Deciphering different instruments in the sustainable bond market

What makes up a market is not cast in stone but rather what the participant in a market collectively reaches a consensus on. New instruments, terminologies and standards may still emerge for sustainability-related bonds.

We have observed, though, that sustainable bond issuers in the SGD bond market align to principles and standards as set out by the International Capital Market Association (ICMA), the Climate Bonds Initiative and the Asean Green Bond Standards. All three standards and guidelines are well regarded by the marketplace. The main type of instruments within the market are: (See Figure 1)

Green bonds: Green bonds and green perpetuals are the dominant types of sustainable bonds in the SGD bond market as at July 28, making up 83% of total sustainable bonds outstanding. The proceeds for green bonds and green perpetuals are ring-fenced for specific uses and/or green projects as part of green financing frameworks.

For example, for a real estate company, proceeds from green bonds may include the financing and/or refinancing of a portfolio of green buildings where green buildings are those that have less environmental impact such as being designed to use less energy and water. We have yet to see events of default being tied to the use or misuse of proceeds. However, non-adherence may amount to “greenwashing”, leading to the market penalising such issuers and those involved in the bond arrangement.

Social bonds: Social bonds are bonds where proceeds are used to fund projects with positive social outcomes set out by the ICMA. There have been no social bonds issued thus far in the SGD bond market.

Unlike green buildings or renewable energy that have a clear economic proposition in addition to building climate resiliency, there are few pure direct economic incentives to pursue social projects by major bond issuers in Singapore. Social enterprises exist although their operating scale is thus far small, making them less likely to issue SGD bonds in the capital markets.

However, several markets within the region can generate both social and financial returns, for example, in microfinance and micro-entrepreneurship. In 2020, Singapore-based Impact Investment Exchange (IIE), an investment management company, raised US$39.7 million across two tranches of Women’s Livelihood Bonds where proceeds were put on loan to borrowers in developing countries. As an impact investor, IIE aims to generate social impact as well as financial returns. At the sovereign level, the government of Malaysia raised RM500 million ($160.5 million) of Sukuk Prihatin from retail investors to fund Covid-19 recovery efforts.

Sustainability bonds: Similar to green bonds, green perpetuals and social bonds, sustainability bonds have a defined use of proceeds although they are more flexible in that proceeds can be used for numerous green projects as well as projects with positive social outcomes rather than ring-fenced for specific uses and/ or green projects.

In practice, sustainability-linked projects that are green in nature often also simultaneously fulfil a social goal. For example, sustainable sourcing of agricultural products. As several Singapore corporate bond issuers have aligned their sustainability frameworks to United Nations Sustainable Development Goals, these bonds may become increasingly popular in our view, given the flexibility and signalling effect of their sustainability commitments.

Sustainability-linked bonds (SLB): Unlike green and social bonds, SLBs are linked to specified sustainability goals and targets where proceeds can be used flexibly. SLBs can be structured with a carrot (lower interest rates for meeting targets) or stick (higher interest rates for not meeting targets) or a combination.

For example, for an SLB that links interest cost with reducing carbon emissions by 25% in five years’ time, non-fulfilment may lead to an increase in interest cost. The largest sources of greenhouse gas emissions in Asean are land-use change and forestry, followed by electricity and agriculture. These are sectors where there are no easy fixes without causing a disproportionate impact on the economy and livelihoods.

As eliminating such industries and “brown companies” or companies in polluting industries, is impractical, it can be more impactful to fund transitions for sectors and companies to turn less brown. Traditionally, certain green finance investors viewed SLBs with suspicion, perhaps for good reasons given that some structures are somewhat lenient.

However, we think SLBs are a practical way for companies to transition as transitioning requires heavy investments and capital. SLBs targets are also customisable and can be structured such that it encourages sustainability practices across the company.

Blue bonds: All three of ICMA, Climate Bonds Initiative and the Asean Green Bond have not explicitly set out blue bond standards and guidelines, but these bonds are basically green but “blue-labelled”.

In many ways, the blue label is, for now, a marketing term to indicate to investors that the use of proceeds is specific to the protection of the ocean, marine life, offshore wind farms, water and wastewater management.

Blue bonds are issued per established green bond guidelines. In October 2018, the Republic of Seychelles became the first sovereign to issue a blue bond supported by the World Bank where proceeds were targeted at supporting sustainable marine and fisheries projects. In September 2020, the Bank of China, a frequent green bond issuer, issued the first blue bond from an Asia-based issuer. There are no SGD-denominated blue bonds yet.

Nascent market although impending developments likely to spur growth

The first green bond in the SGD corporate bond market was issued in April 2017 by CDL Properties, a wholly-owned subsidiary of City Developments. Since then, the market for green bonds and perpetuals have grown to a total amount outstanding of $1.9 billion as of July 28. The SGD corporate bond market has also seen the first sustainability bond issue from Frasers Commercial and Logistics Trust which was priced in July ($150 million) and the first sustainability-linked bond issue from Surbana Jurong in February ($250 million). Collectively, the green bond, green perpetuals, sustainability bond and sustainability-linked bond market are the primary instruments in the SGD sustainable bond market.

Within Singapore, we see four key developments that are likely to spur the growth of the SGD sustainable bond market.

First, the development of a proposed taxonomy that would give financial institutions a common language to identify and classify “green” activities. The Green Finance Industry Taskforce (GFIT), convened by Monetary Authority of Singapore (MAS) aims to address the issue of “greenwashing” when an entity presents an inaccurate or exaggerated claim that it is environmentally sound.

Next, MAS and the Singapore Exchange have set out roadmaps for mandatory climate-related financial disclosures to address the longstanding issue of inconsistent climate disclosure that has hindered the mainstream development of green finance.

Thirdly, MAS has earmarked US$1.8 billion for five asset managers to make climate-related investments. This should strengthen Singapore’s ambition to become a sustainability investment hub for the region, especially in public equities and bonds.

Last but not least, funding of infrastructure projects through green bonds, with up to $19 billion of public sector green projects identified. While many of these plans are still in progress, the pace of development has been accelerated since the beginning of the year with Singapore catching up with more developed sustainable finance markets.

What next for the SGD sustainability bond market?

While companies are undertaking more green or sustainability-linked projects, for example, building solar installations and green buildings, we expect new issuance of green bonds, sustainability bonds and SLBs to be driven more by substitution from conventional corporate bonds as the sustainable bond market as a whole has become a viable funding source.

From the demand side, we expect investors to increasingly favour green bonds, sustainability bonds and SLBs, with investors increasingly tilting portfolios into sustainable investments. From the supply side, we see issuers driven to this market as they build out their sustainability credentials and sustainability-centred business models.

Ezien Hoo, Andrew Wong, and Wong Hong Wei are credit research analysts at OCBC Bank’s Global Treasury Research & Strategy

Photo: Samuel Isaac Chua / The Edge Singapore