Sustainable Finance in 2019
In 2019, investors globally continue to be concerned about climate change risks and the transition to a low-carbon economy. As investor awareness around climate risk has grown, so too has the sustainable finance market. Sustainable finance, as defined by experts, is any form of financial service which integrates environmental, social or governance (ESG) criteria into business or investment decisions.
The growth in the green finance market for issuers has been especially strong since the introduction of green bonds. While sustainable finance has traditionally focused on the performance of companies, green bonds moved the spotlight to the performance of assets with positive environmental impact and economic value. Since 2007, when the first green bond for was issued by the European Investment Bank and the World Bank, the market has grown to more than $160 bn in issuances in 2018.
With green bonds picking up pace, both government (municipal, local or national) and business entities have started to explore opportunities, and diversify their bond portfolios by incorporating social and sustainability factors. With this backdrop, we look a three sustainable finance trends that we think will shape the market in 2019.
From Green Bonds to Sustainability Bonds
In 2018, approximately USD 58.8 billion in social and sustainability bonds were issued. Investors are increasingly using the UN Sustainable Development Goals (SDGs) as a benchmark for impact and are creating more demand for sustainability bonds. Companies struggling to find assets to benchmark the size of a green bond, have started to look beyond green assets to match treasury needs. They are looking to social assets (assets with a positive social impact), particularly in new markets like Asia where greater flexibility in choosing assets, allows for faster growth.Our Outlook: This push and pull effect means 2019 will see an increase in sustainability bond issuances. The bond market may also see the appearance of other labels already proliferating in the loan market, such as ESG performance incentive loans. In parallel, sustainable finance will diversify to new asset classes like collateralised loan obligation (commonly known as CLOs) and equity capital.
Transition of Companies’ Business Models
With regulatory and policy pressure from the Paris Agreement, OECD, the European Commission’s Technical Group on Sustainable Finance, and other national bodies, investors are asking companies to embrace the transition to a low-carbon economy. Investors are looking for companies to demonstrate how a green (or sustainability) bond contributes to their transition strategy, and other sustainability commitments.Our Outlook: Issuer’s sustainability strategies will become increasingly important for investors, in addition to project-level impact from green or sustainability bonds. Investors will start to ask for increased disclosure around companies’ ESG ratings to better understand the company’s exposure to climate risk.
Taxonomies will lead the way
Global regulatory initiatives for sustainable finance will be in the spotlight this year, driven by the European Commission’s efforts to create and regulate a green finance taxonomy. Taxonomies help to create clarity on what is considered green or sustainable and which activities can be labeled as such. In doing so, taxonomies can help to simplify transaction costs to enter the market. However, taxonomies are also generally slow to evolve and prohibitive to inclusion of new technologies.Our Outlook: In the short term, the European Commission’s taxonomy may increase costs for issuers. In the long term, the taxonomy could create a robust market for green finance, including a pricing benefit that will occur from a clear and common understanding of what is green. Whether the taxonomy facilitates the growth of the green finance market will depend on if thresholds in the taxonomy are applied as guidance or requirements.
The Role of Sustainability-Linked Financial Instruments in Heavy Industry Decarbonization
With the effects of climate change looming, governments and organizations of all stripes need to work with carbon-intensive industries and invite them to participate in global decarbonization efforts. This can, in part, be achieved through sustainability-linked instruments.