Green financing has become a large and fast-growing segment of the capital markets, with investors looking to incorporate ESG practices across existing portfolios of assets
"Green financing”, “responsible investing” and “sustainable investing” is a broad umbrella of terms that refer to the incorporation of environmental, social, and governance (ESG) considerations into investment decisions. Green financing has become a large and fast-growing segment of the capital markets, with investors looking to incorporate ESG practices across existing portfolios of assets to minimize their exposure to ESG risks, and increasingly shifting capital from more traditional assets to green assets.
ESG and climate-related finance is not a new phenomenon
Climate change has become one of the key challenges of the 21st century, prompting unprecedented global action. ESG issues related to a project’s exposure to climate change and its climate impact have been at the core of discussions in the financing community. While the roots of green finance can be traced back to the 1970s, the tipping point of the sustainability movement didn’t come until 2015, with the launch of the Sustainable Development Goals and the Paris Agreement. This year in November, the U.K. is set to host the 26th United Nations Climate Change Conference of the Parties (COP26). Financing will be a major topic of COP26 and several organizations have recently announced their participation with the COP26 Finance Coalition Coordination Mechanism.
Green finance and capital markets
In response to initiatives at national and supra-national levels, growing investor demand for green assets and momentum from key industry organizations, an ever-growing menu of ESG-related financial products has been created.
Some of the notable industry initiatives include the Principles for Responsible Investment (PRI), where investors commit to voluntarily adopt and implement six principles for responsible investment (i.e. incorporating ESG issues into investment practice), the Sustainability Accounting Standards Board disclosure standards, the Task Force on Climate-related Financial Disclosure and, most recently, the European Union (EU) Taxonomy, which creates a common language and a clear definition of what is considered environmentally sustainable. Together, these initiatives are helping to move the needle on green financing by creating a set of common principles and standards, which are shaping the behavior of today’s markets.
With a variety of names and purposes, green finance debt structures can be broadly divided in three categories: activity-based debt, behavior-based debt, and the recently introduced transition bond.
Activity-based debt such as green bonds, social bonds, sustainability bonds, and green loans are used to raise money to finance or refinance green projects or activities. Green bonds and social bonds are the most popular in the activity-based debt category, as they have been around the longest, and have a well-established framework.
Issued in November 2008, the World Bank’s first green bond created the blueprint for sustainable investing in the capital markets. Today, the green bond model is being applied to bonds that are raising financing for all 17 SDGs reaching $1.2 trillion as of the end of 2020. On the backdrop of the COVID-19 pandemic, social bonds were the highlight of 2020, recording a 720% annual increase in issued volumes, as reported by Bloomberg.
Behavior-based debt such as sustainability-linked bonds and sustainability-linked loans do not have a specific use of proceeds, rather they contain sustainability goals with the issuer tying corporate sustainability to financing needs. Sustainable targets could include greenhouse gas emission reduction goals, a quota for diversity in the workplace, and many others.
Southern Company recently announced their sustainable financing framework, allowing them to issue a variety of green finance products, the first large cap utility in the U.S. to do so.
Transition bonds, the most recent structure, focus on bringing financial resources to activities that are hard to be categorized as green but still play a role in the environmental transition. Recent examples include issuances from Snam S.p.A., Etihad Airways, and the European Bank of Reconstruction and Development, where the use of proceeds was mainly directed towards energy efficiency projects, resource efficiency, gas transmission network retrofits, carbon/emission reduction, and other projects that support the energy transition.
Impact on financing for new projects
Green finance has moved to the forefront of the minds of the financial community. Bloomberg estimates that global ESG assets are on track to exceed $53 trillion by 2025, representing more than a third of the projected total assets under management. ESG impact is increasingly the first topic banks, equity funds, and private investors ask about when considering whether to deploy capital. Investor appetite has changed and will continue to rapidly evolve in a world increasingly focused on climate change.
In Larry Fink’s 2021 letter to CEOs, he stated that “there is no company whose business model won’t be profoundly affected by the transition to a net-zero economy”. Bechtel interacts with a wide range of financial partners around the world who echo the comments made by Blackrock’s CEO.
In conclusion - What should developers and asset owners consider?
There are more resources than ever for those looking to raise green finance. Last December, the International Capital Market Association (ICMA) published the Climate Transition Finance Handbook, providing a guidebook to help bond issuers make robust climate disclosures and set standards related to a company’s transition strategy to net zero. The ICMA Green Bond Principles were most recently updated in 2018 and provide a guide to disclosure, transparency, and integrity for the issuance of green bonds. The Green Loan Principles provided by the Loan Syndications and Trading Association provide similar guidance for those seeking bank debt.
Developers and asset owners should consider integrating green finance products into their plans to finance, or refinance, projects in their portfolio. Doing so unlocks access to a broad range of financial products and may provide reputational benefits as well. Demand for these assets can also create pricing benefits for issuers of green debt, potentially lowering capital costs for new and existing projects.
Published first on bechtel.com