Sustainable finance, sometimes seen as a gimmicky alternative to real finance, has grown up. It is now a viable means of funding that has potential benefits for us all. Here’s how all treasurers can use it to make a difference.
The old proverb, ‘those who live in glass houses shouldn’t throw stones’ has a new twist. In today’s somewhat perilous climate, where weather systems seem to have become more extreme, living as we do under a great protective atmospheric ‘greenhouse’ demands that, at the very least, we all do our best not to make things worse. The City of London Corporation’s Green Finance Initiative says that globally, US$90trn will be needed by 2030 to achieve global sustainable development and climate objectives. It seems an insurmountable figure. So why bother?
In treasury terms, there is something that can be done that arguably achieves a positive outcome for us all. That something requires bringing about a change in the way funding is sourced so that, ultimately, only the most environmentally responsible corporate activities are sustained.
What it means
Sustainable finance is, according to the European Commission, “the provision of finance to investments taking into account environmental, social and governance (ESG) considerations”. It includes a strong focus on the notion of ‘greenness’, aiming to support economic growth whilst reducing pressures on the environment from pollution, and being more efficient and considerate in the use of natural resources. It includes a wide range of financial products such as bonds, loans, securitisation and fund portfolios.
Since 2015, the Paris Climate Agreement and, in particular, the UN 2030 Agenda, have asked for commitment to align financial flows with a pathway towards low-carbon and climate-resilient development. The 17 Sustainable Development Goals (SDGs) set out in the 2030 Agenda have been likened to ‘a purchase order from 2030 for business and government action today’.
The Global Sustainable Investment Alliance shows that in 2017 there were US$22.9trn of assets being professionally managed using responsible investment strategies. This represents an increase of 25% since its 2014 review.
With the sovereign green bond market slowly expanding (Poland, France, Belgium, Indonesia and Fiji, so far) and large institutional investors such as Swiss Re announcing the movement of its entire US$130bn investment portfolio to ESG indices, steps are being taken in the right direction. However, there is a major regional imbalance in support.
The Global Sustainable Investment Review of the proportion of global socially responsible investment assets by region shows Europe at 52.6%, the US at 38.1%, and Asia (excluding Japan) at just 0.2% (Japan accounting for 2.1%).
Whilst the key driver of ESG is often the customer, there is a strengthening policy and regulatory focus in this area, says Michael Wilkins, Head of Sustainable Finance, S&P Global Ratings. Indeed, the international Financial Stability Board (FSB) has released a set of recommendations for better disclosure on climate-related risk and opportunities. These, he notes, are being adopted “in a widescale manner”.
“Green finance is very much becoming a mainstream part of capital markets,” Wilkins says. “If you look at the signatories, there are in the region of 1,800 asset and fund managers who are now part of the Principles for Responsible Investment (PRI), and that represents over US$60trn of assets under management.”
With countries signed up to the Paris Climate Agreement starting to implement so-called Nationally Determined Contributions, financing of projects to meet targets is assured. With most of the necessary financing coming from the public sector, there is a massive opportunity for private sector companies able to assist the transition to a low-carbon economy or improve the environment in broader ways.
But these projects need to be benchmarked, says Wilkins. In the capital markets, although the value of credit is well-understood by investors, understanding the “value of green” is more difficult to grasp. “If it can’t be measured it can’t be priced. If you can’t price it, you can’t discover what the value is,” he states. Because not all green bonds are equal, he believes that enabling a relative ranking of ‘greenness’ enables better price discovery. To this end, S&P’s Green Evaluation is an environmental credential applied to bond issuances and bank loans, providing investors with a clear picture of the green impact of their portfolios.
For issuers, although generally “the jury is out” as to whether green pricing benefits can be achieved, there is evidence from larger, well-recognised names making benchmark issues in the corporate bond market, suggesting it can, says Wilkins. Renewi (see case study) has beneficial margins linked to sustainability targets, as has Danone in France.
Of course, few investors would openly declare their preparedness to pay more for green bonds but Wilkins notes a two-to-three basis point advantage in the primary market, and in the secondary markets, anything up to 25 basis points. For now, it appears that green pricing is at least as good as for regular issuances. For the longer term, Wilkins says benchmarks and better information on the relative value of greenness will be necessary to facilitate market growth at scale if the projected investment required to meet the transition goals is to be met.