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Japan in the Capital Markets Sept 2021

Covid crisis fuels ESG focus among Japan’s top credits

Japanese issuers have had to adapt to an incredibly challenging market backdrop over the past two years, as the turbulence unleashed by the Covid-19 pandemic shows no signs of abating. This makes for an equally unpredictable future as corporations, financial institutions, government agencies and investors find ways to navigate difficult conditions.

But amid the volatility, opportunities have emerged, especially in the environmental, social and governance (ESG) market, which has received a huge impetus in Japan, as well as globally.

In this roundtable, GlobalCapital talks to some of Japan’s high-profile issuers and investors about how they are preparing for the future — and the lessons learnt so far.

Participants in the roundtable were:

Yoshitaka Hidaka, director, capital markets and funding division, Japan Bank for International Cooperation (JBIC)

Shingo Kanatani, director, Development Bank of Japan (DBJ)

Jason Mortimer, head of sustainable investment, fixed income, Nomura Asset Management

Moderator: Rashmi Kumar, Editor, GlobalCapital Asia

GlobalCapital: It has been more than 18 months since the pandemic started. How have you adjusted your fundraising plans — and your business strategy — in response to the pandemic so far? 

Yoshitaka Hidaka, JBIC: At the time of the outbreak of the pandemic, the market volatility was huge and so we changed our funding plans. We postponed our funding activities. Since then, things have changed. The US Federal Reserve, as well as the European Central Bank and the Bank of Japan, have been taking very dramatic monetary easing policy measures. As a result of such easing, the bond market has been very favourable for issuers. We are trying to maximize that favourable environment.

We conducted large scale funding activities, and tried to pre-empt the market to find low cost funding opportunities. In January, we issued $1.5bn worth of 10 year bonds, and in April, we issued three year bonds and 10 year bonds of an unprecedented size. It was our largest 10 year bond, worth $3bn. By doing so, our 2021 funding requirement was completed. We think the speed of increase in long-term interest rates will accelerate at the end of this year. Should that happen, the yield curve could flatten. We were expecting that, which is why we issued the long term 10 year bond at the lowest cost for us in history.

JBIC also has a special programme to address the pandemic. The programme helps Japanese companies having difficulty in financing their businesses because of Covid.

Shingo Kanatani, DBJ: Business was greatly affected by the outbreak of Covid-19. Covid-19 was identified as a crisis in March 2020 by the government of Japan, and DBJ, as the designated financial institution under the government, provided liquidity to companies that suffered. In terms of funding, our bond issuance plans were not affected by the pandemic, as the necessary funds for conducting crisis responsibility were provided by the government, and we have offered support to numerous industries in Japan.

We are also supporting the government’s carbon-neutrality project. In May 2021, we disclosed our fifth medium term management plan — the main component of which is the GRIT strategy. G is for green, R for resilience and recovery, I for innovation and T for transition and transformation.

Under the GRIT strategy, DBJ is going to focus on contributing to the achievement of a carbon neutral society by 2050 and supporting the construction of a strong and safe society, providing capital for innovation and to help transition. To drive the GRIT strategy, we will continue to issue both domestic bonds and international bonds.

GlobalCapital: What was the investor feedback and response like to your bonds — and what questions and concerns were raised? 

Hidaka, JBIC: The questions to us mainly centred on our ESG related initiatives. In the overseas market, JBIC has extended loans to coal fired power plants, so investors had concerns about that. But we believe we have very good communication with investors. Rather than meeting them in person, we have been using WebEx and other digital platforms to maintain good communication with our investors in the past year. We have conducted 100 to 150 meetings with investors, both at home and abroad, which has meant that investors have come into our deals, and we were very fortunate to be able to expand our investor base, I think that’s one of our major achievements in 2020.

Kanatani, DBJ: Last year, we expanded our sustainability bond framework, adding social assets to the framework as the outbreak of Covid-19 brought attention to sustainable finance, and especially to that of its social aspect. We explained this to international investors. We will continue issuing sustainability bonds internationally as a way to expand our international investor base using the ESG label.

GlobalCapital: What developments have you seen in Japan’s ESG market — and how has Covid helped shape the asset class? 

Jason Mortimer, Nomura AM: I recently co-authored a piece for the Asian Development Bank about Asia’s social bond market and its development, with a globally comprehensive quantitative assessment of the impact categories funded by these instruments. A couple of interesting things became apparent. First of all, Covid really made clear that it was the time for social bonds, because until then, the focus had been on green, and social bonds were just a small part of the market. It had been difficult to put a finger on what exactly this market was trying to do, because issuance had been limited to mainly government agencies and lacked a unifying issue such as climate change. But with Covid, that changed, and I believe it will be the case going forward as well.

The market has diversified from almost entirely focusing on sustainability and climate change, which are very important issues, to also include the question of resilience during crisis. I think the goal of the social bond structure — and extending that into sustainability bonds as well — really seems to have proved its worth during this period. It’s a type of product that a lot of issuers that perhaps were not well suited for green bonds can issue, which is why issuance volumes have gone up, and continue rising. We look at social bonds and the social part of the sustainability stack to be a compelling way for investors to diversify portfolios by industry exposure as well as impact project type.

As a Japanese investor, we’re involved both in global credits as well as domestic credits in the Japanese market. One of the things that stands out is how we can direct investor capital into projects that are with a global scope, but also within Japan for Japanese specific issues. A lot of lending by banks and issuance by banks are for the SME sector, making it a very crucial social mission. We are interested in that sector, but also in building critical Japanese infrastructure with a focus on resilience. That’s something that is coming to the fore.

Cybersecurity is also something that we are now focusing on and directly integrating into our ESG frameworks. It’s not just about investing in companies provided cybersecurity services directly, but about looking at the cybersecurity risk profile and performance of every single issuer, which we can now do with the data that we have in hand.

GlobalCapital: How difficult is it to monitor the use of proceeds of social bonds? Are their concerns around social washing of bonds? 

Mortimer, Nomura AM: Anytime the ESG market gets big and there’s an issuance rush, these washing concerns do emerge. As ESG reaches mainstream proportions, people are — rightly — asking some serious questions about what exactly this means. Measurement is relatively easier on the green bond side because what’s being measured in terms of impact tends to be physical quantities like tons of carbon, or gigawatts of electricity generated etc. So that’s relatively cut and dried, although of course for many issuers it’s a new type of data, but we can deal with that.

Social is significantly more complex to measure. You’re basically attempting to measure the entire spectrum of human activity. It’s very difficult to put those projects or assets into neat little boxes. What we are doing is assessing the impact issuers are having based on the types of projects specified in the underlying social bond frameworks. It may not be exact to the decimal point, but you can estimate the impact if you know the type of issuer and what’s in their framework.

Based on that database, for both individual bonds and for portfolio bonds, we can see what proportional amounts are allocated to all the different ICMA social bond project categories for example. Based on that, we can choose what project types we want to be contributing capital to and build tailored portfolios and strategies from the bottom up around that.

GlobalCapital: For the issuers in this panel, how have you changed your ESG approach due to the pandemic? 

Kanatani, DBJ: This year, we upgraded our sustainability framework to include social assets. Some important areas for DBJ are basic infrastructure like electric power cable, affordable housing, and healthcare.

Hidaka, JBIC: JBIC has not issued any of these so-called ESG bonds so far. Frankly speaking, I think we’re pretty behind, especially as the volume and numbers of ESG bonds have increased substantially in the past year. We recognize that fully. In June, we came up with a new medium term business plan that covers the next three years. ESG is one of the core parts of our strategy. With respect to our funding plan, a similar approach is likely to be taken. More specifically, in the first quarter next year, we intend to issue a green bond. That’s the first initiative on the funding side.

The measurement of social impact is difficult. Our organisation has been engaged in infrastructure development outside of Japan, through the provision of long-term funds. We have made large loans for greenfield development too. How we can add or incorporate the social and sustainability flavour to that is a very important challenge for our organisation.

GlobalCapital: Are issuers in Japan seeing any pricing benefits from selling a green, or ESG bond, versus a conventional bond? 

Kanatani, DBJ: In the US, yes, we can find a small greenium on bonds. But in the domestic market, there is no premium right now, especially with the low interest rate environment.

Mortimer, Nomura AM: I have published a report though the CBI [Climate Bonds Initiative] and ADB [Asian Development Bank] based on a quantitative analysis of the premium or the performance of green bonds in US dollar and euro markets. During times of market stress is where we see the impact of the green coming through.

Using data from a period of market declines in 2018, we found that green bonds in general outperformed by about one basis point to two basis points on the same issuer curve. It’s not game changing as it’s really not large, but it was interesting that the distribution of the outcomes in which the green bonds outperformed versus the non-green bond counterparts, was overwhelmingly skewed towards the green bond outperformance. So you do get a secondary market effect in turns of greater stability that is welcome by investors.

Personally, I think these are the wrong questions to ask: how much is the greenium and who pays, the issuer or the investor? I think who pays is actually the investor who is not buying green.

That’s how we answer it. That’s the sustainable equilibrium going forward that will encourage the growth of this market, because if the issuer who issues green gets a benefit, and the investor who buys green gets the benefit, obviously someone has to pay for that. There’s no free lunch. And I think the cost goes to the non-green investor. That’s how we think it works, and the data seems to bear that out.

GlobalCapital: The Bank of Japan unveiled its strategy for climate change mid this year, while there are also new guidelines for climate transition finance from the Financial Services Agency (FSA). How is this expected to change Japan’s ESG market? 

Mortimer, Nomura AM: This type of announcement really reinforces that the government, the alpha type investors, the public pension funds and all the other investors and the ecosystem are really behind this kind of concept.

Certainly from our perspective, pretty much all the interest now has some kind of ESG component, especially in fixed income. It’s the case for equities as well, but every single kind of question or interest or new idea that’s coming through almost invariably has some sort of ESG component. I think we will be seeing more demand for this.

On the transition side, I sense that the Japanese government and the FSA are quite keen on this. The messages we’ve heard in public forums like this seem to be that they’re in favour of having even a Japanese style transition bond format. I think that is something that is not so common, and not so popular yet. But if you look at the kinds of issuers, who’s issuing what and who’s doing what kinds of projects, they think transition bonds may have more of a chance in Japan.

We may be looking at dark green, light green, or grey transition bonds. The way to really scale this up, to truly make it mainstream, will be looking at different gradations of that and price that risk accordingly.

GlobalCapital: Would DBJ and JBIC consider selling transition bonds in the future? 

Kanatani, DBJ: Could be. But the government is still having discussions about the concept and definition of transition with Japanese companies. So we have to wait to see what happens.

Hidaka, JBIC: The possibility of transition bonds being issued by JBIC is relatively high. But what is difficult is that just issuing transition bonds does not warrant favourable feedback from investors. It really depends on what kind of KPIs [key performance indicators] we establish, so we have to be careful selecting the KPIs around fossil fuel development, oil, gas, coal, and downstream.

We have offered loans to coal fired power plants in the past, which has raised concerns among investors. But our governor officially noted that JBIC will not extend new loans to coal fired power plants. Under such circumstances, we have to carefully think what kind of KPIs for a transition bond from JBIC will be accepted by investors.

GlobalCapital: How have you shifted to online roadshows and bookbuilding for bonds? Is a hybrid roadshow model likely to play a big role in the future, post Covid? 

Hidaka, JBIC: During the pandemic, I haven’t had difficulties in having remote discussions with investors. It has actually been better. I had access to a great variety of overseas investors, and the opportunities have increased. Going forward, this hybrid type of investor relation activities will be necessary. But if we are going to meet an investor for the first time, we should first have the meeting in person, and then it can be followed up by remote meetings.

That would be the traditional way of communicating with people. After the pandemic we would adopt this hybrid approach and have good conversations with investors.

Kanatani, DBJ: I totally agree with that. For us, remote marketing is a very efficient way of communication. DBJ sells both domestic bonds and international bonds regularly, and therefore we need to cover a wide range of investors in various regions.

Sometimes, we have a couple of online meetings with Japanese local investors in the daytime for domestic deals, and then have a couple of meetings with foreign investors in the evening. So we think remote meetings are very convenient for us, but we also understand the importance of face to face meetings.

GlobalCapital: Jason, what is your take on this from an investor point of view? 

Mortimer, Nomura AM: I agree with everyone that virtual meetings are quite convenient. But face to face meeting and the personal touch cannot be missed. And I think we’re all looking forward to the time we can meet people again.

GlobalCapital: How has the low interest rate environment policy, from both the Bank of Japan and the US Federal Reserve, affected your funding plans? What is the future likely to hold? 

Kanatani, DBJ: The Japanese market has been very stable, and we have all greatly enjoyed this extremely low interest rate environment. There is enough liquidity. But I think market stability is the most important thing for an issuer. We are closely watching how long the negative rates will last, and how the central banks, including BOJ, will change monetary policies to control inflation.

Hidaka, JBIC: We haven’t issued any bonds in the Japanese domestic market in recent years. The Fed has been maintaining its expansionary monetary policy, and as a result of that for the past year or more, we were able to enjoy very favourable funding costs in dollars.

But just recently, Fed chairman [Jerome] Powell mentioned in the Jackson Hole meeting that by the end of this year, they will start talking about tapering, and gradually reduce the amount of bonds they purchase.

This means in the US at least, an interest rate hike is expected and, therefore, short term rates will start rising, and together with that long term rates might start increasing as well. However, I’m expecting a flatter yield curve. The cost of 10 year bonds that we would like to sell would start increasing. The kind of impact that would have on our funding plan, as well as the overall market conditions, are things that we will monitor very carefully.

GlobalCapital: What would happen if the BOJ stops its purchases of domestic corporate bonds? 

Kanatani, DBJ: Maybe in the future, the BOJ could possibly increase interest rates. In such a case, we have to respond to that environmental change as quickly as possible.

Hidaka, JBIC: I find it difficult to comment on this issue. If the BOJ starts reducing its bond purchase, then interest rates will start rising. But the BOJ has responsibility to maintain stability of prices.

The BOJ has stated that it will continue with the current policy until the rate of inflation rises to 2%, or higher than that. Given the current environment, the BOJ will not be able to depart from the current monetary policy stance for the time being. s