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The 2021 United Nations Climate Change Conference (COP26), which kicks off this Sunday, coincides with record pace in the global issuance of green, social, sustainability and sustainability-linked bonds. Heightened market focus on accelerating climate action and realizing sustainable develop-ment objectives is likely to underpin sustained momentum into the fourth quarter, with full-year issuance set to top a collective $1 trillion for 2021.
In its quarterly report on sustainable finance trends, Moody’s ESG Solutions explores the impact that significant progress on four key policy areas at COP26 would have on sustainable debt market activity, particularly with respect to sovereign issuance, transition finance, emerging market (EM) activity, and adaptation-focused green bonds.
Arguably the most important policy area under discussion at COP26 will be whether country climate pledges, or National Determined Contributions (NDCs), are tightened sufficiently to limit global warming to 1.5°C versus pre-industrial levels. While a number of major global economies, including the US, EU and China, have unveiled more ambitious climate targets over the past 12 months, collective goals will be nowhere near sufficient to meet the ambitions of the Paris Agreement.
More aggressive climate targets would likely lead to an acceleration in the phase-out of new coal generation capacity, increasing investment in renewable energy, lowering of fossil fuel subsidies and a ramp-up in sustainable infrastructure. Investors are also likely to mobilize financing for governments that bring climate ambitions to the capital markets via issuance of labelled bonds. However, issuing countries since 2020 account for just 12.5% of global greenhouse gas emissions. As such, we see considerable potential for greater breadth and reach of sovereign issuance on the back of a successful COP26.
The second key area to watch will be talks on both the scope and scale of carbon pricing schemes, including the deployment of innovative solutions to encourage global adherence. For heavy-emitting industries, global coordination on carbon pricing and other decarbonization policies would increase relative costs of production, erode demand for carbon-intensive products and services, and incentivize an acceleration in capital expenditure into greener products and services.
From a sustainable debt market perspective, this raises the opportunity for greater momentum around transition finance, whether through use-of-proceeds green bonds, dedicated transition bond labels or the use of sustainability-linked bonds. Some sectors with elevated exposure to carbon transition, such as shipping, oil & gas, and metals & mining, account for just 3% of labelled bond issuance. There may be significant room for growth in these industries as investors look to finance green capex plans that are aligned with viable transition pathways.
We expect COP26 to provide renewed momentum towards achieving the Paris Agreement commitment of mobilizing $100 billion in annual climate financing from developed to developing economies by 2020, which has so far failed to materialize. Financing for developing economies is of paramount importance, as they tend to be more highly exposed to the physical effects of climate risk. Furthermore, their ability to secure market financing can be constrained by shallow local markets, greater perceived country and regulatory risk and – in more recent times – weaker credit profiles due to the economic and financial fall-out from the coronavirus crisis.
Even if the $100 billion annual milestone is achieved, this would only represent a tiny fraction of investment needed to meet low-carbon infrastructure needs in developing economies. EM sustainable debt markets can help bridge the funding gap, although investing in capacity building, creating robust investable pipelines, and de-risking projects via blended finance mechanisms will be critical enablers. EM sustainable bond issuance has expanded and diversified this year in line with global trends, but EM volumes remain relatively small as a share of total global sustainable bond issuance, and have also been on a relative declining trend since 2016.
There is an urgent need to prepare economies and communities for increasing climate extremes, with the recent report from the Intergovernmental Panel on Climate Change (IPCC) concluding that the physical effects of climate change are largely locked in over the next few decades.
Elevated risk exposure brings the need to invest in resilience, which presents financing opportunities. Only 3% of green bond proceeds have been allocated to adaptation projects to date. The lack of predictable long-term cashflows generated from adaptation projects is one of the reasons holding back growth and development in this area. The Coalition for Climate Resilient Investment (CCRI), which Moody’s joined in October 2021, is one group addressing this challenge by developing tools to help sovereign and municipalities promote an efficient integration of physical climate risks into investment decision-making.
To read more on sustainable finance trends, read the full quarterly report from Moody’s ESG Solutions.
Speakers from Moody’s ESG Solutions recently discussed these trends in a webinar with Anna Smukowski, Senior Director – Investor Relations & Capital Strategies at LISC (Local Initiatives Support Corporation). Watch the replay here.