Gulf states are expected to be at the forefront of ESG bond issuance in 2022 with high-profile borrowers from the region working on plans to issue labelled debt and face down entrenched criticism of their role in fuelling global warming.
ESG supply is set to pick up from a low base, with issuance from sovereigns and corporates in the oil and gas, utilities and real estate sectors expected. Big players such as the Saudi Arabian sovereign, its Public Investment Fund and Qatar Energy are among those preparing the way for deals.
With the region at the centre of the world's climate emergency, with temperatures rising at double the global average, according to the Max Planck Institute, and on course to be four degrees warmer by 2050, the need for green and sustainable financing has never been more urgent.
Yet while ESG-labelled debt has taken root in the countries of the Gulf Cooperation Council, the product is still in its infancy.
Last year, Gulf issuers raised about US$3.75bn-equivalent in labelled debt from international bond sales, according to IFR data, although that includes a US$2.5bn sustainability sukuk from Islamic Development Bank.
Bankers and investors are hopeful that more issuers will press ahead with deals this year. "Many of the Middle East corporates and financials are putting a lot of emphasis on ESG so the next logical point is to see more labelled issuance," said Sergey Dergachev, functional head of EM corporate debt at Union Investment.
There have been tentative signs of progress in the first few weeks of the year. Of the five US dollar bonds from Gulf issuers in 2022 three were ESG-linked. One was a US$700.8m green bond due 2049 for a UAE solar project, issued by Sweihan PV Power. The others were two separate US$750m sukuk deals, one from Saudi National Bank, the other from Riyad Bank, with the proceeds from both going towards sustainable financing.
The fact that the three issuers are from either the UAE or Saudi Arabia, however, points to one of the challenges in the region. "Progress in the Middle East is quite uneven – it has mostly been dominated by the UAE and Saudi Arabia, while the chance of seeing more labelled bonds this year from others like Oman, Bahrain and Kuwait is quite low," said Dergachev. "There is still big differentiation in terms of progress and awareness to the ESG theme between different countries."
Ambitious plans
Investors, though, are excited about some of the region's plans and ambitions. Matthew Vogel, head strategist and portfolio manager at FIM Partners, for example, is bullish about the Middle East's move from oil to solar. "Saudi Arabia is talking about 40GW of solar alone by 2030, which implies about US$20bn–$25bn of investment requirement," he said, adding that he expects desalination units across the region to be converted to solar from thermal.
"With PIF alone expected to undertake some 8%–10% of GDP in domestic investment spending per year, and them saying half [will go] to the green economy, then the debt financing will be substantial," he said.
Aghast
Some ESG specialists will be aghast at the prospect of such high-emitting, hydrocarbon-dependent corporates and sovereigns at the centre of sustainable financing – a point that was demonstrated through, ironically, a non-labelled deal in January.
A US$2.5bn conventional bond offering from a UAE special purpose vehicle, EIG Pearl, which has links to Saudi Aramco, was included in JP Morgan's ESG Corporate Emerging Markets Bond Index. That decision attracted criticism, given the bond was issued to help finance debt taken on to fund an acquisition of an Aramco oil pipeline.
Ulf Erlandsson of the Anthropocene Fixed Income Institute argued that with some ESG investors mechanically following the index’s rules, and with EIG Pearl in effect an Aramco subsidiary, at least from a credit perspective, the loans these fund managers were providing "will, in our opinion, effectively provide financing to an entity which MSCI indicates as 'over 4 degrees implied temperature rise'."
The composition of JP Morgan's ESG index relies on rules-based evaluations provided by external vendors Sustainalytics and RepRisk.
Others are more willing to consider the idea of oil-related sustainable financing. "The market would be open to it, but it would attract high scrutiny if a Middle Eastern energy company is issuing in ESG, to make sure those proceeds are truly for improving ESG metrics," said Jeff Grills, head of emerging market debt at Aegon AM. "But we’ve seen it done elsewhere and therefore expect further ESG bond issuance in the Middle East and from energy producers as well."
Sherif does like it
Last year, Apicorp, which is owned by the 10 members of the Organization of Arab Petroleum Exporting Countries, sold a US$750m five-year green bond. "What started off being maybe scepticism, for want of a better word, when we started to talk about what we wanted to do moved to intrigue and then ....at the stage of the transaction... I was fielding calls from joint lead managers not wanting to have orders from their investor clients scaled down," said Sherif Ayoub, chief financial officer at the multilateral organisation. "People wanted to be part of the story."
But not all issuers will feel the need to bolt on an ESG sticker, according to Dergachev. "Big national oil and gas companies like Saudi Aramco have various funding options available – that is via bank loans or ... global crossover credit investors who are interested in their conventional bonds. So it is unlikely that they put an ESG label for newly issued debt this year," he said.
Discrepancies are also apparent in how much weight different investor bases attach to labels. "Interest from investors has so far come more from the internationals, where to some extent it is driven by regulation with requirements for asset managers in Europe to make ESG disclosures," said a Dubai-based banker. "The Middle Eastern investors are perhaps less incentivised from a regulatory perspective but there is a natural intent in the communications trickling down from the sovereigns to focus on ESG."
The best ESG structure to adopt is another area of debate. Ayoub said the link between assets and use of proceeds for green bonds should help promote that part of the market in particular. But Iman Abdel Khalek, co-head CEEMEA debt capital markets at Citigroup, said issuers could explore other tools.
"It will be interesting to see if sustainability-linked bonds come out or if there is just a focus on green or sustainable," she said. "Once the KPIs are defined at a corporate level then we should see companies committing to this as part of their financing framework and this should only grow from here."