Socially responsible Japan shifts focus from green to social
The Covid-19 pandemic has spurred a shift in Japan’s socially responsible investment (SRI) bond market, which has long supported green deals but is now turning its focus to other environmental, social and governance products.
Japan has long been a frontrunner in Asia when it comes to building its ESG credentials, with the first green bond from the country coming in 2014. But although the green bond market is still the star of the show, other forms of SRI issuance are rising to prominence.
Japanese issuers sold $4.225bn of green bonds through late August this year, up from the $3.334bn during the same period in 2019 and $1.511bn in 2018, according to Dealogic. Sustainability labelled bonds, which combine green and social uses of proceeds, reached $1.869bn, showing an impressive 62% growth over the $1.153bn raised through August 24, 2019 and the $500m raised in 2018.
“Green continues to dominate issuance, despite other products,” says Raj Malhotra, head of debt capital markets for Asia Pacific at Société Générale.
Green bonds have historically been easier for issuers to sell, as there are clear standards and taxonomies in place for green borrowing, he says. “We see more issuers considering social products, although some still find that part of the market possibly more difficult to navigate,” he adds.
That is changing this year — one of the many things being affected by the Covid-19 coronavirus.
Akane Enatsu, the Tokyo-based head of the Nomura Research Center of Sustainability, part of the Nomura Institute of Capital Markets Research, says that even before the Covid-19 crisis occurred, Japan’s share of social bonds in green, social and sustainability bonds was relatively high compared to the rest of the world.
But this year, “focus on social factors in financial markets has led to a steady increase in the issuance of social bonds”, she says.
Social bond sales from Japan reached $2.412bn from 12 transactions up to the end of August this year, up from the $2.082bn raised from six trades during the same period in 2019, and the $497m raised from two deals during that period in 2018.
Japanese issuers and investors have turned their attention to social bonds, in part due to the global pandemic driving a need for social funding.
Projects ranging from the production and distribution of healthcare supplies to preferential lending to businesses impacted by the pandemic may qualify for social uses of proceeds. And while market experts were reluctant to call the shift to social bonds a cannibalisation of the green bond market, there are some signs of that.
“The limelight of the market is more on social than on green,” says Benjamin Lamberg, head of credit for Asia Pacific at Crédit Agricole. Some issuers are shifting to social bonds, while others that planned to sell green notes this year have put their plans on hold, he adds.
The change has not been sudden. Some Japanese issuers had already begun adopting sustainability frameworks, to encompass social and green uses of proceeds in their bonds, before the pandemic, says Malhotra.
Issuers like having the flexibility that the broader remit gives, as opposed to just a green framework, he says. But the pandemic has fast-tracked the shift, with more issuers rushing to update their frameworks.
“The Covid crisis, more than anything, accelerated the awareness that was already building up,” says Singapore-based Malhotra.
Healthcare, funding for small businesses and support for low income workers have become hot topics as Covid-19 takes a toll. “It does open up more avenues for issuers to contribute their support to relief measures,” says Malhotra, pointing to the various ways social and sustainable proceeds can be put to work.
Small and medium-sized enterprise (SME) lending has been a focus for many banks for some time, but the attention given to Covid-19 and sustainability bonds is pushing banks to redefine how they look at SME lending, which neatly fits into questions about sustainability.
Making a transition
What has this meant for Japan’s debt market? The country remains focused on environmentally-friendly investments but the market has embraced alternatives to traditional green bonds. As a result, sustainability-linked and transition bonds have gained traction. Subordinated debt and bank capital deals are also getting green labels.
“We have in Japan such a committed group of ESG investors that even if you present them something that is somewhat outside of the realm of what they are traditionally investing … they will with an open mind, consider it and most likely commit to invest,” says Hong Kong-based Lamberg. “They’re more interested in tailor-made ESG investment now, and they really want their investment portfolio to have an impact.”
Conventional green and social bonds generally come from the highly-rated and frequent issuers, as well as those that have green and social targets at the heart of their businesses. These issuers are more likely to have a clear understanding of the different labels and defined projects that meet those standards.
However, transition and sustainability-linked bonds may bring in more ‘dirty’ issuers. These are not companies that are going to become green overnight but are instead from industries that need to be cleaned up.
Some observers argue that green-related deals from these companies are just as important, if not more so, than green bonds from something like a renewable energy company. This is particularly prevalent in Japan, which has a high dependence on fossil fuels, says Nomura’s Enatsu.
“Transition finance is very important to move to a low-carbon society,” she says.
Enatsu expects more transition bonds and loans will be sold in the country as they become more accepted internationally.
Japan’s Ministry of Economy, Trade and Industry has already taken the first step in spreading awareness of transition funding in the country by releasing a “concept paper on climate transition finance principles” in March.
Reiko Hayashi, Tokyo-based director and deputy president of Bank of America’s Japanese subsidiary, also expects transition bonds to pick up. She says this will be linked to the creation of principles from the International Capital Market Association (ICMA), which already has a working group to set out guidelines for transition bonds.
Like transition bonds, sustainability-linked trades are most likely to come from corporations, as opposed to the banks that have so far led the green bond market. These issuers like having a sustainability option because they can adhere to the United Nations Sustainable Development Goals (SDGs), which are popular in Japan. It also allows them more flexibility if they do not have clear projects to present as a case for a green use of proceeds.
“Sometimes issuers do not have enough funding requirements to fit the [green or social] use of proceeds, but transition bonds and sustainability-linked bonds do not limit the use of proceeds,” says Hayashi.
Some Japanese banks will find that it makes sense to pursue subordinated debt sales with a sustainability label as well, says Malhotra. They likely need to be selling bank capital anyway, so putting a green label on the deal can check off two boxes — and the buyside will appreciate the approach.
“Investors are actively looking for yield, so these types of products can help provide incremental returns,” says Malhotra.
Despite some fears of green-washing, where green labels are used for projects with watered down environmental benefits, investors are willing to invest in these new products, says Lamberg. “Investors say, ‘I want to have an impact. Find me a corporation that is working towards positive change’,” he says.
Investors are demanding about transparency though, so there will be a push for results if an issuer decides to break into the green market, says Malhotra. This means borrowers will need to be clear about how their proceeds will be used.
There is already a notable difference in how Japanese investors approach these deals versus their large international counterparts.
When it comes to green transactions, for instance, European investors have longer established guidelines and criteria for green investment. They may also be more diligent about pursuing dark green —the most clear-cut environmentally beneficial — investments.
In Japan, most investors do not have a rigorous structure for approaching green investments, says Hayashi. They’re still developing local standards and, because of this, they may be more flexible in their approach to green-like products.
The approach of these local investors will be crucial as they are driving the development of the local market — not globe-trotting international funds.
Japan’s Government Pension Investment Fund (GPIF), the world’s largest public pension fund, had invested ¥440bn ($4.14bn) into green, social and sustainable bonds issued by 10 multilateral development banks and four development financial institutions as of the end of March 2020, says a spokesperson from GPIF.
Because of its size and importance in Japan, GPIF has led the way for making ESG considerations important to investing, bankers say. More importantly, it has also helped change the mind-set among a different set of investors.
Traditionally, the large institutional investors have been the most interested in sustainable investing, but recently that has begun to shift. Smaller Japanese institutions, regional banks and even retail investors are asking for sustainable investment options.
“A key development we have experienced over the past six months is that smaller institutional accounts, or the so-called tier two investors, have joined the bandwagon of social investing,” says Lamberg. “It shows that it’s not just five or six institutional heroes of sustainability in Japan. You really have a mainstream [approach] to social and sustainable investment.”