Navigating challenges to sustainable finance

Confidence in sustainable investment is holding strong amid ongoing volatility in global markets. Sustainable finance issuance recorded its highest June-quarter on record in 2022, despite falling 21 per cent year-on-year.

Rising interest rates, energy price shocks, geopolitical tensions and uncertainty surrounding an impending global downturn have adversely impacted debt and capital markets. While sustainable finance has not been immune to these challenges, experts remain optimistic.

“There is some flattening in issuance in the short-term and the astronomical growth we have seen due to a low baseline may not be repeated,” Stella Saris Chow, ANZ’s Head of Sustainable Finance, International said.

“However, overall, the outlook remains positive. We expect to see the sustainable bond market recover next year.”

According to Saris Chow, the sustainability-linked loan market will remain strong as more companies commit to net-zero targets and seek to link their financing cost to sustainability performance.

At the same time, Saris Chow cautioned, it’s important to acknowledge decarbonising economies is complex, especially in Asia, and requires significant capital investment: the journey to net-zero by 2050 is estimated to require $US125 trillion, and the need for sustainable finance is significant.

Part of the puzzle

ANZ has seen a growing number of corporate sustainability commitments, but these are just one piece of the puzzle, Saris Chow said. In the past 12 months there has been a shift by regulators, governments, financial institutions and investors to work together toward a net-zero future.

Sovereign green- and sustainable-bond issuances have risen across the world. The Monetary Authority of Singapore announced its inaugural sovereign green-bond issue in August 2022.

Singapore's stock exchange has mandatory climate-related disclosures and in Hong Kong,  businesses are required to disclose their environmental, societal and governance (ESG) record. Other examples from around the world that show authorities are moving in the right direction include the European Union’s taxonomy to classify sustainable activities, and similar efforts across Asia in China, Malaysia, Singapore and Japan.

While these developments are focused on decarbonisation, the issue of how to conserve the earth’s natural capital remains, according to Saris Chow.

Half of the world’s gross domestic product depends on nature, she said, and there is a recognised need to conserve natural assets and protect biodiversity.

“Nature-based solutions for mitigating climate change is a growing area of interest to our customers,” Saris Chow said. “There is potential for natural capital projects to protect and restore natural carbon sinks, and create unique employment opportunities and benefit local communities.

“The execution of these projects and multi-stakeholder engagement makes the execution not so straightforward but the co-benefits generated make them attractive.”

Hurdles and holistic solutions

Shifting the world’s reliance on fossil fuels to low-carbon sources requires not only scaling up the use of renewables, but also innovative technologies yet to be commercially or economically viable.

Financing green technology across sectors can help clear this hurdle, according to Saris Chow.

Greening the transportation sector, which contributes more than a third of all CO2 emissions from end‐use sectors, is seen as an effective approach. And while the success of such efforts is predicated on the availability of timely and affordable financing, banks are well positioned to meet that requirement.

ANZ, along with six other global banks, recently provided Chinese automaker Geely Automob`ile Holdings with a three-year $US400 million sustainable club loan to support the company’s development of green technologies and production of new-energy vehicles.

Blended finance – which pairs formal development assistance with other sources of funds - is also playing an important role in addressing the gaps in financing to support new technologies, especially in the role of green hydrogen, which has emerged as a low-emission fuel source for a number of industries, including transportation, heavy industry and manufacturing.

It’s also important to recognise lower growth in the sustainable finance market is not the market’s sole challenge.

First, it’s important to ensure sustainable finance is achieving ‘additionality’ – i.e. the financing is driving a positive environmental or social impact critical to the development of the market.

At the issuance level, structuring transactions consistent with market principles is vital. Issuers can do this by adhering to a framework of guidelines and principles set out by a number of bodies, such as the International Capital Market Association and the Asia Pacific Loan Market Association’s green and sustainability linked loan principles.

Additionally, it is market standard to have a third party review the issuance’s structure to ensure alignment with the principles, a sufficient level of ambition and where relevant science-based sustainability targets, and positive environmental or social impact, Saris Chow said.

Second, a push for differentiated pricing is instrumental in improving outcomes in the sustainability-linked loan market. Corporate loan facilities increasingly have ESG metrics built in that align with the borrower’s sustainability strategy and, in turn, performance against these metrics drives loan pricing.

For instance, an outperformance on sustainability metrics will result in a lower cost of borrowing while equally important is for underperformance to trigger a margin step up.

“We are seeing differentiated pricing becoming a feature not just in Europe, but in the US and Asia-Pacific,” Chow said.

Finally, the market  can address the lack of standardisation in ESG targets and documentation by providing guidance on financing documentation.

Saris Chow is Co-Chair of the Green and Sustainable Loan Committee at the Asia Pacific Loan Market Association, and the recently released ESG Term Sheet, which had contributions from the market, will go some way to addressing this, as will tying sustainability-related performance targets to transition pathways relevant to a particular sector.

This will help companies better demonstrate the impact of their green issuances against climate or other ESG metrics - and help enhance the credibility of sustainable finance. Such incremental steps will go a long way towards financing a net-zero future, Saris Chow said.