Rising volumes, an ever-diversifying issuer base, new structures and yield-hungry investors have characterised the sustainable bond market in Asia, say Jarek Olszowka, Nomura's head of sustainable finance, and Olcay Yagci, a senior banker in its sustainable finance group
Environmental Finance: What were the highlights for the sustainable bond business at Nomura in 2020?
Jarek Olszowka: We had a great 2020 in terms of sustainable bonds. We acted on the equivalent of more than $62 billion in aggregate notional of bonds underwritten, with some really landmark transactions. For example, we were joint lead managers on the EU's record-breaking inaugural dual tranche SURE social bond issuance, helping to raise €17 billion ($23.5 billion) off an order book of well over €233 billion. We helped bring to the market the first Covid-19 response bond from a European bank, from BBVA, and the first green Tier 2 subordinated debt instrument from a European bank, for the Dutch bank de Volksbank.
We also arranged the first sovereign green bond in Samurai format, selling Hungarian government debt in yen to Japanese investors. Of the four tranches, totalling ¥62.5 billion ($24 million), two were in green bond format.
In terms of market development, we were one of only five underwriters elected to the International Capital Markets Association (ICMA) Green and Social Bond Principles inaugural Advisory Council, and we have been actively participating in ICMA's Climate Transition Finance Working Group, which published a key handbook on climate transition in December 2020, as well as a number of others, such as the Social Bond and Sustainability-Linked Bond Working Groups. We also picked up a number of awards, including the Investment Bank of the Year for Sustainable Corporate Finance from The Banker.
It was also a year where, as a large international financial institution, we have put in a lot of inward-facing efforts to improve our own sustainability metrics and footprint, and also to further widen the breadth of environmental, social and governance (ESG) solutions and products we are able to offer. We completed our acquisition of Greentech Capital Advisors, now Nomura Greentech, a leading boutique investment banking firm focused on supporting clients across sustainable technology and infrastructure. This has certainly strengthened our primary and advisory services relating to our ESG capabilities.
In 2020, we have also, among other things, published our first TCFD Report, joined the UN Principles for Responsible Banking and launched the Nomura Sustainability Research Center in Japan, focusing on conducting research and identifying strategic sustainability themes directly linked to the financial and capital markets.
To accelerate our efforts and to provide financing and other solutions for low-carbon projects, we formed the Wholesale Sustainability Forum across our Wholesale Division at Nomura. Led by Steve Ashley, our head of wholesale, and comprising senior employees from across the firm, the forum's purpose is to monitor market and regulatory trends and identify opportunities for financial products and services that contribute to sustainability. We have also put in place a Wholesale ESG Sectoral Appetite Statement to guide us where, from an ESG perspective, we do and do not want to get ourselves involved.
In Retail, we have been continuously expanding our line-up of SDG-linked investment products, having launched a number of ESG-related funds. Apart from giving our clients opportunities to invest in companies that are working to resolve social or environmental issues by marketing these funds, we also aim to bring greater awareness to investors about sustainable finance.
So, rather unsurprisingly, it was a very busy year for us on the ESG front, with a lot of work which has also been externally recognised, with Nomura receiving significant uplifts in three of our ESG ratings.
EF: What have been the key developments in the sustainable bond market in Japan and Asia more broadly?
JO: It was a record year for green bond issuance in Japan – both the overall volume and the number of transactions nicely maintained the upward growth trajectory which we have been observing over the past years, despite the onslaught of the Covid-19 pandemic. (See figure 1)
Figure 1. Annual green bond issuance in Japan, 2014-2020
Issuance of social bonds in Japan virtually doubled to over $8 billion. Based on our own observations, social bonds in Japan have historically been overrepresented as a percentage of overall ESG bond issuance and when compared to other developed markets. In 2020, the volume of social bonds issued almost matched the amount of green bonds, which is pretty much unprecedented. (See figure 2)
Figure 2. Annual social bond issuance in Japan, 2014-2020
The same is also true about the issuance of sustainability bonds, which allow the mixing of green and social eligible projects, with the volume more than doubling to over $5.5 billion equivalent. (See figure 3)
Figure 3. Annual sustainability bond issuance in Japan, 2014-2020
We think that the announcement in September by Japan's new prime minister, Yoshihide Suga, that the country will become a net-zero economy by 2050, will be transformational.
At the same time, an interesting taskforce on climate transition finance was established by the Ministry of Economy, Trade and Industry (METI), the Ministry of Environment and the Financial Services Agency of Japan to further work on the concept of transition bonds and how to help companies from harder-to-abate sectors transition to a low-carbon business model. There have been calls from METI to introduce a goal of 30 transition bonds to be introduced by fiscal year 2023, and there was discussion around perhaps introducing a subsidy programme to reimburse the incremental costs incurred by issuers compared with issuing conventional bonds, similar to the scheme which has been introduced in Japan to stimulate green bond issuance.
Corporate Japan tends to closely follow government policy, so we expect a transition towards decarbonisation will accelerate in the years to come.
In terms of ESG bond product innovation, last year we lead-arranged the first sustainability/KPI-linked bond for a Japanese issuer, a real-estate company called Hulic, which has committed to source 100% of its energy from renewables by a predefined date and also to construct a new commercial property using specific green technologies. If the issuer does not meet both of these targets, there will be a step-up in its financing costs.
Olcay Yagci: One other element of ESG bond markets in Asia ex-Japan is the relatively higher yield offered by many issuers. Given the current low yielding environment, this technical element had helped Asian ESG issuers to look into this product. The sovereign frameworks have been especially encouraging non-sovereign issuers, leading to a more vibrant and diverse market. In the past two months, we have seen transactions from issuers in China, Hong Kong, Korea, the Philippines, Indonesia and India in different formats.
EF: Interest in Japan in ESG investing, and in sustainable fixed income in particular, appears to have reached a tipping point. What's behind that?
JO: One of the triggers in our view has been the involvement of the Government Pension Investment Fund (GPIF), which is the largest pension fund in the world. Having commissioned a lot of research, GPIF has over the years become a vocal proponent of ESG integration and sees ESG bonds as another way to fulfil its long-term goals. This has provided an additional push for asset managers acting on behalf of GPIF to integrate ESG factors more comprehensively also into fixed income portfolios. Also worth mentioning here are the numerous direct partnerships entered into between GPIF and the leading global sovereign and supranational ESG bond issuers which aim to strengthen and develop sustainable capital markets and further promote ESG integration in fixed income through purchases of ESG bonds from these issuers.
Another development in 2020 is that issuance has moved beyond the financial sector, and other established green bond issuers, such as say Japan Railways, and into the broader real economy. So we've had bonds from issuers such as Asahi Kasei, the chemicals company, Asahi Group Holdings, the food and beverages giant, telecoms group NTT and Komatsu, which manufactures industrial equipment, just to name a few.
We are also seeing the Japanese municipal market broadening beyond the longstanding participant, the Tokyo Metropolitan government. We've seen other prefectures such as Nagano and Kanagawa tapping the market. Finally, we've seen some of the big government agencies continuing to be active in the ESG bond markets – such as DBJ, with its numerous sustainability bonds, and JASSO, the overseas students association, issuing a number of social bonds over the years to fund scholarships.
EF: What patterns of issuance have you seen from sovereigns in the region?
JO: One interesting development was the decision by both the Kingdom of Thailand and South Korea to issue sustainability bonds. Most governments tend to issue green or social bonds; in Europe, it's only Luxembourg that has gone down the sustainability bond route, because it has a limited amount of pure green assets.
Elsewhere in Asia, both Hong Kong and Indonesia have issued green bonds. There have been discussions about Japan potentially doing so, but we're not expecting anything imminently.
OY: For emerging market sovereigns, including those in Asia, the significance of these sustainable bond issues is not so much about raising revenue, but about putting the market infrastructure in place to encourage other entities to follow along in the footsteps of the sovereign. When sovereigns issue these bonds, they create the legal and taxation frameworks, they start to create a green yield curve, and then you see domestic corporates, financial institutions and other government-related entities come to the market. There has been a number of examples of such initiatives, namely in Indonesia, Thailand, and South Korea in Asia and, in the Americas, with Chile and a number of Central American states.
EF: How are transition bonds thought about in the Asia- Pacific region? What sort of issuance do you expect?
JO: As discussed, we have been active in discussions around transition. We see transition finance as much needed across the board, but particularly in the Asia Pacific region with hard-to-abate sectors and resource-intensive industries featuring prominently in many of the countries located in that part of the world. Take countries such as Australia or Japan, whose economies are dominated by mining and natural resources and high-end manufacturing, respectively; we're seeing lots of enquiries from clients who want to participate in the ESG bond market but who don't have sufficient volumes of eligible green or social assets to issue benchmark-sized use of proceeds-based bonds.
However, between use of proceeds-based transition bonds and sustainability/KPI-linked bonds, where the margin or some other key features of the bond are linked to issuer sustainability performance targets, we think the latter are going to be more effective in opening the ESG market to companies which lack qualifying capital expenditures.
OY: One of the key things here is what investors think. One school of thought favours the labelled use of proceeds products, such as green or social bonds, because the assets being financed are readily identifiable. The other school of thought prefers sustainability-linked products, which are linked to quantifiable direct evidence that the company is transforming itself. We think sustainability/KPI-linked products are going to gain momentum in the future, because they open the market to so many issuers who aspire to become more environmentally friendly.
JO: The challenge with transition bonds is that it is very hard to define 'transition' across every industry, and therefore to draw up guidelines about what is an appropriate use for the proceeds from transition bonds. As we've seen with the EU's effort to create a taxonomy of green economic activity, it's taken years and it's still not finalised.
I think the risk of 'transition washing' is much higher with transition bonds than green washing is with respect to green bonds. There are limited standards at present to measure what is the acceptable minimum level of transition, whereas with KPIs, we have a much more transparent and potentially more holistic transformational instrument.
EF: What about on the investor side? How are investors in the region approaching the market?
OY: There is certainly a different investor base in the region compared with Europe, which is more institutionalised, and dominated by large pension funds and asset managers that are risk-aware. In contrast, Asian investors, especially private banks, tend to be more open to risk and prefer higher-yielding products. So we're likely to see more structured products and lower-rated entities coming to the market, because they can offer the yields necessary to attract domestic investors in the region.
As a consequence, I expect to see smaller public companies and even private equity-owned firms in the region tapping the ESG market. Asia is going to be a quite interesting market over the next five to 10 years for that reason. In our view this region (and Latin America) are therefore going to be ahead of the curve when it comes to market growth.
JO: For example, in January 2021, we arranged a US dollar green bond for a Chinese real estate company called Modern Land China, which paid a coupon of above 9%. I believe this is not something you'd see in Europe.
EF: What opportunities does the acquisition of US-based Nomura Greentech create for Nomura's sustainable bonds business?
JO: The acquisition, which completed on 1 April 2020, is transformational for us. Prior to the acquisition, Nomura Greentech was a leading boutique investment banking firm focused on supporting clients across sustainable technology and infrastructure. It comprises close to 80 professionals, which is huge in the sustainable finance space. The firm is a market leader in sustainable finance advisory and M&A, with a focus on connecting investors and clients across different geographies, with a particularly strong foothold historically in North America, to help them incorporate innovation into particular sustainability themes such as energy, transportation, food, water and waste infrastructure systems.
Some of their clients are very fast-growing but have yet to access the public bond markets. We believe that the new policies that the Biden Administration is looking to promote on climate and clean energy are going to accelerate their growth, and we're going to see a lot of opportunities in green infrastructure and sustainable transport.
We think Nomura Greentech is going to represent a good pipeline for new issuers – which is exactly what ESG investors want to see. They want more diversity in terms of types of issuers, sectors and credit ratings. This allows investors to develop more interesting investment strategies rather than following the same names and the same indices.
This acquisition shows how serious Nomura is about its sustainable finance business. This isn't about announcing some goals for the future, or how much money we plan to invest in time – this is a major investment in the business right now.