Green bond market has room to expand in MENA

Egypt has issued the Middle East and North Africa’s first sovereign green bond in a deal that was heavily oversubscribed and opened up a new avenue for sovereigns in the region to diversify their funding sources. Green bonds are a subset of the environment, social and governance (ESG) investment universe and have grown substantially over the last few years. However, take-up has so far been relatively limited in the MENA region—either among corporate or government borrowers—despite increasing appetite among investors for ESG investment options.

Egypt priced its five-year USD green bond at 5.25% and raised USD 750m. The total order book was USD 3.7bn, allowing Egypt to tighten its pricing below initial guidance of around 5.75% and tighter than the Eurobond Egypt issued earlier this year (USD 1.25bn at 5.75% for a four-year deal). Egypt will use the bond to support projects in clean transport, renewable energy, climate change adaptation and energy efficiency among other green project goals.

Egypt USD curve

Source: Bloomberg, Emirates NBD Research. Note: bid yield.

Green bonds have no universally accepted definition but broadly encompasses bonds that are used for environmental or climate-oriented projects. Several standards currently exist to ascribe whether a bond is ‘green’ (eg, the Climate Bonds Initiative, the ICMA Green Bond Principles or the EU taxonomy for sustainable activities) and issuers must be able to identify or quantify the environmental impact of the proceeds. Just as credit rating agencies continually monitor the credit worthiness of a borrower, green bonds are continually evaluated to ensure their funds are directed to projects as originally mandated and thus require a high degree of transparency. Egypt’s bond was assessed by an independent ESG ratings firm.

Market for green debt has grown quickly

The market for green bonds has grown tremendously over the last decade and a half. By the end of 2007 just USD 807mn was raised through green bond issuances while more than USD 225bn was raised in 2019. Total green bond issuance so far this year has so far been strong, up 6% y/y as of the end of September compared with the same period in 2019. The Covid-19 pandemic has enhanced investors’ awareness of ESG trends with funds directed toward ESG exchange traded funds (ETFs) at USD 42.9bn year-to-date as of early October. Shifting demographics among investors—towards a younger and more impact investment focus—should help to expand the appetite for ESG investment, and green bonds, further.

Expanding universe of green bonds globally

Source: Bloomberg, Emirates NBD Research. Note: 2020 is ytd.

The Euro and US dollar account for the largest share of green bond issuance, accounting for 48% and 27% of the total value of current bonds despite them being taken up by an increasingly broad number of countries, Egypt being the latest sovereign example. Corporates still dominate the total share of active green bonds, accounting for more than three quarters of the market with industrial firms the largest borrowing sector at 35% of the total universe. Banks have also begun tapping the market for green bonds, directing the proceeds to green energy or climate oriented projects.

Euro and USD dominate green bond issuance

Source: Bloomberg, Emirates NBD Research

European nations dominate the issuance of sovereign green bonds but emerging market economies have been increasing their use of the market to diversify their funding options. In 2020, Indonesia, Mexico, Pakistan, Thailand and Tanzania have all issued sovereign green bonds or sukuk along with Egypt.

Issuers of green bonds have been able to benefit from a ‘greenium’ in the form of lower borrowing costs thanks to a captive pool of investors looking to gain exposure to ESG assets. European markets for green debt show consistently tighter pricing for green bonds compared with conventional borrowing, albeit not at an order of magnitude tighter.

Degree of tighter pricing available in green bond market

Source: Bloomberg, Emirates NBD Research. Note: yield to worst.

In emerging markets and the Middle East the yield compression is harder to observ, in part because the universe is smaller and has a shorter track record. Indonesia’s sovereign green sukuk, for instance, price roughly in line with the rest of its USD curve. Green bonds from EMs may also be taken up by broader, non-ESG funds seeking exposure to EMs generally, rather than any specific investment theme.

Indonesia sovereign USD curve (conventional and sukuk)

Source: Bloomberg, Emirates NBD Research

Room to grow for MENA green bonds

There are 15 active bonds or sukuk in the Middle East, North Africa and Turkey region classified as green bonds with a total universe of around USD 4.8bn. In the UAE, Majid al Futtaim has issued two green sukuk (USD 600m each in two separate deals in 2019) while FAB has four securities in the market.

MENAT green bond universe

Source: Bloomberg, Emirates NBD Research

A green bond initiative for Abu Dhabi’s department of energy was announced at the start of 2020 but has yet to issue any debt. The UAE has an ambitious energy strategy that it will unfold over the coming decades with a target of having 44% of country’s energy mix met by clean energy by 2050 (with 38% from gas, 12% from clean coal and 6% from nuclear power). Expanding the UAE’s existing renewable power facilities along with new projects will require considerable capital and we would expect to see greater take-up of green finance, including green bonds, over the coming years. At the corporate level there is also likely to be use of green financing options for energy efficiency or climate change mitigation projects.

Well governed and transparent green bonds could open up the Middle East debt space to a wider pool of investors that may otherwise have looked askance at the region. The economy of the MENA region still relies enormously on oil and gas production and the climate footprint of many economies is high: carbon emissions per unit of GDP are about 1.25x higher in the UAE than they are in the US. Hence there may be some investor skepticism of how “green” bonds from the region actually are and that there will be a risk of ‘greenwashing’, labelling debt as green to take advantage of the investor appetite but then directing funds to non-green projects. It will be imperative then for regional issuers seeking to use the green bond market that projects are clearly outlined with measurable green outcomes in order to allow investor demand for regional green debt to grow.