How AIIB finds credit plays in emerging markets using an ESG lens

The multilateral development bank believes institutions need to be flexible and pragmatic while trying to make sustainable investments in emerging market debt.
How AIIB finds credit plays in emerging markets using an ESG lens

Institutional investors are well aware of the importance of environment, social and governance (ESG) and climate action investing, yet they can be hampered by 'legacy' situations and a smaller investment universe, a senior executive from a regional development bank said.

Investors, therefore, need to be pragmatic when they seek such investment opportunities, especially in developing markets.

“I think most institutions and sophisticated investors are fully aware of the significance of ESG and the climate agenda,” Dong-ik Lee, director general, investment operations at Asia Infrastructure Investment Bank, told AsianInvestor.

“The challenge lies often in issues such as when a financial structure is created by a product manager for, say, net-zero, the underlying assets sometimes have legacy portfolio companies that don’t necessarily meet the current requirements of ESG and climate change.

“We have to be flexible in how we interpret and handle the situation. We understand the realities of the market,” said Lee.

The Beijing-headquartered multilateral development bank is showing other large investors how it can be done: in 2018, it appointed investment manager abrdn to manage a $500 million bond portfolio with an agreed-upon sustainable investment policy.

The AIIB Asia ESG enhanced credit managed portfolio aims to promote the development of Asia’s debt capital market with a specific focus on infrastructure-related bonds.

The ESG portfolio focuses on bonds issued by corporate (including quasi-sovereign) issuers operating in infrastructure-related sectors, as well as labelled bonds where proceeds are directed toward sustainable infrastructure and other sector projects.

It has proven quite successful and lays the ground for similar mandates in the future, Lee told AsianInvestor previously.


Investment managers need to understand ground realities when engaging with investee companies -- and how they can make sustainable investing work, especially in developing markets.

“We see this [mandate] as an opportunity to engage with the company to understand what their policies are, and in some cases, help them take suitable actions to get back on the right track,” said Adam McCabe, head of APAC fixed income at abrdn.

So rather than just thinking about the challenges of ESG data or the limited opportunity set, “what I see is an opportunity to assess in a forward-thinking way and engage with companies to make a difference,” he added.

With the emergence of transition finance – financing companies in their journey to go green – new opportunities are emerging for sustainability-minded investors.

Yet, several emerging transition projects in Asia are unviable for commercial capital due to political, currency and credit risk.

Adam McCabe

There is an urgent need to de-risk projects for investors and lenders and also to find ways to realise the value of environmental benefits to improve the commercial viability of projects.

The reality is that all companies will not go on a straight-line journey on energy transition, added abrdn’s McCabe.

“From time to time, investors will need to step back and make a judgement on what the ramifications of situations (as Lee mentioned) are,” he said.


In addition, investors remain wary about emerging market (EM) fixed income.

EM debt, which is considered riskier than developed market debt, has evolved significantly in the last two decades, with strong growth in the depth and breadth of countries and number of issuers.

The EM debt universe has nearly tripled in size, expanding to $26 trillion from around $10 trillion, according to research by Amundi Institute.

Along with the growth in conventional EM debt, there is a rising trend of sustainable debt issuance. The sustainable debt market has now grow to over $400 billion, the research report, published in March, said.

Sustainable debt includes green, social, sustainable, as well as sustainability-linked bonds.

While the share of EM in global bond markets has rapidly increased to nearly 30% from 8% in 2003, EMs remain underrepresented in global bond indices and in investors’ portfolios.

The caution among investors about investing in emerging market (EM) credit is understandable, even though the potential for gains is high, said AIIB's Lee.

“If you look at the global allocation towards emerging markets, it’s still tiny compared to the huge fund flows coming from global investors. Investment flows are definitely skewed towards developed markets,” he noted.

“Even from a global interest rate situation, EM credit is attractive, if you look at the spread. And that could be the case for the next three to five years down the road as well, especially if you invest in high quality EM fixed income,” said Lee.

Along with the growth in conventional EM debt, sustainable debt issuance has also climbed.
Image credit: Shutterstock


The options in Asian hard currency fixed income are more limited – not many entities can issue US dollar bonds in emerging markets in Asia.

“By definition, these can only be very established state-owned enterprises or big corporations,” said Lee, noting that these can be an attractive investment options.

These entities will already be very familiar with the credit market and will have high credit ratings.

"Some of them may be considered to have higher ratings than the country they are headquartered in," said Lee.

"This is considered a good investment opportunity as such large or established organisations have US dollar bonds as they often have uncovered market value," he added, noting there are interesting opportunities in the secondary market for Asian credit too.

AIIB hopes its ESG credit mandate will encourage other institutions to follow suit.

Vivian Tang

“Investors like us have a catalytic role to play to bring in more capital,” said Lee.

abrn is also optimistic: "As our collaboration matures, we are also looking at other ways and investment vehicles to invest in this space to facilitate crowding in investors in a more efficient way," Vivian Tang, head of institutional business Asia Pacific, told AsianInvestor.


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