Allegro… ma non troppo. Geopolitical tensions and the potential energy supply shock raised questions about the energy transition path. Company investment in clean technologies could be delayed by higher costs and interest rates, but energy transition is still on the agenda. The current environment can be an opportunity to accelerate toward Net Zero, through investing in sustainable bonds – but selectivity is key!
Due to market conditions, sustainable bond issuance has been below expectations
2022 has been a challenging year for sustainable bonds with $700 billion of primary supply YTD[1], against $950 billion for 2021. We are far from our expectations of $1 trillion per year ! Market volatility, primary market shutdown and tighter financial conditions contributed to the decline in issuance, with a monthly volume of $58 billion compared to $86 billion last year. However if global issuance was much lower than last year, the share of sustainable issuance has increased relative to conventional bonds. For investment grade non financials, sustainable labelled bonds represent 30% of the total yearly issuance compared to 19% in 2021 and 8% in 2020. Even high yield companies have increased their sustainable bonds share to 9% relative to traditional bonds, versus 4% last year. This reflects a higher desire to tackle sustainable issues, and the order book reveals that demand is still intact.
The case for energy transition has never been stronger
The Ukraine /Russia conflict has reminded the urgency to find more clean energy technologies. The EU has proposed a plan to reach independence from Russian fossil fuels well before 2030. “RePower EU” aims to increase the resilience of the energy system and diversify gas supply sources, boosting the use of biomethane and hydrogen, increasing renewables and promoting energy efficiency. The “Fit for 55” package should already cut gas consumption by 30% by 2030 and “Next generation EU” should build a more resilient Europe post-Covid by allocating 30% of its resources to financing green projects between 2021 and 2026.
Even the European Central Bank wants to decarbonize its balance sheet by favoring green investments in its corporate bond portfolio. Climate considerations are now incorporated by tilting corporate purchases towards issuers with better climate scores. From October, reinvestments of bonds matured in APP (Asset Purchase Programme) and PEPP (Pandemic Emergency Purchase Programme) should favour issuers with low carbon intensity, ambitious and credible decarbonization strategy and good quality of sustainable disclosures. They also want to impose bond maturity limits on issuers with a low climate score.
The “Inflation reduction Act” in the US is another example of the largest investment in US history to combat the climate crisis, increase energy security and lower the cost of living for families. This plan will invest more than $300 billion and includes tax credit to buy electric vehicles assembled in the US, make affordable housing more energy efficient or manufacture solar panels or wind turbines.
We expect a rebound of sustainable bonds issuance : Allegro
2023 should see a rebound of sustainable bond supply with an expected $900 billion across the four types of instruments: green bonds, sustainability and sustainability-linked bonds, and social bonds.
Green issuance should continue to prevail (60%) due to the number of green projects to be financed in Europe, as well as in the US under the Inflation Reduction Act.
Sustainability-linked bonds (12%) should grow as well, as they enable issuers to display their sustainability commitments and decarbonization strategies which could attract growing interest from high yield issuers.
Social bonds (14%) should remain limited to the banking or agency sector as it is more difficult to finance social projects on the capex side. But in case of severe or prolonged economic recession, they could see a revival.
And finally, sustainability bonds (14%) should remain a favorite instrument for some supranationals or banks but their market share is expected to decline on the medium term given the lack of clarity on their real impact and given the number of green or social projects to be financed.
So overall the pick-up in issuance should be driven by non-financial companies, governments and supranationals while banks should maintain stable volumes. The European Union should continue to be active next year.
… ma non troppo!
As we expect the economic environment to remain challenging and dispersion between laggards & winners to increase, we believe issuer risk analysis will remain key and thus we favor a careful issuer selection. The current crisis and governance issues have reinforced the case for ESG integration in fundamental analysis. Regulation and sustainable data disclosure (notably Corporate Sustainability Reporting Directive) will improve transparency, consistency and comparability between entities. As the sustainable bond market is growing and diversifying, avoiding greenwashing is a priority. An in-depth analysis of the project and management of the proceeds will help us make the right choices as we want to make sure the bonds do contribute to a sustainable future.
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[1] For all issuance data in this paper, source is Candriam analysis based on Bloomberg data, November 2022
