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Capital Markets

Japan plays catch-up with world leader China in green bonds

Higher demand and greater transparency begin to sow seeds of growth

Toda plans to use the money raised from its green bond issue to build offshore wind turbines in Kyushu, southwestern Japan.

TOKYO -- Worldwide issues of "green bonds" by the private sector in 2017 reached about $73.8 billion, some 29 times larger than in 2013, and they are all the rage with global investors. China looks to have become the world's largest issuer for the second straight year, and growth is robust in Europe, where demand for environment-related capital investment, such as wind and solar power plants, is rising.

China is eager to cut pollution and seems keen to play a larger global role in tackling climate change. The world's largest carbon emitter issued around $25.4 billion of green bonds in 2017.

Japan is late to the party. Green bonds issued by Japanese companies, including those issued overseas, totaled $2.06 billion dollars in 2017, which is less than a tenth of those by Chinese companies. Only two rounds of yen-denominated green bond sales have taken place inside Japan. The development the market has been slowed by cumbersome procedures.

On the bright side, there is plenty of room to grow. Investors are increasingly aware of efforts by Japanese companies to demonstrate their commitment on environmental, social and governance issues.

In December, construction company Toda issued bonds worth 10 billion yen ($88.3 million) to build offshore wind power facilities. Nomura Research Institute issued the country's first yen-denominated green bond in 2016. 

Institutional investors are eager to take part. Nippon Life Insurance, has plans to buy up to 200 billion yen of green and ethical bonds through March 2021, reflecting its interest in these assets. But it has struggled to find suitable domestic projects to invest in. Japan's largest insurer has so far spent roughly half the targeted amount, mostly on foreign bonds. 

For the past year or two, investors in the European bond markets have been willing to pay a premium for green bonds. These bonds typically offer a lower interest rate than a similar conventional bond.

Thanks to enthusiastic investors, environmental bonds issued by international organizations with high credit ratings typically yield several basis points less than other bonds issued by the same organizations for nonenvironmental purposes. Lower yields translate to higher prices.

The Japan exception

That is not the case in Japan, according to Nomura Securities, for several reasons. First, there are simply few environmental projects in Japan that require mass fundraising. Secondly, green bond issuers in Japan often have to jump through expensive, time-consuming hoops, including independent certification that a bond is, in fact, green.

Given these obstacles, some Japanese companies opt to look overseas for environmental funding. Hitachi Capital, for instance, issued dollar-denominated environmental bonds in Hong Kong earlier in December.

But things may be changing. When Toda issued its green bonds on Dec. 14, it used a technique popular in Western markets used to gauge market conditions. The "pot method" allows the bond issuer and the lead manager to assess demand from potential buyers by sharing information about potential investors, including their names and how much they are looking to buy.

This offers greater transparency than methods typical in Japan, where lead managers do not disclose the names of potential buyers.

It worked for Toda. Its green bond offered annual interest of 0.27%, while other five-year bonds of the same class -- those with a BBB+ rating from Rating and Investment Information, a major Japanese ratings agency -- have paid an average 0.33% since May.

The green premium could thus be coming to Japan in the near future. "I feel the domestic green-bond market is about to bloom," said Hajime Suwa, co-general manager of debt capital markets at Mitsubishi UFJ Morgan Stanley Securities, the lead manager of Toda's green bond issue. Developing a framework that benefits both investors and issuers is vital if the green bond market is to grow in Japan.

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