Rising interest rates and slowing economic conditions are weighing on the overall bond market, however the market for green, social, sustainable and sustainability-linked (GSSS) bonds is showing some resilience.
- S&P reduced its 2022 forecast for global issuance of GSSS bonds by 42% to $865 billion, after a 20% decline in 1H.
- Rising interest rates, lower near-term refinancing needs, and an increasing probability of recession have pressured the market for new issuance.
- A higher proportion of sustainability-linked bond issuance as a percentage of the total indicates a greater near-term focus on transition financing.
Higher rates and slower economic growth are a bad recipe for bond market growth, and GSSS bonds are no exception. S&P’s reduced forecast probably means fewer new green projects should be expected in the near term, until economic conditions improve.
However, sustainability-linked bond issuance has actually grown in size, and now accounts for 12% of total GSSS issuance according to S&P. This may provide some hope as it suggests that companies are becoming more aggressive about their transition plans.
Declining economic forecasts through the year add to gloom
Forecasts for economic growth have steadily declined in 2022, as the energy crisis, and the post-COVID economic fallout keep inflation at stubbornly high levels, with the resulting interest rate hikes from central banks dampening new issuance in the bond market.
At the end of 2021, few people would have discounted S&P’s $1.5 trillion forecast for GSSS bond issuance – demand for the bonds was high post-COP 26, and even though energy prices had risen sharply, the Ukraine war had not yet begun.
More importantly, while rising energy prices and supply chain bottlenecks had prompted the World Bank to forecast 2022 economic growth of 4.1%, below the rebound-driven 5.5% seen in 2021, it was still well above the long-term global GDP growth rate of 3%.
The World Bank lowered its forecast for global growth to 2.9% in June, as the Russia-Ukraine war increased the risk of stagflation – persistent low economic growth and high inflation. At the time, it expected growth to remain around the 2.9% mark in 2023-24.
The World Bank’s September 2022 update sees an increasing risk of global recession in 2023, with global GDP growth slowing to 0.5% in 2023. Further risks to global bond markets are elevated inflation rates, and the prospect of financial crises in emerging and developing economies.
Green bond forecast vary according to expert
While S&P’s slashed forecast appears drastic, other bond market experts have also reduced their forecasts, albeit at regular intervals, and therefore more gradually.
Market headwinds were apparent at the end of the first half of 2022, when Moody’s forecast GSSS issuance of $1 trillion for 2022, flat compared to 2021, was down 26% from its prior forecast of $1.35 trillion at the start of the year.
Yet, while aggregate volumes were down 21% year-on-year, that was a smaller decline than the broader bond market, which gave GSSS market participants hope.
Sustainability-linked bonds (SLBs), on the other hand were up 21% on the prior year period, and as a result of the decline in overall GSSS issuance, their proportion had increased to 11% of the total, compared to 7% in the first half of 2021.
SLBs have emerged as the instrument of choice for issuers in hard-to-abate industries that are not planning large-sized green or social projects. The flexibility from using the proceeds for general expenses while meeting certain key performance indicators adds to their attraction.
Transition hope kept alive via sustainability-linked issuance
Rising investor attention to carbon transition risk has accelerated carbon transition plans for many companies, especially in the cement, steel, buildings and transportation sectors, which are in early stages of transition.
Rapid changes in regulations and rising economic certainty have also required companies to remain financially flexible which has given a boost to sustainability-linked debt instruments (bonds and loans) from companies.
A key feature of these instruments is the prospect of negotiating lower interest rates based on performance against sustainability and transition key performance indicators (KPIs). This may also become more attractive to issuers in a rising interest rate environment.
Greenwashing concerns have been raised for this class of financial instruments, especially when issuer decarbonisation targets seem particularly ambitious, especially for high emitting industries, which could create a headwind to new bond and loan creation.
As the perfect economic storm that detracts from bond issuance rages on, it is possible that market forecasts may decline further. However, the trend seems to continue to favour GSSS issuance, even if it means a relatively smaller rate of decline compared to the broader market.