(Bloomberg) -- The gold rush for greener debt may be over.
Global sales of ethical debt are set to suffer their first drop this year, as volatility and higher rates deter borrowers. Next year may see a slight recovery, yet arrangers and analysts aren't predicting a return to the exponential growth of the past decade that turned a fringe concept into a $5.6 trillion asset class.
There's plenty of factors that risk holding it back now, from growing regulation in Europe and a political backlash against ESG in the US, to greater scrutiny from buyers and bankers needing more time to get deals done. That's taken the market from commanding a so-called "greenium" to underperforming conventional debt.
"We expect greenwashing concerns and higher rates to continue to be headwinds to overall supply and to keep the amount below 2021's high-water mark," said Carolyn L Campbell, a strategist at Morgan Stanley.
While Morgan Stanley and Barclays Plc predict just under $1 trillion of global ESG bond sales in 2023, many market watchers seem to be holding back on forecasts, after uncertainty in the wake of Russia's invasion of Ukraine. Global sales of ESG and green bonds have reached about $870 billion this year, a 15% drop on the bumper $1.1 trillion sold in 2021, according to Bloomberg Intelligence data.
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Europe, where ESG bonds now make up a quarter of the primary market, is expected to continue to lead the sector with around €350 billion ($372 billion) in sales. Yet even here, there are challenges.
There's been a decline in post-pandemic social spending by governments, while a looming recession and an energy crisis mean policy makers may prioritize national security and financial liquidity over long term sustainability, said Bloomberg Intelligence analysts Christopher Ratti and Remus Negoita in a report.
Governments and agency sales will only post mild growth, while issuance from another key sector — financial institutions — will lose "some steam" given an anticipated slowdown in general lending, according to ING Groep NV strategists including Nadege Tillier.
"For 2023 a stabilization is likely," said Stephan Kippe, head of ESG research at Commerzbank AG, of the euro ESG market. "Growth in this market segment seems unlikely though, absent any surprising events like a potential decision by the EU or member states to use social bonds as a means to finance energy cost support measures."
Regulators are also getting tougher as they seek to prevent greenwashing, after companies from Tesco Plc to Chanel have come under fire for setting soft goals when selling debt. Lawmakers want to extend voluntary standards so that climate transition plans are mandatory for all issuers. That's already drawn an industry warning that it could hurt sales.
"Its potential effects to sustainable bond market activity and Europe's clear leadership position thereof have not been properly scrutinised," said the International Capital Market Association. "Listing of sustainable bonds in the EU may be particularly impacted."
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In the US, the market is also feeling the heat from politicians — but in this case, Republican officials who are sharply critical of ESG investing as a concept. Intense scrutiny may delay or hurt sales, according to BNP Paribas SA, the biggest arranger of green bonds globally this year.
"Most corporates are interested to issue ESG bonds," said Anne van Riel, the head of sustainable finance capital markets for the Americas at BNP Paribas, in an interview in New York. "At the same time there's a little bit of, 'if we do it, let's do it right,' because of all the attention to ESG. They may take more time to structure, which will definitely impact volumes in the end."
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ESG deals that would take just weeks to structure in 2021 are now taking months, especially for sustainability-linked bonds, said Van Riel. It looks a similar picture from the perspective of a buyer such as BlackRock Inc., the world's largest money manager.
For Emily Weng, who's part of the team responsible for the ESG-labelled bond market at BlackRock, the backlash means vetting the bonds to make sure they are truly green.
"I can't speak for the whole firm but I just wish this was not a political issue," said Weng at a Climate Bonds Initiative seminar in New York this month. "I don't think we see that happening in Europe. We are just razor-focused on doing what we do really, really well. Every single bond that we include in our fund we have that due diligence in place."
Asia Is Outlier
The US and European picture is a sharp contrast to Asia, where sales are expected to continue growing from a lower base. In fact, BNP Paribas expects China to be the main driver behind green bond issuance, thanks to supportive local policy and the recent alignment of its local rulebook with international standards.
Green bond sales in China have jumped to $90 billion this year from about $68 billion in 2021, according to BI data. BNP Paribas also expects a 10% rise in sales in the rest of Asia, with India planning to issue its first sovereign green bond in 2023.
In Japan, yen-denominated ESG bonds from Japanese borrowers have risen about 50% to around 3 trillion yen ($23 billion) this year, and now make up nearly a quarter of corporate bond sales, according to data compiled by Bloomberg.
"Next year, we will likely have an increase of 1 trillion yen and more of ESG bonds compared with this year," said Kazuyuki Aihara, head of sustainable finance products at Nomura Securities Co. "Green bond and transition bond deals will probably lead the gain."
While debt to fund the transition to cleaner industry hasn't picked up outside Japan, the fastest-growing niche type has been sustainability-linked bonds. They've already exploded in the corporate world, growing 10-fold last year, though there's been a backlash this year given too many firms are setting weak goals and some are even starting to use targets that are flexible.
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In any case, tiny penalties for missing these obligations, not to mention a serious lack of transparency in sustainability-linked loans, are leaving creditors cautious. A number of the world's largest ESG funds now refuse to touch SLBs, while early investors have voiced concerns the market overall risks losing credibility.
For Barclays analysts including Charlotte Edwards, these bonds have "lost their mojo."
Elsewhere in credit markets:
EMEA
Markets edged higher on Wednesday following a positive session for the S&P 500.
- The Russian exodus triggered by Vladimir Putin's invasion of Ukraine has put the currencies of former Soviet republics at the top of global rankings this year
- Georgia and Armenia in the Caucasus mountains, as well as Tajikistan in Central Asia, are among the best performers against the US dollar after tens of thousands of Russian citizens settled there since February, bringing the equivalent of billions of dollars in savings with them
- The European Union approved Germany's nationalization of two major gas companies, Uniper SE and SEFE Securing Energy for Europe GmbH, the former European trading and supply unit of Gazprom PJSC, with a long list of conditions requiring both firms to sell off assets and subsidiaries
Asia
Japanese bonds continued to adjust after the Bank of Japan's surprise policy shift. Two-year yields rose above zero for the first time since 2015, bringing an end to the global era of negative yields.
- The cost of insuring corporate bonds in Japan was little changed at about 89bps, according to a CDS trader; the Markit iTraxx Japan CDS index jumped around 7 basis points Tuesday, the biggest rise in three months, after the BOJ doubled its 10-year yield cap as part of tweaks to the yield-curve control program
- Taiwan's economic growth is likely to slow in 2023, as waning global demand weighs on key export sectors, S&P Global Ratings said in a statement
- South Korean President Yoon Suk Yeol said the debt problem of households and corporate sector could become serious next year as real estate and asset values decline due to higher interest rates
Americas
Wall Street banks led by Bank of America Corp. offloaded $359 million of loans for the buyout of Nielsen Holdings in one block trade of the debt that lenders have been stuck holding for months, according to people with knowledge of the matter.
- Some of the lenders that helped fund the leveraged buyout of the TV ratings business sold the term loans in a $359 million block trade this week at a price of 88.5 cents on the dollar, said the people, who asked not to be identified discussing a private transaction
- Better Nutritionals, a gummy supplement manufacturer, filed for Chapter 11 bankruptcy Tuesday amid a dispute with gummy retailer and major customer Goli Nutrition
- US investment-grade bond sales are expected to be hefty in the first week of January with $35 billion to $40 billion pricing in four days following the New Year's Day holiday, according to an informal survey of debt underwriters
- Companies from all sectors are expected to sell bonds, with at least one issuer said to be looking with a jumbo trade in the first week. During the first week of January in 2022, estimates called for about $40 billion, which was quickly surpassed. All told, almost $60 billion of new supply was priced
(Adds regional credit market news.)
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