With growing pressure on businesses to incorporate ESG in dealmaking, green bonds are proving increasingly attractive. What does growth in this method of sustainable finance mean for the investment market?
Sustainable finance has climbed up the agenda in the boardroom, and investing in deals that have a positive green element has moved from niche to mainstream in recent years. This method of dealmaking allows large scale players to merge return on investment with environmentally responsible impact. According to Bloomberg data, year-to-date issuance of corporate and government green bonds had reached USD151bn by October 2019. This figure exceeds 2018’s total issuance of USD135bn, reflecting significant momentum in the financial markets.
Along with the introduction of global targets such as the Paris Agreement and the measures recommended by the G-20 Green Finance Study Group, the drive for responsible investing has been increasingly influenced by shareholders in large-scale companies. However, it is only recently that these conversations have taken place with major clients, says Baker McKenzie’s EMEA Head of Capital Markets Adam Farlow. “This is not a boutique area any longer, in fact it is huge money. We’re seeing a deep reengineering of the finance system as the investment management community pushes for an improvement in reporting and investment in ESG.”
Invest to Impress
In effect, a green bond is just like any other bond. It is a fixed income instrument which has the same purpose as its traditional counterparts and a similar risk profile, but its proceeds go into projects that have a sustainable purpose. However, part of the growth in popularity, argues Halla Tómasdóttir, CEO of The B Team – a cohort of global leaders from business, civil society and government brought together to catalyse a better way of doing business - is that as well as its inherent environmental advantage, sustainable investment can offer better returns on investment over the long term.
“We try to squeeze out profit at the expense of nature, at the expense of people, and that is just not sustainable. So, you might be able to deliver short-term profit, but long-term sustainable value creation can’t happen that way. And, I don’t really think this is rocket science even though we are now only just embracing that ESG needs to be on the boardroom agenda.”
While there are currently lower levels of issuance in the green bond market compared to traditional capital markets, there is little doubt that with issuance in 2019 estimated at USD250 billion, there is an increasing flow of large amounts of capital into this area. Alongside this uptick, Baker McKenzie’s Global Co-Head of Renewable Energy and Clean Technology, Paul Curnow notes that ESG risk analysis frameworks, rating agencies and regulation have become more sophisticated to allow for the “viability of business.”
Regulate to Accumulate
There are moves, such as the proposed European Commission's action plan for sustainable finance, to make disclosure in ESG related deals more transparent. According to Curnow, investors are keen that the regulatory side of sustainable finance continues to develop. “The market requires greater disclosure and consideration, and this will ultimately mean better business. Yes, it’s becoming mainstream, but this means businesses have to show they’ve considered how stringently deals can be called truly green. These requirements are in the process of being recalibrated and to a certain extent people are still relying on previous frameworks.” While different standards are still being applied to disclosure in deals, it still remains “a little fragmented.”
The factors behind the growing appetite for green bonds are clear. They meet the demands of investors, offer a level of ease and a simplicity that helps funds tick their ESG boxes without having to delve too deeply into project and market level risk, and help create reputational merit. It removes, as Adam Farlow puts it, the “Hobson’s choice between supporting companies that are doing the right and responsible thing by the environment and those that aren’t, without compromising on return.”
However, we are some way from seeing an ESG element to every deal in the market. While it’s not routine across the spectrum yet, a move towards greater regulation and transparency is pushing sustainable finance very much up the agenda. The impact that ESG continues to have on the market means that deals are being judged and valued against green standards more than ever before. Ignoring this, says The B Team’s Tómasdóttir, is impossible. “The system that we have operated in has been so focussed on short-term profit creation at the expense of people and planet that this approach is no longer an option.”