Is ESG a luxury or a necessity?
October 16, 2020Is ESG a luxury or a necessity?
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By Fanny Doucet and Jason Taylor, Directors, Sustainable Finance, Global Banking and Markets, Scotiabank
With the rise of Environmental, Social, and Governance (ESG) integration across the business, government, and investor communities – initially driven by concern over climate change – it’s no surprise that sustainable finance and green investments have grabbed the spotlight. However, the sustainable finance market is growing ‘beyond green’ to include a variety of sustainable, social, transition, and sustainability linked bonds which offer compelling benefits to both investors and issuers.
It’s hard to ignore the strength of sustainable finance when you consider the size of the market and the speed with which it has developed. In a remarkably short time, it has become one of the fastest growing parts of the capital markets. Clearly, the global focus on climate change and social equity, combined with the emergence of influential standards and benchmarks has pressed most organizations to begin factoring ESG into their business strategies, financing, and operating activities.
Pressure to do so has come from the grass roots (bottom-up), with asset owners prompting money managers to change the way they make investment decisions and allocate capital. While this may be ‘a good thing to do’, they also see it as an opportunity to outperform benchmarks and invest in companies that will succeed down the road through superior sustainability performance. Given its ability to affect corporate value creation, some investors are using ESG performance as a signal of management quality, with the view that those who can manage intangible risks can be expected to better manage other aspects of an organization.
Keeping up with demand through transition bonds
An interesting result of the green wave is that investor demand often exceeds market supply of quality green assets. Consider the fact that, with the world population estimated to reach 10 billion by 20501, the supply of renewable energy projects will be insufficient to meet the projected growth in global energy demand of approximately 50% growth2. This represents an opportunity for energy companies to access excess demand from investors who want to invest and build diversified (industry, term, currency) green bond portfolios.
In response to the imbalance, investors have the opportunity to channel capital towards high emitting companies that have potential to transition to lower carbon business models. To make this shift possible, the transition bond market is developing to help companies with robust sustainability strategies, frameworks and governance, and the ambition to transition to raise capital and direct proceeds to projects that materially lower their emissions.
Demand for transition assets is expected to be robust, in part thanks to limited supply of green assets, as evidenced by an increasing frequency of premiums (paid by investors) for green issuances. In tandem, some traditional companies may be exposed to a brown discount potentially establishing itself into their non-green sources of capital (conventional bonds and equity), if they fail to demonstrate a roadmap to make their business models more sustainable in the future. This market-based incentive can provide opportunity for organizations to ‘signal’ their long-term commitment to a low-carbon economy and prevent their cost of capital from potentially increasing. Thus, transition bonds have the potential to play an important role in strengthening the dialogue between companies and investors, and disincentivize growing climate-related divestments.
Innovation beyond the green screen
While the sustainable finance market grew up as green, an important trend has developed in response to the social impacts of the COVID-19 pandemic and the Black Lives Matter movement. Many companies and investors are looking beyond environment factors due to the inter-connectedness and appeal of the other two sides of the ESG triangle. As a result, social bonds are gaining popularity, particularly since COVID-19 demonstrated how companies must have proper policies and programs in place to address health, equity, and other important social issues.
Many issuers are racing to develop their sustainable finance strategy in an effort to align it with the material ESG factors responsible for driving organizational performance. In response, this has set the perfect backdrop for the sustainability linked bond and loan market to regain its growth trajectory after having temporarily stalled throughout the pandemic. The pricing of these instruments depends on the achievement of pre-established key performance indicators (i.e., GHG emissions reduction, diversity & inclusion targets, ESG rating performance), and permit proceeds to be used in a more flexible manner for general corporate purposes (including to alleviate green capex shortfalls). The opportunity for variety and innovation combined with use of proceeds flexibility, lead some to speculate that sustainability linked bonds could overtake green bonds in popularity.
As corporates and governments continue to realize the benefits of sustainable financing, we expect that sustainable finance options will be available to any issuer with sustainability ambitions, regardless of the sector.
Going beyond for clients
As the sustainable finance markets continue to evolve, Scotiabank has launched a range of sustainability capabilities and initiatives to better serve customer needs, while integrating a sustainability lens across the Bank. For example, in late 2019, Scotiabank committed to mobilize $100 billion by 2025 to reduce the impacts of climate change to support clients in the transition to a low-carbon economy, decarbonize our own operations, and contribute to the global conversation on climate change.
And, in June 2020, Scotiabank launched a new Sustainable Finance Group in the Global Banking and Markets division. As members of this new team, we bring complementary skills in finance and sustainability to collaborate and deliver timely solutions that are additive to the funding cycle. That means applying creativity to funding strategies through demonstrated leadership in numerous international transactions supporting a variety of sustainability objectives such as COVID-19 pandemic relief, GHG reduction, and other social objectives.
For example, in September 2020, we supported Suzano Austria GmbH (BBB-/BBB-) with their first Sustainability-Linked Bond transaction (US$750mm – 3.75% January 15, 2031). The coupon, tied to a GHG emissions intensity target, was met by strong investor demand achieving almost a 10 times over-subscription. It was the first transaction to align to the International Capital Markets Association Sustainability Linked Bond Principles and the first to receive a Second Party Opinion.
We’ve definitely gone beyond green bonds by advising clients on their entire capital structure, so they can integrate material ESG factors into their business models and funding strategies. It’s a fast-moving market, but we can move fast with it, especially when a world-wide event like COVID-19 illuminates urgent societal needs. We’re reacting in real time, to support our clients, and go beyond green, on the road to sustainability.
1 UN 2019
2 EIA 2019
For more information about Sustainable Finance, please contact:
Director, Sustainable Finance
Director, Sustainable Finance