Liquidity in credit markets is getting greener

Liquidity is steadily increasing across sustainable debt markets, with a 40 percent year-on-year increase in sustainable debt issuance expected in 2021 and interest growing in lower-rated credit sectors. 

This is the view of S&P Global that explores liquidity and pricing within sustainable debt markets in a new report in response to the surging interest in ESG. 

"Liquidity is growing as issuers and investors alike seek to deliver upon their ESG goals and objectives, and this should bode well for the future growth and stability of sustainable debt markets," said S&P head Patrick Drury Byrne. 

There are other signs that liquidity is increasing. The average size of sustainable debt transactions is also steadily rising. Plus, the market has globalised. 

Sustainable debt was issued in 32 different currencies last year.  

While Europe and the US are the dominant markets, it is noteworthy that the largest sovereign social bond in 2020 was issued by Chile, and the largest corporate social bond was issued by a Japanese company. 

According to the report, there are some signs that sustainable bonds may be pricing at a premium in certain sectors, although it is difficult to isolate the impact of ESG factors. 

"Improved standardisation within sustainable debt markets could bolster liquidity further," Drury Byrne added. "However, issuers that cannot satisfy investors' ESG thresholds may in time face higher financing costs and lower liquidity." 

Green monetary policy 

The report also discusses the path to a greener monetary policy. Greening monetary policy operations might not be an easy task, but options exist, and their implementation could accelerate the development of green liquidity, especially in corporate bond markets. 

The four options consist of tilting asset purchases toward climate-friendly assets, implementing a positive screening strategy, aligning the pool of collateral to climate factors, and adjusting the price of lending operations to reflect the counterparties' climate-related lending. 

As central banks control current financing conditions, understanding their future role is becoming increasingly important to sustainable debt market participants.  

But the report’s author warned that this needs to be handled with care.  

"Central banks will need to find the right balance of policy instruments to deliver on the primary mandate of price stability on one hand while mitigating their balance sheet risks and supporting the green transition on the other, "he said. 

"This is necessary to avoid falling "from green neglect to green dominance." 

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