Heather Lang, executive director of Sustainable Finance Solutions at Sustainalytics, a leading independent ESG research and ratings provider, discusses some of the innovations spurring growth of the green finance market and how they are creating new opportunities for the North American corporate market.
What do you think are the most important innovations underway in the green bond market?
We've witnessed incredible growth in green bond issuances over the last year across multiple regions and industries. We’ve also observed an increased thematic diversification, stretching beyond standard green bonds. A number of companies and municipalities are issuing “social bonds”, where proceeds may be used in areas such as healthcare, for example. And some are issuing “sustainability bonds” that combine both environmental and social areas of focus.
We’re also observing a trend towards linking use of proceeds categories to the UN’s sustainable development goals, as the SDGs become more central to company and investors approaches. Institutional investors are now allocating more capital to investments aligned with SDGs – and in some cases even their product offering – while large cap companies are aligning their reporting to the SDGs. So it’s a logical extension for sustainable bond issuances to be formally aligned with the SDGs.
What challenges does this innovation give rise to?
With standard green bonds, expectations and best practices are clearly laid out by the ICMA Green Bond Principles and qualification criteria for use of proceeds are fairly well understood. Yet, when we look at different types of sustainable bonds, the use of proceeds categories may be less clear-cut.
There is also increased investor scrutiny of additionality. For example, in the case of a refinancing project, we need to make sure that it's not just business as usual being repackaged as a green bond. Moreover, the focus can’t be too operational. The sustainable impact must be clear and intentional.
We also need to ensure that the issuer is credible, at least in the context where they're issuing the bond, and that the frameworks they've developed are aligned with the company’s sustainability strategy. We have had to turn a number of companies away due to concerns over credibility and misalignment.
ING and Sustainalytics were responsible for the first ever ESG-linked loan in the syndicated lending market last year — how would you describe the market response to date?
This is a rapidly developing area for which there seems to be strong support among investors. I think it’s a game-changer for issuers to start disclosing their ESG ratings alongside their credit ratings to demonstrate their intrinsic value to investors.
With these general purpose ESG-linked loans companies get a lot more flexibility. The funds don't need to be channelled to specific use of proceed categories but are linked more broadly to the company's ESG improvement over time.
ING was our first client to use our overall ESG ratings as a key measure for determining loan financing terms, incentivizing its customers to improve their sustainability performance via lower interest rates. Overall ESG ratings from a credible external party are a clean and simple measure for tracking sustainability improvement.
We’ve also seen interesting examples in the market of different types of sustainability assessments being applied. For example, Finland’s Stora Enso used science-based targets on greenhouse gas emissions, while Danone used the percentage of sales covered by B Corp certifications as one of its criteria. I think this trend will gather pace as other companies seek to use different types of measures that are best aligned with their business models.
What will you need to focus on as market participants look to use different types of indicators and metrics?
Alignment with the SDGs represents one key areas of focus, including product-focussed indicators aimed at offering solutions to a range of sustainability challenges. A subset of the most measurable SDGs, such as Climate Action and Gender Equality are likely to gain the most traction.
On the flip side, there’s also a need to delve more deeply into metrics assessing ESG risks and exposure that pose material business or operational risk to companies, which often involves a different set of indicators.
What do you think will be the most significant drivers of further growth in the US market over the next couple of years?
I think we’ll see more North American lenders and borrowers entering the sustainable finance space in the coming years based on the momentum that’s already underway in Europe. Such demand will be driven in part from their global investor base as regulatory developments like the European Commission’s High Level Expert Group gain further traction.
We can expect to see an increase in sustainable bond issuances from both municipalities and corporates, the latter of which have been under-represented to date. The focus on the issuer’s sustainability performance will be more closely scrutinized alongside the use of proceeds.
I think there's a lot of opportunity with U.S. corporates too, especially small to mid-cap companies that want to expand their investor base, while improving their sustainability performance.