Sustainable Finance: securities, frameworks and solutions
Usually, companies issue ESG debt instruments to finance debt with a specific purpose and in a more sustainable fashion. For companies, this means finding new sources of investment, which are remarkably intriguing for institutional investors and whose side-effects are key in the Climate Transition. Sustainable finance has recently seen a dramatic increase in ESG financial instruments.
There is truly a wide array of debt financing securities, which relates to topics such as the Climate Transition, the Environment and even the Oceans (i.e., Climate Bonds, Green Bonds and Blue Bonds). Debt issuance becomes ESG whenever it complies with at least 4 conditions: Use of Proceeds; Management of Proceeds; a certified third-party opinion verifying the compliance with one of the frameworks defined by the International Capital Markets Association (ICMA) and finally reporting. These four characteristics summarise what is generally known as the “ICMA Principles” (ICMA, 2018 and subsequents).
Some recent developments have seen the issuance of new debt instruments such as the Sustainability-linked Bonds and Social Bonds (Sole 24Ore, 2020; White Case 2020), always led by a “purpose”: to finance Social, Environmental or Governance corporate projects, often driven by key company-wise changes concerning the Sustainability Strategy, or rather the company’s approach to Sustainability.
The Covid-19 pandemic has certainly put in place a set of two causes and subsequent effects that would probably spill-over capital markets. The first macro-effect could be the rise of corporate debt. Or better, the increase in corporate financing through the issuance of corporate bonds. What if “sustainable debt issuance” will play a key role this time? Mario Draghi recently stated that debt can be issued with the remit of financing growth (Financial Times, 2020). A prediction could thus be expressed in this sense. There is still hope that debt will be financed with sustainability-led purposes as data and forecasts shows. Despite a consistent decrease in H1 2020, the forecasts made by the Climate Bond Initiative (2020) and Moody’s (2020) reported above might suggest that this scenario is likely.
Even though there has been a remarkable increase in sustainable debt securities, these could not be enough compared to the general-purpose debt instruments, as most recent data shows (ICMA, 2020). Another query is whether the issuance of sustainable debt will be enough compared to general purpose corporate debt. The real potential of issuing debt aimed at growth shall be traced from general purpose bonds A clear-cut statement from the Sustainability Rating Agency Standard Ethics tracks the record: “All debt must be sustainable” (Standard Ethics, 2020). In October 2020, Standard Ethics launched the Securities Rating: nothing else than a sustainability rating on corporate debt. Built through an innovative and independent opinion, the Agency has selected and rated 40 general purpose bonds. Market-wise consequences are two-fold: firstly, general purpose bonds can be rated on sustainability matters and, secondly, companies might be engaging with general purpose securities aimed at financing their sustainability strategic priorities and not only cash-flows needs.
Whether or not this would make the case for to make a definitive step for capital markets towards sustainable debt issuance, there is certainly a further key macro-effect to be considered: yes, all debt must be sustainable.
Climate Bond Initiative (2020) “Sustainable Debt Global state of the Market H1 2020” https://www.climatebonds.net/files/reports/cbi-sustainable-debt-global-sotm-h12020.pdf
Financial Times (2020) “Draghi: we face a war against coronavirus and must mobilise accordingly” https://www.ft.com/content/c6d2de3a-6ec5-11ea-89df-41bea055720b
International Capital Markets Association (2020) “Bond Market Size” https://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/Secondary-Markets/bond-market-size/
International Capital Markets Association (2018) “Green Bond Principles – GBP” https://www.icmagroup.org/sustainable-finance/the-principles-guidelines-and-handbooks/green-bond-principles-gbp/
Moody’s (2020) “Green, social and sustainability bond issuance to hit record $400 billion in 2020” (citato) https://www.eticanews.it/wp-content/uploads/2020/02/Sector-In-Depth-Sustainable-Finance-Global-03Feb20.pdf
Sole 24Ore (2020) “Sostenibilità, arriva il bond legato a obiettivi e non ai singoli progetti” https://www.ilsole24ore.com/art/sostenibilita-arriva-bond-legato-obiettivi-e-non-singoli-progetti-ADQ6DjW.
Standard Ethics (2020) Press Release “Standard Ethics General-purpose Bond Rating: All debt must be sustainable”. 7 October 2020. https://www.standardethics.eu/media-en/press-releases/standard-ethics-general-purpose-bond-rating-all-debt-must-be-sustainable/viewdocument/432
Whitecase.com “Sustainability-linked bonds: the new face of transition finance” https://www.whitecase.com/publications/alert/sustainability-linked-bonds-the-new-face-transition-finance#:~:text=Unlike%20green%20and%20social%20bonds,a%20green%20or%20social%20bond