Sustainable finance instruments to grow a greener future

Tim Evans, CEO of HSBC Vietnam

The World Bank believes Vietnam is among the top five countries likely to be affected and estimates that climate change will reduce its national income by up to 3.5 per cent by 2050.

Moreover, Vietnam is one of the most carbon-intensive economies in Asia, and it needs to undertake a rapid transition out of high-carbon activities. As the country pursues this ambitious path, its finance sector will have to play a significant role with a wide range of innovative financial solutions.

The demand for green, social, and sustainability bonds continues to hit record oversubscriptions, confirming that both issuers and investors remain keenly focused on green finance. According to Moody’s, global issuance is expected to reach another new record of $650 billion in 2021, a 32 per cent increase over last year.

In Vietnam, the government has put in place several robust responses and measures, which includes promoting green growth as a key focus in the country’s socioeconomic development strategy.

With the introduction of Decree No.163/2018/ND-CP, corporate green bonds were expected to make more of a presence in the market. Decree 163 was considered the first-ever legal framework for corporate green bonds in Vietnam. It aimed to support the Vietnamese roadmap for bond market development for 2017-2020.

In fact, Vietnam has been actively progressing towards sustainable finance regulation and harmonisation of green definitions with a number of domestic guidelines for green bond issuance, namely the Ministry of Planning and Investment’s guidelines on the classification of public investment for climate change and green growth, or the Ministry of Natural Resources and Environment’s criteria for green projects. Besides that, the State Bank of Vietnam (SBV) issued Decision No.1552/QD-NHNN and Decision No.1604/QD-NHNN as the general action plan for green credit growth and developing green banks in Vietnam.

Additionally, in April, the State Securities Commission introduced a handbook on green, social, and sustainability bonds to help corporate issuers and other market players to understand and follow the international and regional best practices.

According to the 2017 Global Infrastructure Outlook, Vietnam requires an infrastructure investment of $605 billion towards 2040, leaving a gap of $102 billion after adjusting for current investment estimates.

The Global Green Growth Institute (GGGI), in partnership with Luxembourg and the Ministry of Finance, signed the Vietnam Green Bond Readiness programme in October 2020. This proposal aims to enhance institutional capacity and the regulatory framework, combined with practical experience in piloting green bond issuance. The GGGI estimates implementing a green growth strategy in Vietnam will require $30 billion by 2030.

Key instruments

Green bonds and loans are debt instruments to finance projects, assets, and activities that support climate change adaptation and mitigation. The green bond label can be applied to any debt format including, for example, private placement, securitisation, and covered bonds.

In fact, green bonds are regular bonds with two distinguishing features: the proceeds are allocated exclusively for projects with environmental benefits (understood to be essentially coupled with social co-benefits) and provide clear transparency and disclosure on the management of the proceeds.

While there is no single set of global definitions for eligible projects to be funded with green bonds and loan proceeds, the Climate Bonds Initiative uses the Climate Bonds Taxonomy, which features eight use of proceeds categories: energy, buildings, transport, water, waste, land use, industry, and ICT.

Meanwhile, sustainability-linked bonds are any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability objectives. Though still very small, this market segment started to grow in the second half of 2020, particularly in ASEAN.

Sustainability-linked loans (SLLs) can also support borrowers in meeting sustainability performance improvements such as significant greenhouse gas emissions reductions or reductions in waste or water usage. If targets are met, borrowers are rewarded with a reduced loan margin, resulting in a cheaper cost of capital. SLLs do not require a definition of green assets and projects to be financed, but instead allow all types of entities to commit to company-level sustainability targets linked to the terms of the debt. As such, they can provide an alternative for borrowers in sectors that currently lack clear definitions of green, such as the food and beverage industry.

Sustainability bonds are defined as bonds whose proceeds are applied exclusively to finance or re-finance a combination of green and social projects, such as projects with clear environmental and socioeconomic benefits. These projects should link to the country’s Sustainable Development Goals, socially responsible investing, and environmental, social, and governance standards.

Meanwhile, HSBC has recently supported Vinpearl, a subsidiary of Vingroup, to issue a $425 million exchangeable sustainable bond, the world’s first of its kind. As the sole sustainability structuring bank, HSBC supported Vingroup in developing its inaugural Sustainable Finance Framework, which is having a positive impact on the environment and society according to Sustainalytics.

The second sustainable-debt financing innovation came about in 2015 with the issuance of the first social bond. Social bonds are defined as bonds whose proceeds are used exclusively to finance or re-finance social projects, meaning projects with clear socioeconomic benefits related to housing, gender, health, and education. Social bonds may also have environmental co-benefits.

Finally, transition finance describes instruments financing activities that are not low- or zero-emission, but have a short or long-term role to play in decarbonising an activity or supporting an issuer in its transition to Paris Agreement alignment. The transition label can thus enable the inclusion of a more diverse set of sectors and activities in the sustainable finance universe. Many of the candidates are currently highly polluting, hard to abate, and do not fall within existing sets of green definitions but are key to meeting global climate targets. Example sectors include extractive industries such as mining; materials such as steel and cement; and industrials, including aviation.

Hopes for a greener Vietnam

According to the IFC Climate Investment Opportunity report, Vietnam’s climate-smart business investment potential is an estimated $753 billion from the 2016-2030 period. Potential investment in renewable energy totals $59 billion, with over half of this in solar and another $19 billion for small hydropower projects. New green buildings represent an almost $80 billion investment opportunity. Those numbers prove that Vietnam’s sustainable finance market is going to evolve remarkably in light of the ongoing pandemic and heightened attention to sustainable economic recovery.

With the dedication of the Vietnamese government, new strategies, funds, and financing instruments engaging with environmental and social issues are expected to emerge at an accelerating pace in the next few years.

There are some recommendations to transform the finance to finance the transformation. The SBV could set a clear requirement for each credit instrument so that banks can develop a better green credit framework and progress plans for themselves. It is also essential to have a clear framework for the capital market instruments.

Next, the SBV should set out a clear target on green credit performance for each bank. The central bank could consider higher credit growth towards green sectors or financial subsidies for green credit.

In addition, more rewards to motivate banks on the green journey include a higher general credit growth cap for those who comply or overachieve the target. A lower growth cap for those who don’t could be an option to consider. Finally, no or lower required reserve ratio for green outstanding balance is also a driver towards green market growth.