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Case Studies—Filtering Asian Green Bonds Through Our Framework
- By Yanru Chen, Credit Analyst, Emerging Markets Corporate Bond Research Team
- August 17, 2021
Issuers have myriad incentives—often including a lower cost of capital than a traditional bond—to apply the green label to their bond offerings. Yet, once filtered through our Green Bond Framework, it’s clear that many of these securities present the opportunity for only marginal environmental improvements or possibly none at all. Although this less-than-green issuance has occurred globally, it has become prominent in Asia as the size of the green bond market has grown and issuers’ ESG initiatives have continued to evolve from their early stages.
The growth in Asia’s Green Bond market reveals the extent to which issuers regard it as a viable, lower-cost financing avenue. Green issuance in Asia accounted for about 6-8% of the region’s total corporate supply through mid-2021 and reached the equivalent of $56.7 billion through late June, which was more than three times the total that priced through the same period in 2020. It was also solidly above the $32.8 billion that was issued out of the U.S. and up to about a third of the $154 billion issued out of the euro area.1
Banks and financial institutions were first out of the gate with Asia’s green bond offerings, followed by utilities and real estate developers, particularly those based in China.
As we’ve run these offerings through our framework, some common traits have emerged. Many demonstrate lax segregation of the issuance proceeds and a high degree of fungibility across the enterprise. The securities also tend to lack strong mechanisms for post-issuance monitoring and reporting (most issuers still self-report).
In terms of market performance, the bonds generally price 5-10 bps inside of issuers’ traditional credit curves. While that premium often fades and reverts to the existing curve, we believe that demand for securities financing projects with material environmental impacts outweighs those with less of an impact. Hence, our framework is critical to avoid “overpaying” for new issues that may not meet the objectives of ESG-focused investors.
Case #1—Shuifa Group: Low Additionality Based on Existing Business Model
Shuifa Group came to market in March 2021 with an inaugural dollar-denominated green bond. Shuifa is wholly owned by China’s Shandong Province and is the sole financing and operating platform for water utilities, water-related construction, and management of water sources within the province.
As determined by our framework, we assessed the bond from the perspective of its credibility at the security and issuer level and its additionality regarding the incremental impact on the environment (Figure 1).2
In terms of the latter, we viewed the offering as a classic example of a company leveraging an existing business model with green characteristics—in this case water conservation—to tap a new financing channel. While some participants may observe a green focus in the structure and application of the bond, we think it ran counter to the objectives of green investing considering that Shuifa’s business already includes a large proportion of green activities that would be financed by the bond’s proceeds.
Figure 1: The Combinations of Determining a Green Bond Impact Rating
On the credibility side, although the company indicated that the proceeds would be used to finance and refinance projects that complied with the ICMA’s Green Bond Principles, we found that the entity’s structure made its highly challenging to track the end use of the proceeds. For example, many municipalities in China have set up corporate entities, such as Shuifa, that are known as local government financing vehicles (LGFVs) for the purposes of raising funds for capital expenditure or general purposes. Although these companies tend to have weak credit fundamentals, they often benefit from a strong ratings uplift with investment-grade credit ratings given the implicit government support, and they are frequent issuers in China’s offshore bond market.
The entities are also mandated to carry out activities with a social or public good, which makes it easy for the issuers to affix a green or ESG label when raising capital. However, considering the debt-laden nature of these platforms due to the narrow tax base of most local governments in China, in many cases, proceeds are used to pay down debt. As such, even with a third-party verifier, we were unable to verify the effectiveness of the mechanism ring fencing Shuifa’s bond proceeds.
Case #2—Yuzhou Group Holdings: A Lack of Focus
Yuzhou Group is a prominent real estate developer based in Southern China. The company issued a green bond in January 2021 with the use of proceeds slated for green buildings, energy efficiency improvements, renewable energy construction, and pollution prevention and control.
However, with further analysis, we found that the company’s identified use of proceeds lacked focus in the context of its stated ESG objectives. For example, eligible projects included those that appeared to be ordinary upgrades and regular capital expenditures, such as the installation of energy efficient air conditioners as well as recycling facilities in commercial and residential facilities. We believed these investments would have been realized regardless of any green bond issuance.
Prior to issuance, China’s National Development Reform Council needed to approve the offshore bond’s use of proceeds, with the only stipulation being that the proceeds needed to refinance an existing offshore bond. Yuzhou worked around this condition—while maintaining that the bond met “green” criteria—by setting aside an equivalent amount onshore that it stated would be used for green projects. The offsetting capital significantly reduced the ability to monitor the proceeds as did an unusually long lookback period of 36 months for refinancing eligibility.
The Yuzhou example is a revealing one considering industry trends: China’s real estate sector appears primed to issue more ESG-labeled bonds given the ease with which companies can cite green or social housing projects. However, at this point, the green bonds are unlikely to meet our credibility and additionality criteria, and the bonds are unlikely to provide an uplift to the issuer’s ESG Impact Rating.
Through our framework, traditional and green bonds from China’s real estate sector appear very similar. Yet, considering the potential incentives—including reduced financing costs and broadened investor diversification, especially to ESG-focused investors who might be “stickier” holders—we believe issuers in Asia will continue to enhance their green bond programs. The measure of that success will be evident to us and our impact-focused clients as we continue to filter the securities through our green bond framework.
This material reflects the views of the author as of August 17, 2021 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
1“Green Bonds Hit Record Before H1 Ends,” International Financing Review, June 25, 2021.
2For additional information, please see “Filtering Shades of Green Through Our Green Bond Framework.”
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