The move towards a more sustainable financial system.
The rising global demand for sustainability is evident. Regulatory and policy pressure from the 2015 Paris Climate Accord, the European Commission’s Technical Group on Sustainable Finance, and other national bodies, have pushed the need for more sustainable industry practices. Federal leadership, such as the UK Government, have used such agreements to lead a nations’ transitioning to low-carbon economies. Furthermore, consumers want to act, buy, and invest more sustainably, and expect businesses to care for more than just their bottom line. As a result of heightened consumer awareness and policy changes, organisations are embracing sustainable business practices, thereby finding strategies to align the creation of business value with the creation of value for society and the environment.
So how can financial institutions, such as banks, respond to growing sustainability demands among their consumers? And what is the role of capital markets in facilitating countries’ transitions to “greener” economies?
In step with the global trends, financial institutions, banks, and other capital market organisations have become increasingly aware of their social and environmental responsibility. This can be seen in the continuous shift towards “green finance” or “sustainable finance”. Broadly speaking, both terms can be associated with “the utilisation of financial instruments whose proceeds are used for sustainable development projects and initiatives, environmental products and policies”.
Such financial instruments, for instance green bonds, have seen remarkable growth in recent years. Since 2007, when the first green bond was issued by the European Investment Bank and the World Bank, the green bond market has grown to more than $160 bn in issuances in 2018. Furthermore, after growing 1% in 2018, the sustainable funds market grew 15% to $52bn during the first half of 2019. Clearly, the “green finance” market is undergoing a mini boom.
However, it is not just regulation and policy that have accounted for the recent growth. From a survey conducted by Accenture in late 2019, around 67% of Millennials believe that investments are a way to express social, political, and environmental value, compared with only 36% of baby boomers. Moreover, an astonishing 90% of this younger generation also indicated that they were keen to grow their allocations to responsible investments in the next five years, providing an indication in what the future holds.
Seeking to stay in touch with the consumer base, evermore, banks and asset managers are incorporating environmental, social and governance (ESG) investments in their product offerings. Some of these offerings serve to differentiate a bank’s products. For instance, BBVA now provides business customers with a platform that calculates their carbon footprint, using activity in their aggregated banking accounts related to electricity, gas or fuel expenses. With this information, firms can take the first step toward reducing their energy costs while exploring new, more sustainable lines of business. Meanwhile Triodos is helping its customers to reduce their plastic waste. The bank is offering eco-friendly debit cards from 100% renewable resources like plant leaves and corn. Naturally the card comes with an account that enables customers to ‘finance a fairer and better world’.
Other offerings clearly help to enhance banks’ reputation and shape their competitive advantage. For example, after reports last year revealed that British banking giant Barclays had invested more than $85bn into fossil fuel projects, the bank recently pledged to become net-zero by 2050. Barclay’s new climate policy includes concrete measures on how to decarbonise products, services and large-scale finance activities more rapidly. Riding the sustainability wave, RBS, a bank that has faced much criticism from civil society organisations about its fossil fuel financing, has announced it would become ‘climate-positive’ by 2025. Becoming ‘a purpose-led bank’ RBS also vowed to halve the emissions of its portfolio of investments by 2030, in support of the UK’s 2050 net-zero target and in line with the Paris Agreement’s 1.5C trajectory. Finally, the company has implemented responsible business travel policies by introducing travel breaks for its employees. Doing so is set to significantly reduce the company’s carbon footprint and send a clear signal to its global workforce.
The issuance of green bonds, for example European Commercial Papers (ECPs), are one way that banks can support green initiatives. Green bonds were created back in 2007 to fund projects that support positive environmental and / or climate benefits. Most of the green bonds issued in the market to-date are green “use of proceeds” bonds. These require a percentage (or all) of the proceeds generated from the issuance to be used in “green” investments. Between the conception of green bonds and now, there has no doubt been ambiguity in the term “green” and what constitutes as a suitable investment. It has been the responsibility of issuer to specify the approved usages of the proceeds and eligibility.
However, times are changing. The European Commission has tasked a Technical Expert Group (TEG) on sustainability to devise a green finance taxonomy to create clarity on what is considered green or sustainable and which activities can be labelled as such. In doing so, the taxonomy will set the standard for what investors can expect and will drive the transition to “greener” economies through ensuring issuers use the proceeds for covered activities. The first company reports and investor disclosures using the EU Taxonomy are due at the start of 2022.
Furthermore, it is not just banks that can help drive the transition to more sustainable economies through the issuance of green bonds. Large corporations and even Governments have also dabbled in the issuance of green bonds over the years to help bankroll projects and initiatives. For example, in 2017 Apple issued its second green bond, selling USD $1bn in debt to finance clean energy and environmental projects at Apple facilities. PepsiCo, Inc., have also issued a USD $1 billion green bond in October 2019 to help advance its corporate sustainability agenda. The proceeds generated were invested in the development of sustainable plastics and packaging, decarbonization of operations and supply chain, and water sustainability. Whilst countries such as France, The Netherlands, Belgium and Nigeria have also participated in the issuance of sovereign green bonds to help finance wider sustainable infrastructure initiatives.
Evidently, there is a growing consciousness among investors to ensure that their savings are responsibly invested and this is coinciding with a time where banks, large corporations and Governments are trying to finance the transitioning to “greener”, more sustainable, operating models and economies. The issuance of green bonds, particularly in the European market, can deliver the solution for both investor and user of funds. Through the guarantee that proceeds will be appropriately used under the upcoming EU Taxonomy, investors will have the assurance needed to put more of their cash into green bonds and the issuer will have the means to fund further sustainable change.
Sustainable change is on the horizon – I’ll bank on that.
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