In the past few months, as the world grapples with the Coronavirus pandemic, society’s vulnerability to natural disasters has become painfully apparent.

Sustainable finance had already been gaining momentum pre-crisis, but the current situation has prompted a greater sense of urgency around the need to prioritise the transition towards a greener global economy.

Long Say Huan — senior banker for financial institutions at Commerzbank, outlines why financial institutions are uniquely positioned to drive this change — and how they can fulfil this role.

Interest in sustainable finance had, of course, preceded the COVID-19 crisis. Indeed, 189 states [1] representing 97% of global greenhouse gas emissions — have now signed up to the Paris Agreement, which commits them to reaching a net zero emissions target by 2050, resulting in increasing scrutiny on progress and a growing awareness around green credentials in the investment space.

However, the ongoing crisis following the Coronavirus outbreak has marked a step change in what had previously been a more gradual ideological shift towards collective stakeholder responsibility to drive progress on the sustainability agenda.

No longer are environmental and social problems considered solely issues for governments, international institutions and NGOs to solve. The related economic downturn has necessitated a rebuilding of large segments of the economy, which, in turn represents a unique opportunity to overhaul the current system and consider how our financial decisions impact the environment and society in the long term.

Demand is growing

It is well documented that scrutiny of sustainable practices among the financial community has grown in line with the COVID-19 response.

But the recent oversubscription of Kookmin Bank’s COVID-19 Response Sustainability Bond — the first COVID-related issuance by a non-sovereign institution in Asia — provides tangible evidence of a growing interest among financial institutions in prioritising sustainable outcomes.

The issuance, which Commerzbank played a part in successfully pricing, attracted orders worth USD$3.9 billion from 180 investors across Asia, Europe and the U.S — a sum exceeding the offering of US$500 million by almost eightfold.

Clearly therefore the demand is there, but more needs to be done to create the conditions to accommodate and further drive this growing trend.

And banks are well positioned to push sustainable finance into the mainstream. In their capacity as capital providers, this involves using their balance sheets in a positive way and lending more capital to businesses that prove themselves to be sustainable.

In the German market, for instance, the green-labelled variation on the Schuldschein loan — a tradeable instrument that typically offers longer-term loans to corporates that plan on using the proceeds for sustainably-linked purposes — is a possible solution.

But in broader terms, instruments such as Loan Market Association-aligned green loans and sustainability-linked loans are an increasingly popular way of incentivising better sustainability performance among borrowers.

Adjusting the commercial lens

Another means of heightening market interest is offering lower costs of capital where transactions are linked to sustainability outcomes.

Though this could appear less economical for banks at first glance, sustainability-linked products and services have been shown to hold longer-term commercial benefits for both the borrower and creditor.

Transitioning to a greener economy therefore requires the lens to be adjusted to look beyond immediate commercial gains towards long-term sustainable profitability; something that in the post-COVID economic environment may, on the surface, look less appealing but is absolutely necessary.

Ensuring that sustainable financing becomes more accessible — for instance, by making sustainable investment platforms more affordable for both the borrowers and investors — should be a key performance indicator for the financial services sector, and would contribute to opening up new avenues of growth in the long run. 

As intermediaries in debt capital markets, banks can also go some way towards easing the transition towards more sustainable practices among other entities, too.

The originate-to-distribute model employed by some banks — which involves originating a large sustainable debt transaction before selling portions to third parties — is a prime example of how financial institutions are uniquely positioned to influence the flow of investment towards sustainable projects, marrying up creditors and borrowers with similar objectives.

What’s more, as trusted advisers with expertise and strategic oversight, they can help educate their clients around the benefits of directing finance towards improving sustainable outcomes.

Working with regulation

This, of course, all needs to be supported by effective regulatory frameworks — which have been largely welcomed by financial institutions and corporates alike.

Indeed, the growing interplay in recent years between corporates, regulators and financial institutions has resulted in a growing demand for the inclusion of sustainable objectives in policy-making, and greater engagement by the full range of impacted stakeholders in establishing intelligent policy that works for all involved.

In April 2020, for instance, a coalition of European businesses called the European Corporate Leaders Group (CLG Europe), called on EU member states to commit to a European Green Deal that would expedite countries towards achieving their net-zero emissions pledges by 2050 by incorporating these into COVID recovery plans — yet another example of how the crisis recovery could mark a turning point for the industry.

Increasing transparency

A significant step forward in this regard will be the launch of the EU Taxonomy, which comes into effect in late 2020.

The Taxonomy is a tool that investors, intermediaries and issuers can use to navigate the transition towards a low-carbon, resilient and sustainable economy and will encourage asset owners to disclose more data to enable a more accurate assessment of the sustainability credentials of a project or transaction, to ultimately direct more capital towards such financings.

This is forecast to dramatically improve transparency, which has thus far been a frequently cited hindrance to the growth of sustainable finance. “Greenwashing” — wherein companies or issuers provide misleading information around how environmentally sound a project is — is a common issue that faces investors in their decision-making process, so having universally-recognised standards for benchmarking purposes will provide much needed reassurance for investors looking to increase their participation in green investment opportunities.

While the Taxonomy is an EU-led initiative, we anticipate its influence to extend well beyond the EU’s jurisdiction. It will likely be a starting point for sustainable issuers and investors worldwide — not least because around 50% of the world’s managed investments in sustainable and responsible investment products originate in Europe [2].  

Sustainable finance is, in short, good for business. As with any nascent sector, there is a need for consistent and comparable data, however, this can only be achieved by increased participation by financial institutions in the sustainable finance space and by clever policy-making on the part of regulators to ensure that standards are established and adhered to.

The myth that sustainable investment and better returns are mutually exclusive ought to be debunked — and evidence is already building that rejects this misconception. As we look to recover from the economic devastations of the COVID-19 pandemic, the public and private sector alike should be looking ahead to lay sustainable foundations for the good of tomorrow.

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[1] http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf

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[2] https://cop23.unfccc.int/process/the-paris-agreement/status-of-ratification