Research Reports 17 March 2020
Growth of Sustainable Debt in Emerging Markets
Deepening Focus on ESG
Emerging market (EM) economies are particularly susceptible to ESG risks. Increased focus on ESG credentials and top-down policy support will remain important in driving the growth and development of EM sustainable finance.
Authors: Rahul Ghosh, Anne Van PraaghDownload PDF
The overall sustainability strategies of EM issuers will come under greater scrutiny in 2020 and beyond, given the material ESG risk exposures of EM economies and the huge funding needs required for low-carbon, climate-resilient investments.
In general, EM economies are more susceptible than their developed market peers to environmental and social risks. Exposure to issues such as physical climate risks, income inequality and natural capital constraints are prevalent across all markets, but EMs typically have a greater economic dependency on natural resources, such as commodities or agriculture-based economic activity, exports and employment. They also tend to have lower overall income levels, weaker quality of infrastructure, and more limited economic, financial and institutional capacity to address sustainability challenges. Governance can also be more opaque.
The analysis highlights the material ESG exposure of EM issuers. Both at a national and subnational level, EM governments face greater risk exposures than developed markets in both our global environmental risk heat map and our global social risk heat map. For example, EM sovereigns in Asia, the Middle East and North Africa are most exposed to rising sea levels. EM corporate debt also carries significant environmental risk exposures. Most of the outstanding debt within the universe of EM companies that we rate is concentrated in sectors that score as either elevated (22% of total) or moderate (34%) risk in our environmental risk heat map. The oil and gas sectors alone account for more than one-quarter of rated EM corporate debt outstanding.
The scale of financing required to address ESG risk exposures is considerable. The funding gap needed to meet the UN Sustainable Development Goals (SDGs) in EM economies will be in the order of $2.5 trillion to $3.0 trillion per year through 2030. Furthermore, the International Finance Corporation (IFC, Aaa stable) estimates cumulative climate investment of almost $30 trillion needed across six key sectors in EM cities by 2030, including waste and water management, renewable energy, public transportation, electric vehicles and green buildings. Finally, according to the International Energy Agency, EMs will add roughly 4,000 GW of renewable energy capacity by 2040, equivalent to almost two-thirds of global capacity additions (with China and India alone accounting for 50%). Public financing alone will be insufficient to meet such significant growth in renewables.
Against this backdrop, EM issuers in exposed sectors and regions are under growing pressure to adapt their business models and undertake investments to reduce or mitigate underlying ESG exposures. Those that are constrained, or show a lack of preparedness, in addressing material ESG risks may find it more difficult to raise or refinance debt in the capital markets. This is particularly relevant for issuers operating in sectors exposed to climate risks (both transition and physical) with limited available substitutes and significant funding needs. Indonesian coal miners, for example, will face large debt maturities in the next couple of years at a time when banks, investors and insurers are facing more stringent environmental and social lending requirements.
In contrast, rated entities that outline clear financing plans to reduce their ESG and climate risk exposures stand to benefit from robust investor demand – and potentially more attractive funding costs, or access to a more diversified investor base. For example, strong investor appetite for the government of Chile’s (A1 stable) debut 30-year green bond issued in June 2019 indicates that the sovereign has a ready pool of funding to support its commitment to combat climate change. The bond was more than 12 times oversubscribed with a historically low interest rate of 3.53%, with proceeds dedicated to climate shock mitigation and adaptation projects in six sectors across (1) clean transportation, (2) energy efficiency, (3) renewable energy, (4) living natural resources, land use and marine protected areas, (5) efficient and climate-resilient management of water resources, and (6) green buildings.
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