Emerging markets need a significant overhaul of their debt capital markets if they are to take advantage of investor interest in climate change and sustainability.
A report by the Centre for Climate Finance & Investment at Imperial College Business School identified a number of obstacles for developing economies that may be looking to issue green bonds and other types of sustainable instruments.
Emerging markets are "highly vulnerable to climate change and require significant amounts of foreign capital to fund transition, mitigation, and adaptation measures," the report said. The report said without intervention this situation will persist.
One issue is that, unlike in developed markets where there has been a surge in strategies dedicated to climate-change issues, very few green bond funds exist in emerging markets, meaning there is little natural demand for green bonds. "Moreover, most of the EM fixed income asset class is too volatile, illiquid and risky to attract capital from dedicated DM green managers," the report said.
Another obstacle is that most emerging markets countries do not have a local green framework for issuance, although the report added that transition bonds — which channel capital toward reducing greenhouse gas emissions in high-emitting sectors — might be more suitable than green bonds.
Many emerging markets also do not have "credible plans outlined to meet their Paris Agreement pledges." A concerted effort to educate and provide incentives to local investors, as well as support for governments in building the proper infrastructure and protocols, are needed to improve green issuance, the report said.
Other proposed solutions to improving green bond issuance in emerging markets include the creation of a forum for emerging market debt managers — similar to the Climate Action 100+ initiative for equities — "to thrash out fundamental questions surrounding climate strategies"; and greater involvement by other sources of capital such as sovereign wealth funds.
"Big forces are pushing the capital markets towards more sustainable investing," said Charles W. Donovan, executive director of the center, in a news release accompanying the report. "Yet so far, they've done little to address the resource dependency and climate vulnerability that's holding back the countries that house the vast majority of the world's population. Multilateral development banks and sovereign wealth funds are perfectly positioned to lead, but are so far failing to catalyze sustainable finance in the countries where it's needed most."
The report was based on interviews with more than 40 emerging market money managers and global banks.