In the ever-evolving landscape of global finance, green bonds have emerged as a resilient force, with issuance of these bonds reaching an impressive $232 billion in the first four months of this year alone. As Southeast Asian countries accelerate their decarbonisation efforts and investors demand more ESG products, the region's green bond market is experiencing a significant surge, promising a greener future for both the environment and the financial sector.

 

The buzz surrounding environmental, social and governance (ESG) might have been overshadowed by the hype of AI and emerging technologies, but sustainability investing products have withstood the currents and stayed in the favour of global fixed-income investors.

A report from Morgan Stanley has pegged the total value of global green bond issuance at $232 billion in the first four months of this year. That’s equal to the issuance in the same period in 2023. The non-profit Climate Bond Initiative predicted that the issuance of green bonds to hit a total of $1 trillion this year.

But globally, the issuance of sustainability-linked bonds, which tied the bond’s yield to the issuer’s performance in satisfying certain environmental standards, has plunged 51 per cent in the first four months of this year to $12.5 billion, the Morgan Stanley report found.

In Southeast Asia, the issuance of green bonds took off significantly in recent years as countries in the region have turbocharged decarbonisation efforts while keeping up with investors’ demands for ESG products.

 

GREEN LABELS

In general, green bonds are debt issued by countries or corporations to finance environmental projects, such as development of climate-friendly energy sources, etc.

In terms of factors including the legal structure, financial aspect, and the issuers’ credit profile, ESG bonds are largely similar to traditional bond products. “It is the commitment to ESG targets by the issuer that differentiate such bonds from traditional bonds,” points out Giles Kennedy, partner at Milbank in Singapore.

The disclosure documentation for an ESG bond is one example. It is akin to a conventional bond, but only with the inclusion of a description of the ESG nature of the bond in the offering document, i.e. a label for sustainable debt.

Sustainability-linked bonds, on the other hand, are structured in a way that companies will need to fork out higher interest payments to bondholders if they miss environmental targets as agreed.

But unlike “use-of-proceeds” green debt where proceeds are restricted to a specific use, the issues of sustainability-linked bonds are allowed to deploy the funds raised as they see fit if they have met their climate commitment.

“Then a determination will need to be made as to whether the bond will align with relevant guidelines, standards, principles and/or taxonomies and, if so, which ones,” explains Andy Ferris, Singapore-based partner at Hogan Lovells Lee & Lee.

 

“The green bond framework across regions varies but most issuers would look at using ICMA Green Bond Principles and the ASEAN Green Bond Standards which are ultimately voluntary in developing their own green bond framework.”

- Farhana Sharmeen, Latham & Watkins

 

The key considerations when structuring and offering green bonds in Southeast Asia, therefore, are ensuring that representations of the green features can be independently verified and supported. Especially, issuers and underwriters are advised to pay heed to the Green Bond Principles issued by the International Capital Markets Association (ICMA).

“The green bond framework across regions varies but most issuers would look at using ICMA Green Bond Principles and the ASEAN Green Bond Standards which are ultimately voluntary in developing their own green bond framework,” notes Farhana Sharmeen, partner and head of Singapore law practice at Latham & Watkins.

She adds that the ASEAN Green Bond Standards, first introduced in November 2017, have been developed with the aim of ensuring investors that green bonds with the labels of “ASEAN Green Bonds” have met certain uniform standards.

In addition, sustainable finance taxonomies are also meant to provide clarity and a common standard for market participants in terms of disclosure and reporting requirements, Ferris adds.

“The principal challenge will be to ensure there is harmonisation across those standards where possible, while also preserving the need to reflect the unique issues and local market requirements in the various jurisdictions within the region,” he adds.

 

GREENWASHING FINANCE

With sustainability-related obligations being the renounced feature of green debt, the risk of “greenwashing”, which entails misrepresentation of the environmental credentials of a bond offering, has risen materially and presented financial, reputational and litigious repercussions to the issuing companies.

Also, “Allegations of ‘greenwashing’ can occur when the stated use of proceeds of the bond is not fulfilled or is exaggerated in the offering process and disclosure,” says Kennedy.

Ed Kempson, partner and global coordinator of Latham’s sustainable finance practice, notes that investors and NGOs are scrutinising sustainable finance instruments and related disclosure more closely. “Certain NGOs are generally more inclined to commence claims and submit complaints to regulatory authorities,” adds Kempson.

Ferris notes a growth in the volume and impact of hard and soft laws in the space of greenwashing regulations. “Those are backed by increasing numbers of cases in the courts and a rise in ‘crowd-reg’ or ‘regulation’ of a company’s social contract to operate by the broader community, particularly over social media channels,” he says.  

The legal and financial risks for issuers and other deal parties could range from reputational damage, and general litigation, to securities litigation. Kempson believes reputational risk is the hardest to mitigate.

However, both reputational and financial risks can be mitigated, says Kempson. One of the key steps is to ensure that the issuer has a robust green framework aligned with international green bond standards taking into account the location of projects where the proceeds are to be used, the profile of investors subscribing to the bonds, and the applicable standards in the place where the issuer operates and/or is incorporated.

Kempson continues to note that these steps should be in place with clear compliance requirements crafted by third-party experts familiar with the issuer and the projects for which the proceeds will be used. Regular reporting and periodic certification by external reviewers are also needed.

Also, additional diligence is advised when it comes to the sustainability aspect of the debt transaction. The process should cover identifying the assets/projects and expenditures for the use of proceeds and taking the most appropriate taxonomies and standards into consideration.

 

MEASURING IMPACT

Riding on a surge of interest in impact investing and sustainable debt, the pressure has stayed on for issuers and underwriters of green bonds to put the money where their mouths are. Transparency is key when issuers and underwriters are setting key performance indicators (KPIs) and measurement methodologies.

Latham’s Kempson says there are several key legal considerations, including how have these objectives been crafted, and whether they can be verified by management and third parties. The way these KPIs have been verified and achieving these objectives in a timeframe are also factors to consider.

“These all link to legal liability arising out of any misrepresentation in any of the above parameters, increased scrutiny for the issuer’s board and management,” cautions Kempson.

In addition, Kennedy of Milbank notes that underwriters may also request that a coupon step-up feature be included in the terms of the ESG bonds should the issuer fail to achieve certain pre-determined milestone/performance indicators.

“It is recommended that issuers adopt qualitative performance indicators and, where feasible, quantitative performance measures and disclosures of the key underlying methodology and/or assumptions used in the quantitative determination,” he says.

As the regulatory framework matures and aligns with global standards, Kennedy believes that increased transparency and investor demand for sustainable investment opportunities will drive continued growth in green bonds in Southeast Asia.

In addition, transition financing, used to facilitate what many refer to as “light green” projects that are hoped to be environmentally friendly but do not yet contribute, could complement the existing green bond landscape and sustainability-linked bond frameworks, Sharmeen of Latham points out.

“Issuers, advisers, and investors navigating the transition finance space which has substantial potential in Asia will need to assess the challenges, objectives, and risks with even greater self-scrutiny,” she says.

“Supportive policy initiatives and sovereign issuances can provide the sustainable finance market with sufficient clarity and benchmarking to support the development of current or developing sustainable finance instruments,” she adds.