Opportunity awaits - Financing Asia's green buildings through green bonds

One of the most significant growth opportunities in the capital markets today is in green bonds in the Asia-Pacific region, according to the IFC. 

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This opportunity is driven by demographic, economic, and climate changes that will require trillions of dollars of investment, and potentially provide investors with substantial returns.

A key area of investment is in green buildings – a specific type of use of proceeds for green bonds. In this two-part series of articles, Environmental Finance will explore how the market for green bonds to finance green buildings is developing in emerging Asia. This first article looks at the drivers behind the need for this type of financing, the growth of green bonds in Asia, as well as the development of the investor base. The second article will look more in-depth about the financing of green buildings in the region in particular – both challenges and successes.

Understanding the drivers

It's clear that green bonds are an answer – in the form of an opportunity – for the Asia-Pacific region. A recent IFC study¹ identified a US$23 trillion total climate investment opportunity between 2016 and 2030 within a group of 21 emerging market countries. In that total, more than $16.3 trillion of the opportunity is within green buildings alone. Of that, $13.2 trillion – the biggest single country/category block in the whole study – is in green buildings in the East Asia Pacific region. This development in China, Indonesia, the Philippines and Vietnam will be focused mostly on the construction of new green buildings.

Driving these predictions of building growth in emerging markets, and particularly in the East Asia Pacific region, is the ongoing urbanization in these countries. Since 1950, when just 751 million of the world's population lived in urban areas – and these were predominantly in developed countries – urbanization has exploded (see figure 1). Today, 55% of the world's population, or 4.2 billion people, live in cities. Asia, even with its relatively lower overall level of urbanization compared with developed countries, is currently home to 54% of the world's urban population, followed by Europe and Africa with 13% each.²

Overall global urbanization is expected to increase to 68% by 2050. The gradual shift of the human population from rural to urban areas, combined with population growth, could potentially add another 2.5 billion people to urban areas by 2050, with close to 90% of this increase taking place in Asia and Africa. By 2030, the world is projected to have 43 megacities with more than 10 million inhabitants, most of them in developing regions.³

Urbanization means more buildings – and lots of them. According to a recent Climate Bonds Initiative report, there is over 400 billion square meters of gross floor area globally – which is three times as large as New York State. These buildings account for roughly 30% of global final and 40% of primary energy consumption, roughly equal to 135 EJ of final energy.⁴

Looking forward, the International Energy Agency (IEA) projects that residential floor area will increase by 75%, from 200 billion square meters in 2015 to over 350 billion square meters by 2050. It is forecasting a similar growth trend in nonresidential floor area.⁵ A very large chunk of this new building is expected to take place in emerging markets because of their rapid urbanization.

The fear, of course, is that this spectacular growth in buildings which will be the result of rapid urbanization in emerging markets will lead to climate-damaging outcomes. Globally, today's buildings account for some 19% of energy-related greenhouse gas emissions.⁶ Looking at the issue from another direction, the IEA estimates that urban areas currently account for over 67% of energy-related global greenhouse gases, which is expected to rise to 74% by 2030. It is estimated that 89% of the increase in CO2 from energy use will be from developing countries.⁷

So, rapid urbanization in emerging economies will lead to a building boom – which is expected to drive higher levels of energy use and carbon emissions. It is using this logic that the IFC has identified the opportunity within 21 emerging market countries for more than $16.3 trillion within green buildings alone by 2030. Says Jean-Marie Masse, chief investment officer at the IFC in Washington DC, "Green building green bonds will help emerging markets combat climate change, and so the IFC is focused on helping to foster both the supply and demand sides of this market."

Building green

Policymakers globally, including the IFC, have concluded that in urbanizing emerging markets, there must be an enhanced focus on green buildings. "Green bond market forecasts indicate that it will grow, and the larger the green bond market becomes, the more sophisticated it will be, says the IFC's Masse. "We are clearly at the beginning of that trend."

"The only way to achieve the goals of Paris is to bend the demand curve for energy through increased energy efficiency," says IFC CEO Philippe Le Houérou. "We must view standard setting for energy efficiency in the built environment as a key issue for energy security and economic growth."

The International Capital Markets Association (ICMA) is the secretariat for the Green Bond Principles⁸, which are the generally accepted standards and provide a high-level framework for green bond issuance globally. Within the principles, there are defined "use of proceeds". Up until 2017, the use of proceeds of green bonds for green buildings was spread over the range of categories – such as energy efficiency or renewables. However, in 2017 ICMA included green buildings as its own new category, and since then there has been $59.7 billion in new green bond issuance for green buildings through the end of Q3 2018, according to Environmental Finance's database, www.bonddata.org.

This new category defines green buildings as "buildings which meet regional, national or internationally recognized standards or certifications."⁹ There are a range of certifications for green buildings – an area that will be explored more in the second part of this pair of articles. However, the World Green Building Council says green buildings are those with features such as:

• Efficient use of energy, water and other resources
• Use of renewable energy, such as solar energy
• Pollution and waste reduction measures, and the enabling of re-use and recycling
• Good indoor environmental air quality
• Use of materials that are non-toxic, ethical and sustainable
• Consideration of the environment in design, construction and operation
• Consideration of the quality of life of occupants in design, construction and operation
• A design that enables adaptation to a changing environment¹⁰.

The IFC is seeking to encourage the financing of buildings with these characteristics in emerging markets through green bonds. By shifting the new building in urbanizing emerging markets to green buildings, both energy use and CO2 emissions will be greatly reduced – contributing to the world meeting its overall climate targets.

Exciting beginnings

"Learn by doing...it gives us a lot of credibility when we go out to our clients – to say we know how to navigate this process – because we have done this ourselves" Yulanda Chung, DBS Bank

The IFC, as well as other organizations, are very optimistic in their outlook for the growth of the green bond market. "I think this can be a $1 trillion market in five years' time," says Sean Kidney, co-founder and CEO of the Climate Bonds Initiative. With the growth of the overall green bond market, instruments specifically for green buildings will become easier to issue. However, today there is some way to go.

According to Environmental Finance's database, total cumulative green bond issuance is $490.7 billion, with $112.3 billion in green bonds issued in the first three quarters of 2018 alone. Issuance over the past two years has grown significantly – of the total outstanding, nearly 63% was issued in 2017-2018.

However, emerging markets issuance is a fraction of this – about 25% of total cumulative issuance originated from emerging markets. Of emerging market issuance during 2017-2018, 5.2% had a proceeds of use for green buildings. Part of the challenge is the overall appetite among investors for emerging market debt – this needs to develop more, particularly for debt issued in local currencies. A key issue is simply education – getting the word out that emerging market green buildings can be financed via green bonds.

"It's an exciting time for both green buildings and green bonds," says the IFC's Masse, "We are seeing a lot of 'firsts' right now in terms of deals, and this is helping to spread the word among both issuers and investors about the potential for this market. We expect that these types of trail-blazing transactions will soon be replicated across the region."

DBS' own journey in green bond financing of a green building project is a good example of the road that many financial institutions are on today. In July 2017, Singapore's DBS issued US$500 million in floating rate green bonds, which were very well received in the marketplace. All of the net proceeds of the issue were allocated to green assets that are part of DBS' financing of a green building – Marina Bay Financial Centre Tower 3 (MBFC T3), a commercial property in Singapore certified Green Mark Platinum by Singapore's Building and Construction Authority (BCA).

"We wanted to send a clear signal to the market that we are embarking on a journey to be a sustainable bank," says Yulanda Chung, DBS Bank's director and head of sustainability. "One way to do that is to learn by doing...it gives us a lot of credibility when we go out to our clients – to say we know how to navigate this process – because we have done this ourselves." DBS has lead-managed several green bond deals, including one for Singapore-based City Developments in 2017, where the proceeds were used to refinance a 2012 loan to put in place water and energy saving energy measures at the company's Republic Plaza headquarters in Singapore. A green bond for State Bank of India, which raised $650 million in September, includes green buildings in its use of proceeds.

Meanwhile, DBS is now looking at the possibility of doing a second bond, but this could also mix in social or sustainable development goal (SDG) elements. "There are different ways in which a company can describe its sustainability development efforts," Chung says. "We are investigating not just another green bond but potentially a broader framework, so we can put into the underlying assets different things that would contribute to sustainable development."

Diversifying issuance

The IFC is also leading by example. According to the Environmental Finance database, in 2017, the IFC issued five green bonds across three currencies, totaling $1.5 billion. The IFC's cumulative green and social bond issuance since 2010 is $7.7 billion across 14 currencies.

Most recently in October, the IFC issued its inaugural Indonesian Rupiah Komodo green bond, which has green buildings as one of its use of proceeds. The issue attracted a strong investor demand and raised 2 trillion IDR (US$134 million).

It's the first green Komodo offshore Rupiah-denominated issuance by a multilateral development bank for investment into climate projects in Indonesia, and will aid Indonesia in growing its own green bond market. Among the ten Asean member nations, Indonesia is the largest country in terms of green bond issuance, with $1.9 billion in green bonds. However, more green building deals like this one will be needed – construction of new green buildings is a $345 billion opportunity in Indonesia, Philippines and Vietnam, according to the IFC. Yet, no Indonesian green bonds with a green building use of proceeds have been issued to date.

China's green bonds

China is another growing market for green building green bonds. Generally, issuance in Asia is dominated by China (see figure 3). Since the inception of the green bond market, about $85 billion of bonds have been issued in the country, compared with a sum of $10.4 billion for Japan, the second largest country by total issuance. Since the green building designation was launched, five Chinese issues have come to market in a combination of local currency and US dollars, totalling nearly $1.5 billion. "China's demand for low carbon green bonds, and green bonds associated with low carbon buildings has started to pick up," says Peter Munro, director, green and social bond principles, ICMA.

According to the IFC, green building green bond issuance will have to increase further to meet the demand for urbanization in that country. Nearly 81% of the $13.2 trillion of the climate change investment opportunity that the IFC anticipates in the East Asia Pacific region is composed of construction of new green buildings in China ($12.9 trillion). This is a product of China's goal to move 250 million people into cities by 2025.

In short, it's little wonder that the IFC is anticipating such an opportunity in green building green bonds for urbanizing and economically developing Asian countries such as China and Indonesia. The second part of this pair of articles will explore green buildings in more depth, including the role of programs such as the IFC's EDGE in supporting green building green bond issuance. The next question is – will investor appetite sustain this level of growth in green bonds?

Investor base growing

Over the past 18 months there has been significant growth in the green bond investor base. According to a survey by Environmental Finance, total assets under management in green bond funds has more than doubled since July 2017. In the same period, the number of funds rose by more than a third to 38.¹¹

How interested are investors specifically in green building green bonds? The answer is that it is early days, but interest is building. In developed markets, issuers such as Fannie Mae have seen significant interest in their green building green bonds. "When we say there is no special demand for green buildings, the question is, what do we mean by that?" asks Christopher Flensborg, head of climate & sustainable finance at SEB. "No, there are no special, dedicated portfolios for green buildings...but there are investors who are now saying, 'Green buildings are better performing? Come and show me why.' So, the curiosity and the awareness that this might be the case is opening doors for discussions which are benefiting the issuers."

Investors are being drawn to green building green bonds because, according to Flensborg, the buildings themselves are better-performing assets, with lower tenant turnover and so therefore higher returns. Masse adds that green bonds in general have higher levels of information disclosure to investors – they have to comply with green bond frameworks, are usually marketed with the opinion of an external reviewer, and issue annual impact reports.

"Building on a strong history of green bonds in China, the country's issuance of green bonds associated with low carbon buildings has started to pick up, which is a trend that has also been visible globally, with issuance in that sector multiplying 2.4x in 2017" Peter Munro, director, green and social bond principles, ICMA

In emerging markets, the IFC is drawing attention to both green bonds and green building investments. For example, Amundi Planet Emerging Green One (EGO) fund, with assets of $1.42 billion, launched recently. The aim of the fund is to increase the capacity of emerging market banks to fund climate-smart investments. The fund included a $256 million cornerstone commitment from IFC, part of the organization's commitment to increase its climate investments to 28% from its own account. Beyond this, the IFC is seeking to mobilize an additional $13 billion a year in private financing by 2020 for green bonds.

The IFC is also leading the charge on green buildings in more specific ways. These include recent transactions with Punjab National Bank in India, via a secured non-convertible debenture, as well as Turkey's Garanti Bank, through a covered bond for green mortgages. The IFC has also invested in green bond issuances in Colombia and Poland, in which a large chunk of the financing was earmarked for green buildings. IFC's cumulative investments in green buildings tops $3 billion at the end of FY2017, including own account and mobilization via syndicated loans. Of this total, almost $600 million was invested through other financial institutions.

There is more work to do to generate investor demand. The good news is that a recent HSBC study found that 61% of investors and 48% of companies around the world have an environment, social and governance (ESG) strategy in place. As well, 67% of issuers and 57% of investors see no barriers to increasing their ESG commitments. However, the report notes that less than 10% of investors currently have dedicated ESG investment funds.¹²

Some research shows that investors in Asia are also looking to increase the proportion of sustainable investments in their portfolios. One survey, the recent Standard Chartered Private Bank Asia Sustainable Investing Review 2018, said that Asia investors are looking to increase their sustainable investments to an average of 19% over the next three years. Apparently, Chinese investors will lead the way with an expected allocation of 23% by 2021.¹³ The IFC, as well as a variety of industry experts, expect a chunk of this flow into green bonds to go into those with a green building use of proceeds designation.

In conclusion, the green bond market in Asia looks set to develop significantly over the next five years, fueled by demographic, economic and climate drivers. One key challenge that remains is in ensuring sufficient investor demand – but this too looks like it is evolving as both global and regional funds increase their allocation towards emerging markets as well as green bonds. The second article in this two-part series will explore how the financing of green buildings through green bonds is set to play a significant part in this overall phenomenon.

References

1. https://www.ifc.org/wps/wcm/connect/51183b2d-c82e-443e-bb9b-68d9572dd48d/3503-IFC-Climate_Investment_Opportunity-Report-Dec-FINAL.pdf?MOD=AJPERES
2. https://www.un.org/development/desa/en/news/ population/2018-revision-of-world-urbanization-prospects.html
3. Ibid
4. https://www.climatebonds.net/files/files/SEIM-01A(1).pdf
5. Ibid
6. https://www.ifc.org/wps/wcm/connect/news_ext_content/ifc_external_corporate_site/news+and+events/news/new+ifc+report+points+to+%2423+trillion+of+climate-smart+investment+opportunities+in+emerging+markets+by+2030
7. http://siteresources.worldbank.org/INTUWM/Resources/340232-1205330656272/4768406-1291309208465/PartIII.pdf
8. https://www.icmagroup.org/green-social-and-sustainability-bonds/green-bond-principles-gbp
9. https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/GreenBondsBrochure-JUNE2017.pdf/
10. http://www.worldgbc.org/what-green-building
11. https://www.environmental-finance.com/content/news/green-bond-funds-double-aum-to-$5.3bn-in-12-months.html
12. https://www.environmental-finance.com/content/news/only-one-in-ten-investors-aware-of-tcfd-says-hsbc.html
13. https://av.sc.com/corp-en/content/docs/Asia-Sustainable-Investing-Review-2018.pdf

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