restrain credit expansion and weigh on economic activity. or a carbon tax, lower demand for emerging market exports The potential disruptions associated with adapting economic and higher export production costs may generate external and energy models to climate change, known as transition imbalances in export-oriented economies. risks, also present the possibility of highly persistent negative Climate risks could destabilize external liquidity conditions in supply challenges that are inflationary.30 other ways. The introduction of new regulation in advanced 29 The IMF finds that the output-inflation trade-off will be larger for the central banks of countries where there is a significant delay in implementing climate policies. The longer the transi- tion to clean energy generation is delayed, the greater the costs of inflation and output losses. See Carton, B. and Natal, J-M., 2022, “Further Delaying Climate Policies Will Hurt Economic Growth,” IMF blog, October 5. 30 See: Schnabel, I., 2022, “A New Age of Energy Inflation, Climateflation, Fossilflation, and Greenflation,” Speech to ECB panel on monetary policy and climate change, ECB, Frankfurt, March 17, 2022. EMERGING MARKET GREEN BONDS Page 54 The implementation of a carbon tax in advanced economies price spiral. By causing higher and more volatile inflation or a dramatic hike in the global carbon price to align it with in the short and medium term, climate change impacts the true environmental cost of emissions would incentivize how households and businesses plan for further ahead. the shift toward clean energies. These transition policies Government actions could also directly shift inflation would also raise global fossil fuel prices and increase their expectations as economic actors respond to announcements short- to medium-term volatility.31 Central European of new policies and regulations to reduce greenhouse gas countries with large and fossil fuel-intensive manufacturing emissions. sectors within the EU are highly exposed to this type of Climate risks increase uncertainty around central banks’ inflation risk. The progressive phasing out of fossil fuel macroeconomic diagnosis and have significant strategic subsidies in developing countries is also a potential trigger implications for their monetary policy. Central banks for energy inflation. measure price stability by a level or range of inflation Rising energy prices could also arise from strong demand for targeting that is publicly communicated to anchor inflation materials that are central to the expansion of low-carbon expectations. By impacting different aspects of their technologies, such as copper, lithium, and nickel, given inflation-targeting framework, climate change may cause inelastic supply in the near term.32 Indeed, an International central banks to rethink the design of their monetary policy Monetary Fund (IMF) study finds that copper, nickel, cobalt, regimes.34 More precisely, central banks may need to review and lithium prices could all reach historical peaks and stay their strategy relative to the measure chosen as the inflation at elevated levels for as long as a decade.33 These price target, addressing the choice between a target expressed pressures will likely spill over into other material-dependent as a level or interval, the horizon over which the inflation sectors and impact wage dynamics. The extent to which target must be reached, and the level of the target itself. these transition-specific pressures affect different areas and Integrating these key implications of climate change into drive up consumer prices remains uncertain and warrants monetary strategy is currently being discussed among major future research. central banks. Climate change could push central The implications of climate change for banks to act against the risk of financial stability and supervision de-anchoring inflation expectations. Climate change may significantly alter financial conditions Climate-related inflation is most likely to affect food and and endanger the stability of financial systems, a prospect energy prices in the first instance. Yet, households tend to that is attracting increased attention from central banks overestimate the weight of these price rises while forming and supervisory authorities. In 2017, eight financial and their inflation expectations. Therefore, this inflation type monetary authorities launched The Network of Central could amplify the second-round effects and trigger a wage- Banks and Supervisors for Greening the Financial System (NGFS), bringing together 114 central banks, supervisors, and 31 In the long term, fossil fuel inflation is likely to progressively give way to relative price adjustments. But while clean energies are expected to become cheaper with easing supply bottle- necks and scale economies, fossil fuel prices may remain elevated in the long term as a result of environmental taxes and regulations. 32 Miller, H., Dikau, S., Svartzman, R., and Dees, S., 2023, “The Stumbling Block in the Race of Our Lives,” Centre for Climate Change Economics and Policy Working Paper 417, London: Lon- don School of Economics and Political Science. 33 Boer. L., Pescatori, A., and Stuermer, M., 2021, “Energy Transition Metals,” Working Paper No. 2021/243, IMF. 34 Dees, S., Weber, P-F., “Les consequences du changement climatique pour la politique monetaire,”, Revue d’Economie Financiere, 2020/2 No.138. Page 55 Central Banks, Financial Technology, and the Public Sector 18 observers.35 Participation is voluntary, and the network’s increasing the risk of sudden price corrections.38 purpose is to strengthen and align responses to the Paris The materialization of greenwashing risk could trigger a Agreement and to enhance the financial system’s ability to sudden withdrawal by investors from financial products manage risks and mobilize capital for green and low-carbon perceived to be green, hence generating significant capital investment. outflows and selling pressures.39 Any market perception that Central banks and financial supervisors are placing some green bonds might not meet their green aspirations increasing focus on how climate risks could affect the might cause a cliff-edge effect with abrupt repricing for the financial soundness of banks, insurers, and other financial asset class that could even endanger financial stability. institutions.36 More frequent and severe climate-induced natural disasters are likely to translate into higher losses for The financial sector’s exposure to insurance companies, trigger sharp drops in property prices, climate risks means data collection, risk and cause severe deterioration of balance sheets and the management, and regulation must adapt. creditworthiness of households and companies. Risk management frameworks for banks and supervisors Transitioning to a low-carbon economy may also cause need to adapt to incorporate the economic and financial financial losses stemming from stranded capital and lower impacts of climate risks, which are complex and multi- future profit prospects from non-green investments.37 dimensional. Financial institutions are exposed to climate- Sudden changes in climate policies, technology, or market related financial risks through their relationships with sentiment could undermine the value of financial assets customers and counterparties. A complete assessment with a high carbon footprint. Under a late and disorderly of their risk exposures would require the disclosure of transition scenario, the collapse of emission-intensive asset comprehensive climate-specific data sets with sufficient prices would be more severe and cause sizeable damage to historical depth and granularity, accounting for the financial assets and the balance sheets of energy companies heterogeneity of their portfolios.40 that rely on fossil fuels. These sudden revaluations could Several central banks and supervisory authorities have inject fragility into the wider financial system, weakening the recently launched climate stress tests to assess the impact finances of corporations, households, financial institutions, of climate risks on the financial system and the overall and central banks. They could also alter risk premia and economy. Stress testing has been traditionally used to credit conditions. evaluate a financial institution’s resilience to economic Conversely, rapid changes in the price of low-carbon assets shocks, often through a capital adequacy target. Unlike may destabilize financial markets if greater demand for standard stress tests, climate assessments pose additional such investments incentivizes greenwashing. The rush for challenges regarding data availability and model uncertainty. green investment could create green asset bubbles while Without historical precedent on which to build quantitative 35 The NGFS is chaired by Ravi Menon, Managing Director of the Monetary Authority of Singapore, and the Banque de France provides the secretariat function. 36 Network for Greening the Financial System, 2021, “Progress Report on the Guide for Supervisors, Technical Document.” 37 Network for Greening the Financial System, 2019, “A Call for Action: Climate Change as a Source of Financial Risk, Report.” 38 Breeden, S., 2022, “Balancing on the Net Zero Tightrope,” Speech at TheCityUK International Conference, April 7, 2022. 39 European Central Bank and European Systemic Risk Board, 2022, “The Macroprudential Challenge of Climate Change Report.” 40 At the request of the Financial Stability Board, since 2017, the Task Force for Climate-related Financial Disclosures (TCFD), has issued recommendations to companies and other organi- zations to help them improve transparency on the actual and potential impact of climate change on their activities. EMERGING MARKET GREEN BONDS Page 56 scenarios, climate scenarios rely on forward-looking data Another example is the Philippines Financial Sector and transition reference scenarios published by the NGFS. Assessment Program41 by the IMF and the World Bank, Long-term climate socio-economic pathways fundamentally evaluating the impact of extreme weather events on differ from the three- to five-year horizons used in financial stability. The results show that the materialization standard stress test exercises. Finally, incorporating firm- of physical risk could significantly endanger banks’ capital level heterogeneities to capture the impact of the most adequacy and asset quality under a compound shock disruptive climate shocks is a sizeable challenge. Banks and scenario such as, for example, a typhoon that follows a insurers tend to have limited information at their disposal pandemic. to understand the current emissions, transition plans, and Beyond identifying and measuring climate risks, developing physical risk exposure of their customers. new supervisory tools, and adapting existing frameworks Climate stress tests on banks have revealed will be pivotal for regulators to mitigate climate-related potential vulnerabilities around capital adequacy financial risks. Integrating climate risk into capital adequacy frameworks is a widely discussed avenue among supervisory and long-term drags on profitability. authorities.42 Stronger capital rules for climate exposure In 2021, the Bank of England ran its first climate stress would increase the banking system’s capacity to withstand test on the largest U.K. banks and insurers. The exercise future climate-related losses. In addition, adjusting capital revealed that while results vary across firms and scenarios, risk weights in the function of the bank’s climate risk overall climate-related losses would reach a level equivalent exposures would incentivize the banking system to support to 10–15 percent of annual profits. This implies that low-carbon projects. climate risks may persist over time on banks’ and insurers’ A lack of reliable data, the absence of common definitions, profitability, leaving them more vulnerable to future shocks. and partially developed methodologies for running sensitivity Firms’ projections suggest that these costs will be lower if analyses and stress tests, are the biggest impediments early, well-ordered action is taken to lessen their climate- to fully incorporating climate risks into capital adequacy risk exposure. Given data limitations, this stress test exercise requirements. Yet, supervisors should also be mindful of will not be used to set capital requirements for banks and the potential unintended consequences of climate-risk insurers. However, it plays a pivotal role in moving forward capital buffers. Underestimating the risk associated with the discussion among central bankers. green assets may lead to under-capitalizing banks and insurers, making them more vulnerable to shocks. On the other hand, excessively punitive capital requirements for carbon-intensive financial activities may prove inefficient. Over-capitalization of financial institutions would reduce their ability to support the economy through the transition. Banks and insurers must continue providing finance to more carbon-intensive sectors in developing countries with high 41 International Monetary Fund, 2022, "Philippines, Financial Sector Assessment Program: Technical Note on Bank Stress Test for Climate Change Risks". 42 The work on incorporating a minimum capital (Pillar 1) and bank-specific additional (Pillar 2) capital treatment for climate-related and environmental risks in the prudential framework is at an early discussion stage. The Bank of England and U.K. banking regulator, the Prudential Regulation Authority, have proposed an "escalating" climate buffer, which is based on a risk assessment on the materiality of future system-wide transition and the physical risks associated with climate change. Canada’s financial regulator is also considering a new set of capital buffers to ensure that federally regulated financial institutions can endure an abrupt transition to a green economy. Page 57 Central Banks, Financial Technology, and the Public Sector climate exposure and limited financial resources to allow positive screening, expanding eligibility criteria to incentivize them to invest in the transition. banks to lend or capital markets to fund environmentally beneficial projects. In 2018, the People’s Bank of China How can central banks support the included green loans and green bonds as eligible collateral. transition to a low-carbon economy? The National Bank of Hungary started to incentivize green securities. The ECB has announced that it would include Including climate change considerations in monetary policy negative screening, climate-related disclosure requirements, actions will require significant changes in central banks’ and haircuts into its collateral program beginning in 2026. operations. The European Central Bank (ECB) and the Bank of England have been pioneers in initiating the inclusion of Central banks could align their balance sheets with Paris climate-related policies into their operational frameworks. Agreement objectives through asset purchase programs. Implementing these policies by a wider selection of central They can implement green quantitative easing policies by banks would go hand in hand with resolving underlying data targeting asset purchases based on climate-related criteria gaps and establishing a widely accepted green taxonomy. at the issuer or asset level to support green bond markets Green central banking initiatives in developing countries are and increase the share of clean assets in their balance mostly limited to reporting and disclosure. At the same time, sheets. The Bank of England has committed to a 25 percent the People’s Bank of China stands out by introducing green reduction in its corporate bonds portfolio’s weighted average instruments into its operational framework. carbon intensity by 2025, and complete alignment with net zero by 2050. Since the end of 2022, the ECB has also started Central banks could put in place green lending initiatives by to tilt its corporate bond holdings toward issuers with making the interest rate on lending facilities conditional on better climate performance through the reinvestment of commercial banks’ contribution to tackling climate change redemptions.45 or the decarbonization of their business models. Japan and China’s central banks have already introduced various credit These green asset purchases have so far been limited to incentives to boost green projects. The ECB has announced corporate bonds. Greening public sector asset holdings that it might consider green-targeted lending operations in would prove more challenging. In the case of the ECB, the future when its policy becomes expansionary again.43 purchases of sovereign bonds are guided by the capital key, which limits the scope for tilting strategies based on Monetary authorities could also adjust their collateral countries’ carbon intensities. Compared to the size of central frameworks to align with climate objectives and incentivize banks’ sovereign bond portfolios, the overall supply of green asset allocation favoring low-carbon projects.44 They could sovereign bonds remains insufficient. But more importantly, apply negative screening, limiting the share of assets issued a reliable worldwide taxonomy and sovereign rating by entities with a high-carbon footprint that can be pledged framework to assess the alignment of sovereign bonds with as collateral by counterparties when they borrow. They could Paris Agreement goals is still lacking. apply haircuts to corporate and government bonds to better account for climate-related risks faced by the issuers but also Overall, the aforementioned options for green central bank to incentivize the issuance of green bonds. Another option is operations would help incentivize borrowers to improve 43 Schnabel, I., 2023, “Monetary policy tightening and the green transition,” Speech to the international Symposium on Central Bank Independence,” January 10, 2023. 44 Central bank collateral policy defines the type of assets to be pledged to secure central bank credit operations, as well as the risk control measures that apply to them. 45 For now, the ECB follows only a flow-based tilting approach by adjusting its reinvestments of corporate bonds based on a climate score that reflects issuers’ carbon intensity, their decarbonization plans and the quality of their climate-related disclosures. EMERGING MARKET GREEN BONDS Page 58 their disclosures and reduce their carbon emissions. They financial resources, extending central banks’ mandates to would also let central banks set a good example to other address climate change may expose them to greater political financial institutions through their lending, collateral, and pressure that may endanger their autonomy and credibility. asset purchase practices. Most importantly, these green operations would benefit central banks by reducing their balance sheet exposure to climate risks. In emerging market Using Technology to Mobilize economies, central bank green policies will undoubtedly Domestic Resources be instrumental in deepening the green bond market by boosting demand for green financial products and lowering This sub-section focuses on how financial technology their yields. companies, often referred to as fintechs, and blockchain- based solutions—decentralized databases—can aid domestic What are the risks for central banks? resource mobilization for sustainable investments. While climate-related economic and financial considerations We explore how fintechs could complement traditional may require central bank policy action, governments should capital markets and help mobilize financial resources for retain overall control of climate policies. Governments and sustainable infrastructure investments. We also discuss supranational entities tend to have a broader range of fiscal existing notable blockchain-based solutions for bond and regulatory tools to foster the low-carbon transition and development, fintech applications in trading, and cases mitigate physical risk. for mobilizing domestic savings to scale up sustainable Addressing climate-related challenges may require policy investment. The importance of domestic savings in areas decisions that fall beyond the remit of central banks and such as developing infrastructure was highlighted by financial regulators. There is so far no common agreement the large-scale withdrawal of international capital from among central bankers on how to include climate change in emerging economies’ bond markets in March 2020.46 We their monetary policy operations and which boundaries to also highlight a comprehensive framework published by respect. Central banks’ mandates generally exclude actions the Asian Development Bank Institute, the Pathfinder that target specific agents such as firms, households, sectors, Initiative with the Government of Bangladesh, the Bank for and regions or systemically provide direct financing to International Settlements’ Genesis 2.0: Smart Contract- governments to support climate adaptation or mitigation Based Carbon Credits Attached to Green Bonds, and the spending. World Bank’s CAD Trust.47 Adding the fight against climate change to central banks’ There are various potential uses for blockchain technology mandates so that they actively undertake green monetary which can improve the implementation of infrastructure policy carries risks. Central banks may endanger their projects by upgrading processes and enhancing transparency credibility in core activities by making themselves publicly around record-keeping and revenues.48 accountable in areas where they have limited capability and However, questions remain around the political pressures risk-assessment accuracy. In developing markets with scarce that may arise as standards and governance processes are 46 Hofmann, B., Shim, I., & Song Shin, H., 2020, “Emerging Market Economy Exchange Rates and Local Currency Bond Markets Amid the Covid-19 Pandemic,” (BIS Bulletin No. 5). Bank for International Settlements. 47 See Chen, Y., & Volz, U., 2022. “Scaling up sustainable investment through blockchain-based project bonds,” Development Policy Review, 40.3 48 Smart contracts are simple programs stored in the blockchain that can be used to automatically exchange coins based on certain conditions. Page 59 Central Banks, Financial Technology, and the Public Sector developed. Blockchain-based solutions can certainly address markets, carbon credits, and innovation in financial some of the data challenges and increase efficiencies. But instruments, including green bonds. For example, several they are not a standalone solution and should not work in a fintech investment platforms have emerged that enable vacuum. consumers to screen assets and invest personal funds exclusively in green initiatives. How can fintechs be complementary to conventional capital markets? Debt financing has readily embraced principles around ESG frameworks. New technologies are enabling sustainability solutions that can help alleviate the negative implications of climate Emerging fintech lending companies are focusing on change.49 A growing body of research indicates that green sustainability and providing dedicated platforms and fintech has the potential to impact the whole value chain products aimed at addressing ESG objectives for their clients. of financial services covering consumer-to-consumer, A separate but related issue is the importance of addressing business-to-consumer, and business-to-business services.50 concerns like data quality, availability and comparability, Global investment in green finance, particularly in developing and asymmetries in information access between investors economies, requires immediate actions and climate policies, and other stakeholders. These challenges are especially which must be accompanied by fund flows to address global relevant in emerging markets. Technology-based solutions financing gaps. Reducing risks and constraints through have the potential to address some of these data public-private partnerships, with the involvement of entities challenges. For instance, they can enable a more efficient that leverage blockchain technology, artificial intelligence, collection of information, while blockchain platforms can and machine learning, can help mobilize domestic and help ensure the provenance of ESG certifications. Natural foreign private sector capital in climate finance. language processing—using artificial intelligence systems that allow computers to understand written or spoken Public-private partnerships with fintechs can aid the communications— can help to analyze reports and distill development of a sustainable finance framework. To relevant sustainability-related information.52 illustrate, Mauritius is one country actively exploring ways to encourage private actors to cooperate with the public sector Blockchain-based projects are facilitating in creating enabling environments and promoting financing the mobilization of domestic resources structures such as green bonds. In February 2021, the Bank for sustainable investments. of Mauritius published its “Guide for the Issue of Sustainable Bonds,” which followed the creation of the Mauritius Africa Distributed ledger technologies that underlie blockchains FinTech Hub, launched by the country’s government in are being leveraged to support climate action by facilitating October 2018.51 transparent and standardized transactions and enabling more efficient monitoring and accreditation. Blockchains Fintechs can be used in areas such as renewable energy, are decentralized databases that are effective at storing harnessing blockchain technology, decentralized electricity a registry of money, ownership rights, contracts, goods, 49 Schillebeeck, G., 2021. “Digital Sustainability and its Implications for Finance and Climate Change,” MAS Special Feature A, April 2021, Macroeconomic Review. 50 Puschmann, T., Hoffmann, C. H., and Khmarskyi, V., 2020. “How Green FinTech Can Alleviate the Impact of Climate Change—The Case of Switzerland” Sustainability 12, no. 24: 10691. 51 More information can be found at: https://mauritiusfintech.org/about-mafh/ 52 Menon, R. 2021. “What We Need to Do to Make Green Finance Work.” Keynote speech at the Financial Times Investing for Good Asia Digital Conference, Singapore, September 8, 2021. EMERGING MARKET GREEN BONDS Page 60 personal information, and transactions. They can provide technology. IDB promoted the initiative to accelerate the use a tamper-proof, encrypted, and transparent system for of blockchain technology. It will enable BBVA to roll out its implementing innovative business solutions. Blockchain- service in Latin America, where access to alternative project based methods allow for a direct exchange of information finance is limited.55 without going through a central server or an authorized institution. In the conventional bond market, it is difficult Blockchain technology can make for multiple stakeholders to monitor the flow of money and trading green financial assets more exchange real-time updates on the development status. efficient in emerging markets. In contrast, blockchain-based solutions in the green bond Trading of carbon credits and other green financial market could enhance traceability and transparency. assets has enormous potential to leverage blockchain Issuers in high-income and emerging technology, lowering costs and reducing the involvement of economies are leveraging blockchain intermediaries. technology for bond development. Examples of global carbon exchanges include Climate Impact X and Aircarbon, both headquartered in Singapore. Climate In February 2023, the Hong Kong government sold its first Impact X is a marketplace for carbon credits established by digital green bonds, working with the Bank of China, Credit DBS bank, Standard Chartered Bank, Temasek, and Singapore Agricole, Goldman Sachs, and HSBC. This move will put to Exchange Limited. It enables the trading of carbon credits the test Hong Kong’s legal and regulatory framework amid a created from projects involved in protecting and restoring broader push into sustainable financing.53 The initiative also natural ecosystems, with portfolios connected to several includes a policy component, as Hong Kong will embark on recognized forest conservation and restoration projects in a three-year training program for financial professionals on Africa, Asia, and Central and South America. green and sustainable finance. Similarly, Aircarbon is built on blockchain technology and Meanwhile, in January 2023, National Australia Bank (NAB) bundles carbon credits from various projects into a single partnered with agritech start-up Geora to help Australian instrument that can then be traded on its digital platform. farmers report the impact of their sustainability practices. Bundling projects can promote a more standardized carbon The project uses blockchain technology to help farmers credit economy and enable larger-scale trading. with NAB’s Agri Green Loan reporting covenant.54 Geora will integrate existing sustainability data into blockchain Public sector and non-governmental organizations to create a standard record of environmental impact and are exploring the potential of blockchain- emission reduction efforts, adding a layer of transparency to based solutions for several applications. the Agri Green Loan book. This segment explores ways in which domestic savings In July 2022, Bolsas y Mercados Españoles, through could be mobilized through fintech solutions to scale up Iberclear, BBVA, and the Inter-American Development sustainable investment. Bank (IDB), completed the first bond issuance in Spain listed in a regulated market and registered using blockchain 53 Bloomberg News, February 15, 2023. “Hong Kong Hires Banks for Debut Digital Green Bond Sale.” 54 National Australia Bank, 2023, “NAB Helps Farmers Report on Sustainability of Agri Green Loans Using Blockchain.” 55 Inter-American Development Bank, 2022, “BME, BBVA, and IDB Issue Spain’s First Blockchain-Based Regulated Bonds,” Press Release, July 26, 2022. Page 61 Central Banks, Financial Technology, and the Public Sector One comprehensive proposal published by the Asian Overall, this framework could be adjusted to fit different Development Bank Institute56 proposes a blockchain-based projects that mobilize domestic resources for sustainable solution that integrates multiple fintech applications to investments in emerging markets, improving efficiency and mobilize domestic financing for sustainable infrastructure transparency. The framework approach has the potential to investment. The approach uses a public-private partnership provide opportunities to purchase local-currency assets to a model enhanced by including local residents and potentially broad range of investors with varying amounts of money to international development agencies. The proposal, which deploy. It can also help issuers such as municipalities to raise is described below, addresses the three key phases of funds for sustainable infrastructure investment. an infrastructure project’s life cycle from inception and The Pathfinder Initiative with the government of Bangladesh fundraising to realization and to its operational phase. is exploring how to use this framework to mobilize domestic In the inception and fundraising phase, blockchain integrates savings for sustainable infrastructure investment. The with the crowdfunding fintech solution to mobilize domestic initiative has support from the United Nations Development savings for investment in the domestic local-currency bond Program, the United Nations Democracy Fund, and the UN market. In this case, the ledger records the ownership Secretary General’s Taskforce on Digital Financing of the structure to ensure customers’ rights. Existing fintech Sustainable Development Goals. It aims to reduce the need applications, such as M-Akiba, a retail infrastructure bond for international borrowing and uses blockchain-based issued by the government of Kenya, which seeks to enhance solutions to enforce accountability for the funds, the returns, financial inclusion for economic development,57 could be and the dividends from infrastructure investment. used to mobilize local savings for the domestic bond market Project Genesis is a pilot project from the Bank for allowing smaller-sized investments through mobile phones. International Settlements Innovation Hub’s Hong Kong Additionally, applying smart contracts can help reduce the Centre, exploring ways to make investing in green bonds asymmetry of information. more attractive. To this end, it is developing a new In the realization phase, stakeholders would be able to framework for green bonds using blockchain and digital trace the use of proceeds and the construction status tokenization to help investors who purchase climate-related transparently. One of the main issues in several emerging bonds track carbon credits in real time. market economies has been dealing with corruption and The main concept of the product is a mitigation outcome the potential misuse of funds. By using blockchain to record interest, which would take the form of a warrant attached information, investors can better understand the project’s to the green bond that entitles the holder to receive carbon status and exchange information in real time. Here, smart credits generated by the reduction of greenhouse gas contracts are once again leveraged to automate the emissions achieved by projects financed by the debt. The interest rate and return. Finally, in the operational phase, warrant and green bond would be traced separately, and the recording operational data through blockchain can allow for mitigation outcome interest warrant holder will receive the transparency on project revenue streams and minimize the credits generated by the green bond. Blockchain would be risk to investors of being exposed to corruption. used to keep track of the warrant ownership and verify the credits generated by the green bond project. Two prototypes 56 Chen, Y. and Volz, U., 2021, “Scaling Up Sustainable Investment Through Blockchain-Based Project Bonds,” ADBI Working Paper Series, No. 1247, April 2021. 57 M-Akiba is administered through the Central Bank of Kenya in collaboration with: Nairobi Securities Exchange, Central Depository Settlement Corporation, Mobile Network Operators, and the Kenya Association of Stock Brokers & Investment Banks. The money raised from the bond will be used for funding government infrastructure development projects. EMERGING MARKET GREEN BONDS Page 62 were developed to track, deliver, and transfer digitized all sectors, it is particularly important for climate-related mitigation outcome interests using blockchain, smart adaptation and mitigation projects, given the amount of contracts, and other related technologies. capital required to hit targets—as much as $4.55 trillion globally, on average, for the remainder of this decade, under Climate Action Data Trust is an open-source metadata BNEF’s Net Zero Scenario. Other factors to consider include system that uses distributed ledger technology that “links, the typically long-term nature of the projects, many of which aggregates, and harmonizes all major carbon registry data are focused on infrastructure, and the urgency of limiting to enhance transparent accounting in line with Article 6 of global warming to the Paris Agreement target of 1.5 degrees the Paris Agreement.”58 It was established by a joint initiative Celsius above pre-industrial levels. Furthermore, the need for between the World Bank Group, the International Emissions investment is particularly acute in emerging markets, where Trading Association, and the government of Singapore. It public funding is scarcer and capital markets less liquid than aims to create a decentralized record of carbon market in developed economies. While they account for two-thirds activity to avoid double counting, increase trust in carbon of the global population, emerging markets receive just one- credit data, and build confidence in carbon markets. fifth of global clean energy investments.60 The examples discussed in this section show how The small number of dedicated emerging market green bond blockchain-based solutions can improve the implementation investment funds further illustrates this. From its inception of infrastructure and other projects by upgrading processes in 2018 until 2021, Amundi’s EGO fund, which is targeting and enhancing transparency. However, for initiatives to $1.5 billion in assets under management, stood alone. More succeed in channeling more capital to sustainable projects, recently, four other dedicated funds have emerged. Amundi there is also a need for effective public-private partnerships, set up a second vehicle, BEST, seeking to raise $1 billion, in wider frameworks, and robust standards for governance. partnership with IFC. Meanwhile, HSBC launched the REGIO Blockchain-based solutions can make a fundamental fund, which raised $538 million in assets in March 2021, with difference in addressing data challenges, increasing efficiency IFC as an anchor investor alongside HSBC. Additionally, and promoting transparency. Nevertheless, this type of BlackRock set up the BGF fund, with a more modest technology and the involvement of fintechs should be $56 million, while and Germany’s KfW launched LAGreen, regarded as complements to effective capital markets rather aiming to raise $500 million from investors by 2024. This is than a standalone solution. the first fund dedicated to green bonds in Latin America and is supported by the EU, the German government, Finance in Motion, and Santander Asset Management.61 Public-Private Partnerships: Reducing A commonly used measure of funding costs for a project is the Cost of Capital the weighted average cost of capital (WACC). This comprises A structural challenge in emerging markets is the high cost the average cost of equity (COE) and the cost of debt (COD) of capital for investing in projects compared with developed for a project, weighted according to the proportion of each economies.59 While this is an issue that is common across in a project’s capital structure. 58 See https://climateactiondata.org/ 59 See International Energy Agency, 2021, “The Cost of Capital in Clean Energy Transitions Report.” 60 International Energy Agency, 2022, “World Energy Investment 2022.” 61 See Environmental Finance, 2021, “Green Bond Funds: Impact Reporting Practices.” Page 63 Central Banks, Financial Technology, and the Public Sector The higher WACC of projects in emerging markets is risk retention “skin in the game” rules. Because of selling a explained by a higher risk-free rate and a higher country controlling stake in the equity tranche, participating banks risk premium compared with investments in developed could deconsolidate their non-performing loans. countries.62 In practice, however, the actual WACC of Some of the key investors in the junior and mezzanine an emerging market project is even higher, as the lower tranches were granted servicing rights over the overall capacity to tap the debt market in developing economies non-performing loan portfolio, with a performance-based skews the capital structure of projects toward equity. remuneration structure. This helped align the interests of A higher equity weight in the project’s capital structure these investors with those of all other stakeholders, including pushes the WACC higher. the banks themselves, their shareholders, and the Italian Synthetic Securitizations government. It also provided them with a potential upside that improved the risk-reward profile of their investment. Synthetic securitizations involving some public-sector protection have been widely used for making high-risk Crucially, apart from the seeing their ratios of non- assets attractive to institutional investors. They were at performing loans as a proportion of total loans fall, the key the core of successful programs, such as Italy’s GACS and advantage for Italian banks was that they were effectively Greece’s HAPS, to sell on non-performing loans that were swapping bad debt with high risk-weighted assets, for senior weighing down the balance sheets of southern European notes with no risk-weighted assets attached. This allowed banks in the wake of a regional financial crisis that emerged them to free some capital to strengthen their capital ratios as an aftershock from the global storm of 2008 to 2009.63 while increasing the appeal of their non-performing loans, thereby making it possible to sell the junior and mezzanine The Italian GACS (Garanzia Sulla Cartolarizzazione tranches to private investors. delle Sofferenze or Non-Performing Loan Securitization Guarantee) program involved government guarantees, The HAPS (Hercules Asset Protection Scheme), introduced issued for a fee, on a securitization transaction where by the Greek government in 2019, was similar to the GACS non-performing loans comprised the underlying asset. scheme. The key difference was that with HAPS, the senior Operationally, local banks transferred their bad loans to a notes could not qualify for an investment-grade rating due Special Purpose Vehicle that then issued notes (i.e., asset- to the sub-investment-grade score of their guarantor, the backed securities) across three tranches—junior, mezzanine, Greek government. However, an exception was made under and senior— each carrying distinct levels of risk. Europe’s Single Supervisory Mechanism so that the notes also carried a zero-risk weight. GACS served to protect the senior tranche, enabling an investment-grade rating that put the securities on a par These two programs, which would not have been possible with Italy’s sovereign rating at the time. Senior notes without government backing, enabled banks to offload were retained by the banks themselves, while the junior large portfolios of risky assets. In practice, they reduced the and mezzanine tranches were sold to private—generally effective WACC of non-performing loan portfolios by letting private equity—investors, though the banks did hold on to the government absorb part of the risk while optimizing risk a 5 percent vertical slice in both tranches to comply with allocation for investors. 62 For an illustrative breakdown of risks that explain country-by-country variations in the levelized cost of electricityfor a given clean energy project, see: International Energy Agency (IEA), 2022, “Cost of Capital Observatory: Tools and Analysis.” 63 For a review of NPL securitizations and related governmental guarantee programs in Europe, see: Deloitte, 2020, “NPL Securitizations and Related Governmental Guarantee Schemes in Europe Report.” EMERGING MARKET GREEN BONDS Page 64 Beyond non-performing loans, synthetic securitizations are From a financial viewpoint, there are similarities between also beginning to be used to manage other types of risk, both cases. They both involve a need to improve the risk- including that associated with emerging market assets. reward profile of a risky underlying asset to a level that Amundi’s EGO fund, the first-ever dedicated emerging unlocks significant private-sector investment inflows, while market green bond fund, offers a relevant example. EGO minimizing public-sector involvement because of limited invests in green bonds issued by emerging market banks fiscal resources. and then pools the debt before dividing it into three The energy transition in emerging markets and the tranches. The junior and mezzanine tranches, amounting associated potential for green bond issuance would benefit to 10 percent of the total debt, are sold to international from using synthetic securitizations to mobilize developed financial institutions, while the senior tranche goes to private market investors. investors. This implies a multiplier effect of up to 10 times. We suggest five conditions are necessary to maximize the Placing the riskiest portion among development finance chances of success for large-scale synthetic securitizations. institutions improves the risk-reward profile of the senior The first is increased involvement by international financial tranche via credit enhancement. Indeed, because of this, the institutions, either as guarantors for the senior tranche or as tranche’s credit rating is elevated by two notches, from a anchor investors in the junior and/or mezzanine tranches. from BB+ “junk” rating to an investment grade BBB+. Backstops by local governments are, at least in theory, a The result is that, out of the five existing emerging market potentially effective tool to reduce a project’s WACC. But green bond funds, EGO is not just the largest, with $1.4 billion government guarantees may not work as well in emerging in assets at the end of 2022, but also sets an example of markets as in the Italian case due to lower sovereign credit partnering with international financial institutions in ways ratings and higher risk perceptions among investors. Also, that attract more private finance into emerging market just as the market prices for the higher riskiness of emerging projects.64 versus developed markets, via both a higher risk-free rate Gaining scale to support the and a higher, non-zero country risk premium, the market transition in emerging markets will also assign a lower value to guarantees granted by a developing country government. That is, the mitigation The last United Nations COP27 climate summit saw an potential of an emerging market government will be lower agreement on the setting up of a “loss and damage” fund for than that of a developed country government. For this developing economies. The next meeting, COP28 which is reason, more involvement by multilateral development scheduled for late 2023, is expected to yield details around finance institutions may be necessary, sponsoring more its size—potentially up to $100 billion per year, as agreed in funds and increasing their stakes in those vehicles. 2009 at COP15—how it will be funded, and its functioning. These institutions’ participation can be either remunerated In the context of such negotiations, it is worth exploring the guarantees on senior tranches—as with the GACS and HAPS virtues of synthetic securitization on a large scale to improve programs—or direct investments in the junior or mezzanine the risk-reward profile of projects in emerging markets, tranches, similar to the EGO Fund. This seems feasible, as the replicating how these structures were used to address use of equity by international institutions remains extremely the problem of non-performing loans in southern Europe. limited, at about 1.8 percent of their total commitments to 64 Bolton, P., Musca, X., and Damama, F., 2020, “Global Public-Private Investment Partnerships: A Financing Innovation with Positive Social Impact,” Journal of Applied Corporate Finance, Volume 32, Issue 2. Page 65 Central Banks, Financial Technology, and the Public Sector private climate finance in emerging markets at the end Fifth, in order to ensure synthetic securitizations serve of 2020.65 the purpose discussed in the report and do not create any systemic risks, there should be restrictions on the originate- Second, anchor investors in the junior or mezzanine to-distribute business model via adequate bank supervision tranches, whether they are multilateral institutions or and credible reporting standards. specialized asset managers, should be allowed to participate in managing the Special Purpose Vehicle containing the risky assets for a claim against all or part of the management fees. This would improve the risk-reward profile of their investment while aligning their incentives with those of all other stakeholders, as was the case with the GACS and HAPS programs, where a key investor in the junior or mezzanine tranche was also the servicer of the non-performing loan portfolio. Third, securitization should be conducted at the bank, rather than at the investor level, to increase emerging market banks’ capacity for further green debt origination. In other words, it would allow local lenders to finance more green projects and then sell them via the issuance of green notes, or asset-based securities, to private investors in the capital markets. Fourth, deals should allow for local currency-denominated assets. Denominating a project’s revenues in hard currency may make sense from a risk management perspective, but it has major implications from a policy viewpoint. In particular, it may limit the size of the overall market being addressed. Around 70 percent of all green bonds issued in 2022 were denominated in local currency. It may also incentivize local issuance denominated in hard currency, potentially increasing the risk of currency mismatches for sponsors in case of sharp foreign exchange market moves, raising the potential for financial instability. At the same time, however, local currency-denominated projects will carry a higher WACC, due to foreign exchange risk, which will impact the calibration of the size of the junior and mezzanine tranches of a synthetic securitization. 65 International Monetary Fund, 2022, “Scaling Up Private Climate Finance in Emerging Market and Developing Economies: Challenges and Opportunities,” Chapter 2 of the Global Finan- cial Stability Report (GFSR), October 2022. 5 Case Studies on Specific Emerging Market Countries BRAZIL: biomes. Farmers have also been told they must revitalize degraded land if they want to plant more crops. This The new government is planning balance will have to be weighed against the microeconomic to return to the international capital challenges that local people will face as second-round effects of any newly enacted policies. markets with a bond offering to help The rate of deforestation in the Amazon region surged address environmental concerns. 59 percent from an average of 7,500 square kilometers per The victory of Luiz Inácio Lula da Silva in Brazil’s presidential year between 2015 and 2018, to 11,400 square kilometers election in October 2022 is expected to give a boost to per year from 2019 to 2022 (See Exhibit 5-a). This was a the country’s environmental agenda. Lula’s plans include significant setback to global efforts to promote sustainability. granting a new protected status to half a million square Brazil is influential on the global environmental stage, on kilometers (193,000 square miles) of Amazon rainforest, account of the fact that more than 46 percent of its territory subsidies for sustainable farming, and introducing fiscal is covered in rainforest. The country also claims some of the incentives–via a reform of Brazil’s tax code–for the energy world’s highest levels of biodiversity.66 transition. The Amazon rainforest plays an important role in absorbing The new government has set a goal of halting deforestation carbon dioxide from the atmosphere. Indeed, if all the CO2 by 2030 and stated a willingness to use the power of the stored in the region were released, it would equate to state to prevent further invasions of protected lands and roughly 730 billion tons, equivalent to 20 years of global 66 Rainforest Foundation US, 2022, Brazil, Viewed January 31, 2023, https://rainforestfoundation.org/our-work/where-we-work/brazil Page 67 Case Studies on Specific Emerging Market Countries EXHIBIT 5-a Brazil’s New Government Aims to Halt Deforestation After Recent Increases Deforested area in the Amazon rainforest in Brazil 30 28 25 20 1,000 km2 per year 15 13 10 5 0 2022F 2020 2010 2018 2019 2021 2012 2013 2014 2015 2016 2017 2011 2000 2004 2005 2006 2008 2009 2002 2001 2003 2007 Source: Instituto Nacional de Pesquisas Espaciais, IFC emissions at current rates.67 foreign donations destined for the environmental agenda, from a constitutionally mandated spending cap. Importantly, Conservation in the Amazon and other environmental goals the country’s Public Debt Operations office is planning to will require funds, a major challenge given Brazil’s fiscal return to the international capital markets with a bond rules leave it little room for maneuver in terms of securing offering to help address environmental concerns.68 bigger environmental budgets. Germany and Norway have both signaled that they will restart donations to the Amazon One option for Brazil’s government is to sell a sustainability- Fund, an essential tool in combating deforestation. Further linked bond, where the interest it pays creditors hinges on options under discussion to ease the burden on public whether the country protects the rainforest. As mentioned budgets include the exclusion of certain expenses, including elsewhere in this report, two of Brazil’s Latin American peers, 67 Nobre, C., Sampiao, G., and Borna, L., 2015, “Land Use and Climate Change Risks in the Amazon and the Need of a Novel Sustainable Development Paradigm,” PNAS, https://www.pnas. org/doi/10.1073/pnas.1605516113 68 Reuters, 2023, “Brazil Says Plans Green Bond Sale This Year,” January 25, 2023, Viewed January 26, 2023, https://www.reuters.com/business/environment/brazil-looks-forward-environ- mental-bond-sale-debt-head-2023-01-26/ EMERGING MARKET GREEN BONDS Page 68 EXHIBIT 5-b A Sovereign GSSS Bond Issue Could Prompt Brazil’s Corporates to Follow Brazilian green and sustainability-linked bond issuance versus other emerging markets 35 30 25 Emerging Markets excuding China and 20 Brazil Green Bonds $ Billion 15 Emerging Markets excluding China and Brazil 10 Sustainability-Linked Bonds 5 Brazil Green Bonds Brazil Sustainability-Linked Bonds 0 2017 2018 2019 2020 2021 2022 Source: CBI, Bloomberg, IFC Chile and Uruguay, have already made use of this type of A sovereign sustainability-linked or green bond from Brazil instrument. Market participants led by NatWest Bank, have would also help revive the broader Brazilian GSSS market. proposed the idea of a $10 billion sustainability-linked bond Brazilian corporations only accounted for 11 percent of to help Brazil reclaim leadership on the climate front.69 total emerging market issuance of sustainability-linked bonds, down from 40 percent. Meanwhile, Brazil’s share Challenges Brazil will face include ensuring a strong of emerging market green debt issuance increased from governance framework to align with investors and to set 5 percent to 12 percent (See Exhibit 5-b). targets and a baseline that complement existing efforts to reduce deforestation. Additional areas for consideration will be around social safeguarding and ensuring that the rights of indigenous peoples are respected, a key concern for the new government. 69 Reuters, December 19, 2022, “Bank Floats $10 bln Brazilian Bond Plan to Halt Amazon Deforestation,” Accessed December 19, 2022, https://www.reuters.com/markets/rates-bonds/ bank-floats-10-bln-brazilian-bond-plan-halt-amazon-deforestation-2022-12-19/ Page 69 Case Studies on Specific Emerging Market Countries URUGUAY: EXHIBIT 5-c A two-way coupon structure for a sustainability-linked bond The Terms of Uruguay’s Sustainability-Linked Bond In September 2022, Uruguay published its first sovereign sustainability-linked bond framework ahead of a planned KEY PERFORMANCE INDICATOR 1 issuance of new debt. This makes the bond’s interest payment conditional on the country meeting environmental Reduction of aggregate gross GHG emissions objectives and the achievement of climate and nature-based (in CO2 equivalent) per real GDP unit with goals aligned with the Paris Agreements. The Inter-American respect to reference year 1990 (in %) Development Bank and the United Nations Development Programme provided technical support for the issuance. Nationally Determined Contributions (NDCs) commitment: Achieve at The most differentiating feature of the 10-year dollar- SPT1.1 least 50 percent reduction in GHG denominated bond is that there are two key performance emissions intensity by 2025 from 1990 indicators: reduction of greenhouse gas emissions intensity reference year. as a share of GDP and the maintenance of native forest area. The coupon will step up by 15 basis points if either of the Outperformance compared to NDC targets is not met. For the coupon to step down 15 basis commitment: Achieve more than SPTI 1.2 points, however, the country will need to exceed the targets 52 percent reduction in GHG emissions by twice as much as the levels set for the penalty. intensity by 2025 from 1990 reference year. Meanwhile, Uruguay exceeded United Nations reporting requirements on providing greenhouse gas emissions data KEY PERFORMANCE INDICATOR 2 under the Paris Agreement. For the second performance Maintenance of native forest area (in hectares) target, Uruguay will commit to carrying out satellite with respect to reference year 2012 (in %) mapping of its native forest area every four years up to 2033. From the investors’ perspective, the step-down risked lessening the bond’s appeal to so-called buy-and-hold NDC commitment: Maintain at least investors if they perceive the coupon as likely to revise lower SPT2.1 100 percent of the native forest area during the debt’s duration. compared to reference year 2012. In the event, however, the bond met considerable demand and led to many investors allocating capital to Uruguay for Outperformance compared to NDC the first time. This suggests that ambitious, but credible, commitment: Achieve an increase higher SPTI 2.2 sustainability targets are appealing to global investors than 3 percent of the native forest area seeking to deploy funds in assets that meet environmental compared to reference year 2012. or social criteria. Furthermore, the success of the deal may encourage subsequent use of the structure by other issuers both within Uruguay as well as across the broader region, Source: FoSDA Workstream on Taxonomies boosting the liquidity of sustainability-linked bonds as an emerging market asset class. EMERGING MARKET GREEN BONDS Page 70 INDONESIA: Leader in Green Sukuk issuance and Climate Budget Tagging Since 2018 when Indonesia issued the world’s first sovereign green sukuk, a bond-like instrument that adheres to Islamic law, the country’s government has continued to develop the market. Proceeds from the sukuk have been allocated toward projects in renewable energy, energy efficiency, sustainable transport, waste management, and resilience to climate change. What makes Indonesia’s climate finance initiatives ambitious is its Climate Budget Tagging mechanism, which enables the tracking and evaluation of climate-related expenditure from the national budget system. Indonesia is the first country in the world to have adopted this new climate finance tracking system which is based on recommendations from the United Nations Development Programme and United Nations Environment Programme. Budget Tagging has proved an effective mechanism for preventing greenwashing and ensures financing is directed to areas of the economy where it is needed. It should also help with the government’s commitment to climate finance even at times of regime change. Page 71 Annex Annex Annual Emerging Market Green Bond Issuance by Market Segment This analysis uses data consolidated from Bloomberg, maturity of over one year to capture better bonds issued the Climate Bonds Initiative, and Environmental Finance, to fund medium- to long-term projects. It also includes according to the bond definitions in Box 1.1 (Section 1) of eligible bonds, as per the definitions of Box 1.1., issued by the report. A complete data set showing issuance volumes supranational entities. per region, in billions of U.S. dollars from 2012 to 2022 can Finally, we acknowledge there is only a brief mention of be found in the table below. According to Bloomberg’s “transition bonds” in the report (in Box 1.1). While we do take methodology, bonds are associated with the issuer’s country them into account, when calculating GSSS issuance, we also of risk, which comprises four factors: management location, flag their small scale, with their contribution to overall GSSS the security’s country of primary listing, the country of issuance being under 0.5 percent of the total in 2022. This revenue, and the issuer’s reporting currency. Categorizing does not negate the fact that these instruments may have a country as an emerging market aligns with criteria used an important role to play in financing transitions to greener by the Amundi Planet Emerging Green One fund. This list practices in hard-to-change sectors, as well as in aligning is made up of IFC members, including countries eligible to heavy industry with global net-zero efforts. Specifically, receive International Development Association resources we highlight increasing issuance of transition bonds in and official development assistance, as defined by the Japan, where the Ministry of Economy, Trade, and Industry Organization for Economic Cooperation and Development’s published Basic Guidelines on Climate Transition Finance, Development Assistance Committee. Although Russia is leading to a significant uptake of transition bonds in 2022. not included in the fund’s investment universe, it is included In this regard, we also emphasize the importance of other in this data set. Bonds issued in China that do not meet nations adopting similar frameworks to endorse credible international norms or standards as defined by the Climate transition financing and drive market transformation. Bonds Initiative are excluded from the data set. Unlike previous editions, this report only includes bonds with a GSSS Issuance Volumes per Region, in Billions of U.S. Dollars, 2012–2022 Change between 2021 Total Issuance 2012-22 Green 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 and 2022 in US$bn East Asia and the Pacific (excluding China) 0.0 0.0 0.0 1.2 1.8 5.2 3.4 6.6 4.3 9.1 6.1 -33% 37.7 Europe and Central Asia 0.0 0.0 0.0 0.1 0.8 0.5 1.7 4.4 6.6 14.8 6.5 -56% 35.4 Latin America and the Caribbean 0.0 0.0 0.2 1.1 1.6 4.2 1.3 5.8 9.0 10.1 5.1 -49% 38.4 Middle East and North Africa 0.0 0.0 0.0 0.0 0.2 0.7 0.1 1.3 2.1 0.7 7.2 932% 12.4 Sub-Saharan Africa 0.0 0.0 0.0 1.3 15.7 14.3 21.6 21.1 11.7 41.9 67.6 61% 195.2 China 0.0 0.0 0.0 1.3 15.7 14.3 21.6 21.1 11.7 41.9 67.6 61% 195.2 Developed Markets 1.4 5.1 25.8 32.0 47.4 114.5 121.7 197.7 237.9 414.4 353.1 -15% 1,551.0 Supranational 1.7 5.8 9.6 8.3 10.5 10.0 11.7 15.3 15.8 28.5 41.6 46% 158.6 Total 3.1 10.9 35.5 45.2 93.7 163.8 183.1 273.3 299.2 561.3 554.7 -1% 2,223.9 Change between 2021 Total Issuance 2012-22 Social 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 and 2022 in US$bn East Asia and the Pacific (excluding China) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 1.2 1.0 0.6 -40% 3.1 Europe and Central Asia 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.3 0.0 -100% 0.6 Latin America and the Caribbean 0.0 0.0 0.0 0.0 0.0 0.3 0.2 0.0 3.4 17.5 1.4 -92% 22.8 Middle East and North Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 - Sub-Saharan Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0 0.3 0.3 14% 0.9 China 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.6 0.0 0.0 0.6 Developed Markets 0.2 0.8 0.5 3.2 2.9 8.2 11.3 16.5 94.4 125.1 144.4 15% 407.4 Supranational 0.0 0.0 0.5 0.1 0.0 2.8 2.9 1.3 68.9 67.7 17.8 -74% 162.0 Total 0.2 0.8 1.0 3.3 2.9 11.3 14.4 18.4 168.8 211.9 164.4 -22% 597.5 Sustainability 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Change between 2021 Total Issuance 2012-22 and 2022 in US$bn East Asia and the Pacific (excluding China) 0.0 0.0 0.0 0.0 0.0 0.0 0.2 2.0 2.2 8.9 8.2 -9% 21.5 Europe and Central Asia 0.0 0.0 0.0 0.0 0.3 0.3 0.0 0.0 0.8 4.2 0.4 -91% 5.9 Latin America and the Caribbean 0.0 0.0 0.0 0.0 0.0 0.9 0.3 1.6 1.2 10.4 17.0 64% 31.4 Middle East and North Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.1 0.0 2.3 2.4 Sub-Saharan Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.0 0.1 -86% 1.1 China 0.0 0.0 0.0 0.0 0.0 0.0 1.4 0.0 0.5 1.4 0.0 -100% 3.2 Developed Markets 0.0 0.5 0.6 2.1 4.2 9.8 13.9 34.8 49.4 89.4 77.4 -13% 282.2 Supranational 0.0 0.0 0.0 0.0 0.1 0.3 2.7 11.1 79.6 70.6 44.7 -37% 209.0 Total 0.0 0.5 0.6 2.1 4.5 11.4 18.5 49.5 133.8 185.8 150.0 -19% 556.7 Change between 2021 Total Issuance 2012-22 Sustainability-Linked Bonds 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 and 2022 in US$bn East Asia and the Pacific (excluding China) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.2 1.3 -39% 3.5 Europe and Central Asia 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 1.0 2.2 126% 3.7 Latin America and the Caribbean 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.5 14.3 7.9 -44% 24.7 Middle East and North Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.6 0.0 0.0 0.6 Sub-Saharan Africa 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.0 -100% 0.3 China 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.7 1.1 -39% 2.8 Developed Markets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.2 6.7 72.4 59.2 -18% 142.4 Supranational - Total 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.2 10.3 91.8 71.7 -22% 178.1 Change between 2021 Total Issuance 2012-22 Transition 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 and 2022 in US$bn East Asia and the Pacific (excluding China) - Europe and Central Asia - Latin America and the Caribbean - Middle East and North Africa - Sub-Saharan Africa - China - Developed Markets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.8 3.2 3.5 10% 8.5 Supranational 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 0.2 0.0 0.0 0.8 Total 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 2.1 3.2 3.5 10% 9.3 Page 73 Bibliography Bibliography Amundi and IFC. 2022, “Emerging Market Green Bonds - Report 2021,” June Chaudhary, S. 2020. “Look for the green bond label,” GreenBiz. 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