Why you should include sustainable finance in your borrowing strategy
CFOs should know five things about sustainable financing:
- It can cut your borrowing costs — sustainable finance arrangements often include reduced interest rates provided sustainability targets are met.
- It can improve access to credit in certain circumstances — if you need to finance, for example, a project to reduce your carbon footprint, sustainable finance can broaden the number and types of financing instruments available to you.
- Whether you are dealing with a sustainable finance product or a traditional loan, lenders are increasingly building ESG accountability into debt arrangements — questions about ESG are appearing even in traditional loans.
- It’s not just a boutique product or sideshow anymore — UniCredit’s Antonio Keglevich expects the ESG bond market to grow from $904B in 2021 to $1.3T in global primary issuance in 2022.
- Sustainable finance can play a key role in helping organizations meet their decarbonization goals by mobilizing capital to accelerate solutions.
Sustainable finance and ESG in general are still areas of tremendous change and confusion, but what is clear is this: CFOs should add sustainable finance to the mix when considering their credit portfolios.
Today’s sustainable finance market
Three investment tools which center around sustainable finance are sustainability linked loans (SLL or SL), green loans (GL), and green bonds (GB). Depending on the circumstances of the project and instrument used, reduced interest rates may be obtained if sustainability targets are met. These financing instruments typically incentivize improved performance on environmental or social metrics with differentiated criteria for each tool.
According to UniCredit’s Antonio Keglevich, market and ESG professionals are “anticipating strong continued growth [of the sustainable bonds market in 2022],” following a $904B 2021 year. Keglevich also believes that the ESG bond market will break the $1T barrier this year, and reach $1.3T in global primary issuance. September 2021 saw a new issuance volume of green bonds of almost $75B, the most successful month to date since the birth of the green bond segment in 2007.
Recent commentary by Standard & Poor’s (S&P) speculates that sustainability-linked bonds will be the fastest growing segment of the market in 2022, as innovative issuances continue to emerge. In line with that prediction, global payments giant American Express announced in May 2022 that it will issue its inaugural sustainability bond at the price tag of $1B. Set to mature in 2029, the note is part of a larger $3.5B offering, which includes a $2B 2024 fixed rate note, and a $500M floating rate note. At a similar scale, but in a different industry, a sustainability-linked bond was recently issued by Greeley, Colorado-based Pilgrim’s Pride Corporation, the first of its kind to be issued by a global meat and poultry company. The $1B SL bond is tied to Pilgrim’s efforts to reduce greenhouse gas emission intensity across its global operations, directly linking the bond to a sustainability performance target (“SPT”) of a 30% reduction in Scope 1 and 2 greenhouse gas emission intensity across the company’s global operations by 2030 from a 2019 baseline. The bond also aligns to Pilgrim’s Sustainability-Linked Bond Framework , an outline of Pilgrim’s sustainability strategy for the future. The framework reveals an ambition to transform its business, aligning with the goals of the Paris Agreement to keep global warming below 2°C by 2050.
Sustainable finance incentives driven by bank initiatives
Banks have been encouraging net-zero commitments through the sustainable finance products they are offering and their increasing dedication to hiring and developing professionals with expertise who will help clients navigate the transition to a low-carbon economy. In April 2021, JP Morgan Chase announced the creation of its “Green Economy” team, a sustainable investment team within the bank’s commercial banking division, charged with accelerating the flow of capital toward clean-tech and other sustainable businesses. The bank has stated that it will be investing $150M in sustainable investment in the near term for its first fund and has established a target of directing $2.5T to sustainable investments over the next 10 years. The Green Economy team will focus on “providing services to private entities in need of capital that are poised to benefit from the clean energy transition.” Accelerating the energy transition via sustainable finance instruments is an avenue Silicon Valley Bank (SVB) is also pursuing, focusing on start-ups in the technology sector. SVB has committed $5B to sustainable financing by 2027 to companies working toward this goal. HSBC has also announced its new policy which will center around a “science-aligned phase-down of fossil fuel finance.” In addition to a “primary objective of financing the transition,” the bank will request net-zero transition plans from its energy clients, with potential divestment if there is failure to produce. Bank of America, one of the largest underwriters of green bonds and a co-author of the original “Green Bond Principals,” currently offers more than 400 ESG-themed bonds to clients seeking to satisfy environmental and social objectives.
A North America State of the Market report prepared by the Climate Bonds Initiative states that on average, green bonds achieved a reconciled book cover of 3.6x against 2.8x for vanilla equivalents with 60% of green bonds achieving larger book cover. The same CBI report shows that three quarters of green bonds achieved a “greenium” (a green bond premium over equivalent vanilla bonds), which suggests that investors do attach value to the green label.
Recent SEC proposal a driver for action
In March 2022, the Securities and Exchange Commission issued a Proposed Rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors. The proposed rule, modeled after the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol, would require registrants to disclose information relating to the firm’s approach to climate-related risks from a governance, strategy, and risk management approach. Climate-related risks, as defined in the proposal, include both the physical impacts of climate change and also economic transition risks from the shift from a high-carbon to a low-carbon economy. The proposed rule would require registrants to provide the impact of climate risks on the entity’s financial statements and greenhouse gas (GHG) emission metrics. According to Marjorie Whittaker, Managing Director, ESG & Sustainability Services, “The proposal is expected to impact public and private companies alike as registrants assess indirect GHG emissions across their value chain. As investors increasingly view GHG emissions as an indicator of economic transition risk, firms are expected to seek ways to lower emissions across their value chain.” In order to do so, firms may embrace sustainable bonds as a way to finance more sustainable operations.
Sustainable finance and your company
With the exponential growth in sustainable finance fueled by the major banks, along with the pricing incentive that accompanies these debt instruments, companies will need to begin to integrate sustainable finance mechanisms into their borrowing strategy. The likelihood of ESG measures contributing to your cost of capital is increasing, whether it comes from the financing needed to fund a specific project or being included as an integral component of general lending agreements. The increased volume of sustainable finance products on the market has stimulated greater demand for transparency by investors and regulators. Management will need to consider the projects they choose to finance more closely and how each fits into its sustainable finance frameworks. As expectations for transparency around sustainable financing grow, organizations must consider how they will communicate this information publicly.
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