While sustainable development has long garnered the attention of the investment community, focus on longer-term goals has been accentuated by the pandemic. With this in mind, Long Say Huan, Senior Banker, Commerzbank considers how financial institutions can play their part.
If crises such as the COVID-19 pandemic are good for anything, it is in sharpening the focus towards what really matters. For many, the COVID-19-related crisis has put into perspective the requirements and urgency needed to reach longer-term sustainability targets. With respect to business, the pandemic has also served to highlight the very real impact that environmental, social and governance (ESG) factors can have on the bottom line. And for financial institutions, it has illustrated the imperative of integrating integrate longer-term sustainability goals with the shorter-term needs of financial markets.
Some market participants took immediate action as the crisis unfolded. In April 2020, Commerzbank played a role in helping Kookmin Bank issued a US$500 million COVID-19 Response Sustainability Bond – the first pandemic-related bond issued by a non-sovereign institution in Asia. The issuance – which was oversubscribed by almost eight times (attracting US$3.9 billion in orders from over 180 investors) – typified the new prioritising of sustainable investments by many financial institutions globally.
The Kookmin Bank bond will certainly not be the last – demonstrating the growing appetite among financial institutions, corporates and governments as well as society at large to further adhere to the principles of stakeholder responsibility. Evidence suggests that this phenomenon is well underway: according to Moody’s, a credit rating agency, newly-issued debt based on environmental, social and governance (ESG) principles is expected to reach US$375bn this year, an increase of more than US$50bn on 2019’s total.
ESG, in this context, largely revolves around considering how financial decisions impact the environment and society in the longer term. Sustainability-linked initiatives are typically designed to improve environmental outcomes (such as mitigating the effects of climate change), tackle social issues (including themes like inequality and human rights) or even both. It is the latter area that has now acquired new importance due to its links with public health outcomes.
Driving sustainable growth
Further embedding sustainability into investment decisions will require clear-headed action. So, how can banks, being a major representative of financial institutions, play their part? First, as capital providers, they have the facility to deploy their balance sheets in a proactive way, lending more capital to businesses that prove themselves to be sustainable. A tangible way of delivering this in the German market, for instance, is the green-labelled variation of the Schuldschein loan – a privately-placed and tradeable instrument common to the German market that typically offers two-to-five-year lending terms for corporates seeking to use proceeds for sustainable outcomes. Sustainability-linked revolving credit facilities (RCFs) can also offer corporates additional credit lines that incentivise better sustainability performance – with the margin of the RCF increasing or decreasing depending on the corporate’s ability to meet sustainability-linked key performance indicators (KPIs), which can include a sustainability rating or targets set from within the corporate’s business.
Banks could also ease the transition towards a sustainable economy by offering lower costs of capital in cases where transactions are linked to sustainability outcomes. Though on the surface this may seem less commercially appealing, this is not necessarily the case. In fact, sustainably-linked products and services have been shown to unlock longer-term commercial benefits for both the borrower and creditor.
Banks can also make the most of their matchmaker role, in which they represent a conduit between investors and investment opportunities. One way to execute this responsibility is by engaging in the “originate-to-distribute” model, whereby a bank originates a sustainable-debt transaction before selling portions of the debt to third parties. Given the capital-intensive nature of sustainable investment projects and the increasingly stringent capital and risks-management requirements of individual banks, this model mobilises large-scale capital through a syndicate of capital providers, all sharing the financing risks of a given project while meeting their individual risk-reward objectives. Beyond enabling financing for sustainable projects, an additional role for institutions is facilitating inclusivity – opening the doors of sustainable finance to the larger community. Easing the route of financial inclusion will be the availability of affordable, easy-to-use investment platforms that can offer time- and cost-efficient origination-to-distribution services. It is hoped that such platforms will eventually become commonplace among the full spectrum of issuers and investors (both institutional and retail). Main Incubator, a Commerzbank subsidiary that acts as the bank’s R&D unit, has been ramping up efforts in this space by seeking digital solutions that help increase accessibility to ESG investing.
Yet banks have also shown that their interest in harnessing sustainable practices extends well beyond their own institutions; indeed, many are also providing strategic counsel to their clients. This support can be all encompassing – from defining the client’s sustainability goals, to measuring and verifying sustainable practices, to determining how the client can also help its own customers meet emission targets.
In this respect, some banks’ clients are already forging ahead. Corporates of all sizes are finding that that their long-term interests are well-aligned with those of their communities and the wider planet. Indeed, in April 2020 a coalition of European businesses calling themselves the European Corporate Leaders Group (CLG Europe) took a stand on climate change. The coalition called on EU member states to commit to a European Green Deal that would expedite the process of achieving their 2050 net-zero emissions pledges by incorporating these into COVID recovery plans – showing yet again how this crisis could serve as an inflexion point in the drive towards sustainability.
The scramble towards sustainable finance has, understandably, put such investments under scrutiny – since not all ESG-labelled investments are created equally. As such, banks have the crucial responsibility of preventing “greenwashing” – and also safeguarding the integrity of sustainable products.
Claims of greenwashing, wherein companies or issuers artificially enhance a project’s reported environmental benefits, have become increasingly commonplace – which has raised calls for establishing industry-recognised standards that allow for the material impact of so-called sustainable practices to be appropriately benchmarked and compared. To this end, Commerzbank, along with many other financial institutions, participates in various initiatives and working groups dedicated to sustainable finance. The bank has been a signatory of the Green Bond Principles since 2014 and, in 2019 and was among the first cohort of banks (132 in total) to subscribe to the Principles for Responsible Banking, which serves as a framework for achieving the UN’s Sustainable Development Goals (SDGs) and the goals of the Paris Climate Agreement.
In response to these initiatives, regulators are introducing initiatives that seek to enhance transparency. For instance, Europe has taken significant strides forward through the EU Taxonomy, which comes into effect in late 2020. Similar to a glossary, the Taxonomy provides investors, intermediaries and issuers with guidance on properly disclosing their activities that make a significant contribution to climate change mitigation or adaptation. In turn, it is hoped that the Taxonomy will encourage asset owners to disclose data that enables a more accurate assessment of the sustainability credentials of a project or transaction.
This is expected to dramatically improve transparency, which has thus far been an often-cited hindrance to the growth of sustainable finance. And it should ultimately render greenwashing a thing of the past, facilitating the flow of more capital towards the area. The Taxonomy is an EU initiative. However, its influence is set to reach far beyond Europe’s borders. Europe leads the way in sustainable financing and is responsible for 53% of the global market for sustainable debt, according to Bloomberg New Energy Finance. Sustainable issuers and investors in other regions are likely to gravitate towards the best practice put forward by the market leaders.
With the ability to direct capital into sustainable development with credibility and transparency, perhaps the last bit of concern by investors is whether financial performance would be compromised. In this regard, the evidence suggests the opposite – an empirical study by McKinsey found that, in 63% of businesses, implementing ESG considerations was beneficial for returns, among other advantages. At Commerzbank, we believe that sustainability is quickly becoming one of the key foundations for building long-term resilience into any business. While the investment community is making encouraging progress, banks will need to work hard to embrace their new role if they are to help usher in a prosperous, sustainable post-pandemic recovery.