The global pandemic and increasing severity of climate change are redefining how risks are managed and opportunities captured in the financial sector. Our inaugural ESG conference on October 21-22, 2020 took a deep dive into these areas and the sustainable finance trends shaping the decade ahead, with a focus on Asia.
We see strong momentum and development of the sustainable finance ecosystem in Asia, from innovative platforms and products driving market growth to increasing commitment to ESG objectives and collaborative efforts across economies. This is– making it an attractive region for sustainable finance. These developments are critical for long-term prosperity and stability, considering that Asia is among the most vulnerable to climate risks.
Beyond the Inflection Point
Although much remains to be done, we believe that sustainable investing is at an inflection point. We are seeing an increasing alignment between technological innovation, unprecedented capital flows and a favorable regulatory landscape towards ESG.
The recent momentum in public markets surrounding sustainability has also led to a dramatic rise in the number of special purpose acquisition companies (SPACs) interested in acquiring ESG-focused companies. This is contributing to the rise of ESG investment deployment and assessment, as some ESG-focused companies do not fall into a specific category.
Two key sectors experiencing growth that will require financing are low carbon or renewable infrastructure and advanced transportation. In terms of low carbon infrastructure, there are significant opportunities in renewables to displace conventional generation capacity, despite increasing competition and strong historical growth of conventional generation.
The future of mobility combined with electric vehicle (EV), autonomous vehicle, and on-demand technologies is driving an infrastructure revolution. Some original equipment manufacturers are facing challenges in re-tooling their supply chains to adapt to these new business realities. This revolution along with regulatory pressure and changing consumer preferences are leading to the growth of EV adoption, especially across China and Southeast Asia.
Developments in Sustainable Financing
Sustainable financing has been on the rise globally and is an emerging trend in Asia. Investor-driven demand and transition finance towards a low carbon economy will be especially critical in Asia, given the region’s extreme vulnerability to climate risks. In the sustainable debt capital markets, green bonds have been historically dominant and still lead with a record issuance of US$58.6 billion as of September 2020, while the sustainability-linked loan market has also been rapidly expanding.
Covid-19 resulted in a sharp drop in green bond issuances, raising questions about whether green initiatives would be put on hold. However, within months, it was apparent that the pandemic had an accelerating impact on both issuers and investors.
Regulators and governments are realizing that the interconnectedness and the large government expenditures stemming from the lockdown offer a once in a lifetime opportunity to build back better and stronger. As market conditions stabilize, the next frontier is expected to be sustainable bonds and sustainability-linked loans, particularly as more corporate borrowers convert their core revolving credit facilities into sustainability-linked loans.
In order to limit global climate change and achieve emissions reduction targets, it is estimated that the transition finance market will require over US$3 trillion annually towards 2050. Within this market, transition bonds and loans are new asset classes for industries with high greenhouse gas emissions – ‘brown industries’ – that will allow them to raise capital specifically to become less ‘brown’.
There is growing consensus in the investment community that ramping up transition bonds will have a greater impact on mitigating climate change than issuing green bonds alone. Given its broader potential investment base, the transition market could outgrow the green bond market by the mid-2020s.
Investing in Impact
In 2020, the value of global assets applying ESG data to drive investment decisions skyrocketed to a record US$40.5 trillion. With this growth also came greater scrutiny in the assessment of ESG approaches, measurement of its value and impacts, and increasing disclosure requirements. Given the diversity of ESG priorities and criteria within the investment community, there has been a strong need for a more universal adoption for this market to accelerate further.
Significant and collective efforts have worked towards a standardized approach in ESG reporting. The Task Force on Climate-Related Financial Disclosures (TCFD) guidelines are increasingly becoming the global standard with over 1,500 supporters globally. This has spurred investors, companies, regulators, and stock exchanges to integrate climate-related financial risk into their disclosure requirements.
Regulatory bodies are also increasing their expectations. The U.K. government has signaled that all large asset owners and public companies must become TCFD signatories by 2022, and other countries are pursuing similar pathways.
In private markets, limited partners have been instrumental in setting and factoring in ESG principles into investment decisions and portfolio management. While private equity firms have traditionally looked at ESG factors from a risk management lens, there has been growing appreciation that sustainability indicators have a material impact on company value and performance. While this continues to and evolve, we believe investors and companies that embrace ESG considerations will have a strong advantage in creating value and generating returns, especially in a post-pandemic world.
Koueki Shihonshugi in a post 2020 World
Across Asia, Japan is the most advanced country when it comes to adopting ESG investing. The world’s largest pension fund, Japan’s Government Pension Investment Fund (GPIF), has been accelerating ESG investments by integrating ESG throughout its investment process.
As of end-March 2020, ESG investments accounted for 11.3% of GPIF’s domestic equities portfolio. Among its three Kyo-sai funds, only one had ESG investment practice embedded in its process as of end-March 2020. However, the revision to the “Basic Guidelines” this past February will likely encourage other stakeholders to get involved. It is also worth noting that corporate pension funds are also starting to adopt ESG investment by signing up to the “Stewardship Code” set in 2014.
On the other hand, we are seeing a meaningful and increasing focus on ESG investing among retail investors in Japan. The huge capital inflow of ESG funds recorded since July 2020 was mainly driven by retail investors investing in ESG foreign equities. We expect more capital inflow into domestic equities funds if the Government were to provide some incentives for retail investors.
All in all, ESG and responsible stewardship are gaining more attention in Japan and across Asia. We expect investors, companies, regulators, and stock exchanges to continue ramping up their ESG efforts, driven by government reforms and growing stakeholder demand.
Global policy and regulatory developments
2020 has been a turning point for sustainable finance. The role of financial services is key and important policy and transition frameworks are needed for the markets to mature.
While ESG investments have been under discussion for some time – the United Nations Principles for Responsible Investing were established 14 years ago – there has been recent rapid growth of the sustainable finance market. The latest acceleration has been driven by the deepening commitments and actions in bridging the current gap between emissions reductions made and reduction levels needed to achieve the Paris Agreement targets.
Covid-19 has also shone a spotlight on the fragility of the ecosystem and brought social factors to the global forefront. There has also been evolving government policies and finances to better address the impacts of climate change and social challenges.
A crucial topic that will get more attention from policymakers is carbon. Carbon today is the greatest externality which is not priced into the real economy. Economic decision-making needs to be reflective of this, and not only deriving from financial services scrutiny. The range of carbon pricing mechanisms, from emissions trading schemes to direct taxation and the removal of fossil fuel subsidies, are essential parts of the management of climate change.
Financial sector policies are now focused around a twin approach of prudential oversight and product pull factors. The Bank of England has had the strongest focus on climate risk management frameworks and stress testing. However, stress testing time horizons may need to be extended to contemplate very aggressive policy changes. Product labelling starting with green taxonomies has been a core focus in other jurisdictions including the EU, where it forms a central pillar.
China is a key player when it comes to global policy dynamics. China recently announced that it would be moving towards carbon neutrality by 2060. While China has been largely dependent on imports of fossil fuels, such as oil, it has also grown its strengths in electricity generation and battery technologies. Therefore, it is not surprising that China would take a more leading role on carbon neutrality policies and renewable energy generation.
Head of Global Markets<br/>Asia ex-Japan
Head of Senior Relationship Management, Asia ex-Japan
Managing Director, Nomura Greentech Capital Advisors, AG
Managing Director, Head of ESG Solutions
Head of Sustainable Finance, Nomura
Head of International Wealth Management, Nomura
Head of Asia ex-Japan Research
Japan Equity Strategist
Managing Director – Sustainability Governance Officer
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