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Environmental and Social Governance (ESG)


Sustainable finance set for a recovery in 2023.

According to the Institute of International Finance, ESG debt issuance fell to US$1.3trn in 2022, down from US$1.5trn in 2021. However, a recovery is likely to occur in the second half of 2023, as central banks halt or slow down their interest-rate increases, providing some stability to the market. ESG debt issuance is likely to reach US$1.7trn in 2023, driven by the launch of green bonds in China, Europe and Latin America. The Inflation Reduction Act of the US will also give ESG debt issuance a boost. However, fluctuations in the greenium (the higher price and lower yield associated with green bonds relative to their plain-vanilla counterparts) will pose a risk to the market, as will the waning popularity of sustainability-linked bonds.  

Sustainable equity funds have rebounded

ESG equity mutual funds attracted US$37bn of flows in Q4 2022, according to Morningstar, compared to US$24.5bn in the third quarter of the same year. Most of this rebound is attributable to Europe, Canada and Australia. Strong demand from investors for instruments that focus on ESG concerns and the launch of several new ESG funds were pivotal for the recovery of European sustainable funds.

In the US sustainable funds have yet to reach their Q1 2021 peak, following the outflow of US$6.2bn from US sustainable funds in Q4 2022. This outflow can be attributed to a fear of recession and a politicisation of concerns about ESG investment.

Around US$22m flowed out of Asian (excluding China and Japan) sustainable funds over the fourth quarter, while around US$ 557m flowed out from Japan in Q4 2022. In China, around US$1.5bn flowed out in the same period, largely owing to slower economic growth in 2022. 

Sustainable bonds and sustainability-linked loans are likely to recover in 2023

A total of US$863bn in green, social, sustainability and sustainability-linked bonds were issued by firms and sovereigns in 2022, a 19% drop from US$1.1trn issued in 2021, according to Bloomberg.  

Green bonds, which focus on environmental issues, fell by 11% to about US$480bn in 2022, with support coming primarily from Chinese demand. China (along with Europe) is also likely to lead the revival in 2023, bolstered by changes to its local taxonomy.

Throughout 2022, however, greeniums have been decreasing, particularly in Europe. According to the Association for Financial Markets in Europe, greenium levels declined from more than 9 basis points in 2020 to around 2 basis points in July 2022, albeit with a small rebound in September 2022 (latest data). 

Greeniums continue to exist largely because demand for green bonds is significantly higher than supply, despite the boom in green bond issuance. Additional regulatory pressure, such as the launch of the EU taxonomy, is likely to raise the scarcity of green bonds, pushing up greeniums in 2023. However, it is unlikely that they will regain levels seen in 2020. It is also likely that green debt instruments that comply with the EU taxonomy regulations will be able to command a higher greenium.

Source: Economist Intelligence (2023, April 26). Sustainable finance set for a recovery in 2023. https://www.eiu.com/n/sustainable-finance-set-for-a-recovery-in-2023/