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Growth – and challenges – in sustainable finance

Elena Philipova
Elena Philipova
Director, Sustainable Finance, Data & Analytics, London Stock Exchange Group

Amid the gloom of the continuing public health crisis, last year proved a watershed for sustainable finance. As the industry looks back on a year of solid growth, the focus now turns to addressing the barriers that stand in the way of greater success.

  1. 2021 was a record year for sustainable finance bonds, including green, sustainable and social.
  2. There is little consensus on ESG data, resulting in disclosure being voluntary across much of the globe. However, this looks to change in 2022.
  3. The sustainable finance community faces challenges in supporting today’s carbon-intensive industries as they make the transition to reduce their harmful emissions.

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Specifically, there is a pressing need to address continuing challenges around ESG data, uncertainty as to how best to finance the climate transition, and to deliver better alignment across jurisdictions as investors and other stakeholders look for regulatory convergence.

Sustainable finance in 2021

But, before we consider those challenges, it’s important to mark just how far sustainable finance has come in 2021. This can be observed in the following data:

  • Sustainable finance bond issuance surpassed US$1trn for the first time during full year 2021, an increase of 45 percent compared with full year 2020 and an all-time record. As a percentage of global debt capital markets (DCMs) proceeds, sustainable finance bonds accounted for a record 10 percent of overall DCM activity during 2021, up from 6.6 percent a year ago.

Sustainable bond quarterly volumes

  • During full year 2021, Green bond issuance totalled US$488.8bn, nearly double 2020 levels and an all-time record. The sustainability and social bond categories each set all-time records during full year 2021.

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Global green bonds

  • Over the course of 2021, assets under management in ESG funds rose 17 percent, to $7,018bn, according to data from Lipper. This compares with growth of 12.7 percent in the overall funds market. Overall, flows into ESG funds in 2021 reached $814bn for 2021
  • This growth was supported by strong performance in underlying sustainable finance indexes. For example, the FTSE Environmental Opportunities 100, which comprises the largest companies globally that earn significant revenues from the green economy, returned 22.5 percent last year, four percentage points ahead of the FTSE Global All Cap.
  • Mergers & Acquisitions activity involving sustainable companies totalled US$196.5bn during full year 2021, more than three times 2020 levels and an all-time high. Nearly 1, 275 deals were announced during full year 2021, a 60 percent increase compared with a year ago. By number of deals, China accounted for 26 percent of total sustainable deal making activity during full year 2021, followed by the United States (13 percent), India (7 percent) and the United Kingdom (5 percent).

Sustainable M&A quarterly volumes

The drivers behind this growth are well rehearsed. The urgency of the sustainability challenges we face, particularly around climate change, is becoming increasingly apparent, with the pandemic reinforcing that case.

Public concern is feeding through to government policies and regulations designed to deliver positive environmental and social outcomes. Changing consumer preferences and technological and business model innovation are creating markets for more sustainable goods and services.

And these factors combine to help persuade investors that strong environmental, social and governance performance is a predictor of strong financial performance.

I think there is little to no doubt that the sustainable finance market will continue to grow. The challenges will guide how quickly and effectively it grows and how fast we can transition for a more sustainable economic model.

Consensus on ESG data

Perhaps the biggest challenge faced by the sustainable finance market is the lack of agreement on and availability of actionable ESG data.

The lack of standardisation and paucity of disclosure regulation around the world means that corporate ESG disclosure is voluntary and, in consequence, is uneven and inconsistent. Companies choose what data to report, or whether to report at all.

Reaching consensus around ESG disclosure has proved elusive. But there is light at the end of the tunnel.

Last November, the International Financial Reporting Standards Foundation announced the formation of the International Sustainability Standards Board (ISSB). The board intends to develop “a comprehensive global baseline” for sustainability disclosure standards to help meet the information needs of investors.

It is due to produce its first standards, covering climate disclosure, in the second half of 2022.

It will be challenging but critical to produce a consensus from an alphabet soup of existing standards and frameworks.

It is likely to be a more iterative process than sustainable finance advocates would prefer. But, if the ISSB can lay the foundations for consistent and comparable corporate ESG disclosure, it will remove one of the biggest excuses some investors continue to use against engaging with sustainable finance.

Financing the net-zero transition

A second challenge faced by the sustainable finance community centres on its role in financing the shift to a net-zero global economy.

The challenge here is not funding the green technologies of the future. Identifying and investing in the next generation of zero-carbon technologies is, relatively speaking, the easy part.

What is more difficult is supporting today’s carbon-intensive businesses transition their business models to a world with a fraction of today’s greenhouse gas emissions.

How fast should investors demand that companies decarbonise? How do they differentiate between sincere but gradual corporate transformation, and greenwashing that sets out to mask business as usual?

Initiatives such as the Climate Action 100+ benchmarking process are seeing investors work together to undertake forward-looking assessments of corporate climate strategy.

Growing reporting by corporates in line with the recommendations of the Task Force on Climate-related Financial Disclosures is helping provide investors with the insights they need to guide investment decisions. And taxonomies that include transition pathways are being developed, for example, by the Singapore Green Finance Industry Taskforce.

These efforts will help guide investors and corporates from carbon-intensive to zero-carbon business models. But more work will be needed to persuade sustainability-orientated investors that they can help finance the net-zero transition without being accused of investing in bad faith.

Better alignment across jurisdictions

There are a range of regulatory issues where alignment would help investors and market participants. Most fundamentally, at the definitional level.

For example, taxonomies aim to provide guidance on which investments are green. But we are seeing conversations relating to numerous taxonomies in development around the world.

The implications for financial market participants are very significant because most organisations are global in nature and operate across boundaries. Having to comply with multiple “definitions” can be costly, risky and may not deliver the transparency and reduced risk of greenwashing objectives underpinning the regulatory developments.

Most of these taxonomies are built of the same main principles: they are all rigorously science-based and have adopted dynamic classifications that change as the real economy changes.

This can be an important common ground for taxonomy work across jurisdictions to ensure regulatory alignment is achieved and the strong momentum of sustainable investment continues.

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