Investors, NGOs raise questions ahead of Japan GX bond issuance

Investment sector stakeholders are gauging the suitability and sustainability performance of Japan’s imminent multi-billion “green transformation” bond initiative, which is scheduled to debut this year or early next.

The so-called GX bonds are the centrepiece of Japan’s long-term plan to shift its economy from fossil fuels to cleaner energy sources such as hydrogen and ammonia, and ramp up the use of carbon capture and storage.

The government aims to raise an estimated 20 trillion yen ($157 billion; €146 billion) through the instruments across a 10-year period to fund its efforts.

Some market participants have, however, raised concerns about the Japanese government’s continued focus on promoting industry and future technology options with limited feasibility, and prolonging the use of fossil fuels.

Given the urgency of the transition, some domestic investors in Japan are also unsure how well the bonds’ maturities will line up with their own investment horizons. No official details have so far been provided, but local brokerage Daiwa Securities has recommended that the government issue five and 20-year bonds under this format.

A senior manager at a major Japanese life insurer tells Responsible Investor there is a possibility the bonds will mature too quickly to be considered for his firm’s portfolio.

“In my personal view, major buyers of five- and 10-year bonds would be banks, while 20-year bonds may attract interest of banks but also group pension funds. Life insurers like us would prefer 30- to 40-year bonds so we can avoid asset-liability maturity mismatch.

“But I don’t know if 30- to 40-year GX bonds are likely, as we have less than 30 years to get to the decarbonisation deadline of 2050.

“Supporting green finance is certainly a priority for us, but at the same time we cannot sacrifice returns in order to keep our insurance business sustainable.”

Another leading Japanese asset owner, who also requested anonymity, is more supportive, arguing that the success of the issuance was a prerequisite to achieve the government’s aim for a lower carbon transition.

“I remain hopeful that the transition bond will help attract investment from a broad range of investors in and out of Japan,” he says.

Cedric Rimaud, APAC senior credit analyst at ESG think tank the Anthropocene Fixed Income Institute, questions whether the issuance will gain traction among foreign investors. He notes that almost all the transition bonds issued to date have been issued in Japan to Japanese investors, and uptake from international investors has been very low.

International investors are also likely to show a lacklustre response to use-of-proceeds  bonds that include controversial technologies such as hydrogen and ammonia co-firing, and to the complex value chain being proposed, says Rimaud.

“Japan does not have a cost-effective source of hydrogen or ammonia at home and will need to import it from far-away producing countries, such as Australia. It will then be treated so it can be used in existing coal fire plants. There are also no guarantees that the hydrogen or ammonia will be produced using carbon-neutral processes.

“Carbon emissions resulting from the combustion will then need to be captured before being shipped to Asian countries for storage. This is unlikely to be economical and may lead to the wrong kind of outcome.”

He suggests that Japan should instead consider issuing sustainability-linked bonds similar to the first-of-its-kind bond issued by Chile in 2022, which would be linked to a specific target for absolute greenhouse gas emissions as a key outcome. This would allow a shift to other technologies if the solutions being discussed today turn out to be unfeasible or unworkable.

Japanese government officials have indicated that it is unlikely the GX Bonds will be issued against ICMA’s Green Bond Principles, according to Daiwa Securities senior strategist Shun Otani.

At the same time, he notes that sovereign bond investors pushed for the instruments to be subject to an external verification framework in meetings held with the Ministry of Finance in March.

Otani says the issues should attract sufficient demand to generate a greenium of 1-2b basis points, similar to that posted by some of Germany’s green bonds issued via the “twin bond” format.

He adds that Japanese investors will likely face expectations to subscribe to the GX bonds and that conversations around ESG are more positive in Japan, unlike in markets such as the US, which will further buttress local demand.

The first GX bond issuance is expected to take place in the second half of the Japan fiscal year, between October 2023 and March 2024, according to Otani.