As part of a new series of publications entitled ‘A journey through Green Bonds, Microfinance, Impact Investing and ESG’, published by Banque de Luxembourg Investments, Sperling & Star and BZZ Advisory, LuxSE’s Business Development Manager Chiara Caprioli put pen to paper to discuss current innovations in the Sustainable Finance Market. Following the successful first publication in the series which focussed on Green Bonds, we sat down with Chiara to discuss why the paper is important, and what to expect for the future.
Chiara, well done on an excellent contribution. What can readers expect to learn from your piece?
My article in this first paper is entirely dedicated to Green Bonds and recognises how Green Bonds have been instrumental in building investor confidence around a minimum set of voluntary standards while also creating a much more engaged role for fixed-income investors than ever before. The journey of sustainable finance has been a linear one until 2019 recently, with Green Bonds having acted as a trailblazer for the market’s fundamentals, and virtually dominated the scene for thirteen years. This can be seen through Green Bond issuances hitting the trillion dollars as of October 2020. But since end 2019 things have started to get more diverse. We have been seeing issuers venturing into new structures such as Sustainability-Linked Bonds, which come with a much broader application scope than green bonds and we are now witnessing companies in high-emitting sectors positioning themselves to help fight climate change.
But, that’s not all. The proposal for an EU Green Bond Standard, with its requested mandatory alignment to the new EU taxonomy and enhanced reporting and verification requirements, has the potential to reshape the fundamentals of Green Bonds quite a bit. Finally, the dramatic surge of Social Bonds since the outburst of the pandemic to tackle health, food security and other recovery projects has fuelled a debate on how to strengthen the framework for such instruments. We are moving into a phase of increased maturity in which the market will have to come to terms with some new level of sophistication coupled with higher expectations and more widespread knowledge. My article tries to clarify what this complexity looks like.
You have touched upon companies from high-emitting sectors raising their profile to play a role within decarbonisation if not around broader sustainability targets. Is this credible?
We have seen an impressive surge of low-carbon alternatives in the past few years, but most industries still rely on heavy CO2 consumption. Most companies, including those from high-emitting sectors, are creating decarbonisation strategies for their businesses to allow them to contribute to the Paris objectives, and meet consumer expectations. In terms of market capitalisation, gross profits and GHG emissions, these companies represent a large percentage of the economy so it is just natural that sustainable finance is considering ways to support them. Standards and rules are starting to be codified around the first few market deals but it is too early to say whether new solutions such as Transition Bonds and, to some extent, Sustainability-Linked Bonds will get traction in the market.
There is still some suspicion among investors and consumers around the way companies go about implementing their sustainability and decarbonisation strategies, but it is a good sign that companies are considering how to future-proof their business models and transform into more sustainable companies. Investors will ultimately be able to tell the difference between marketing-oriented and structurally meaningful changes.
Is the Sustainable Finance market moving away from ‘use-of-proceeds’ bonds?
Use-of-proceeds bonds have played an incredibly important role in building the Sustainable Finance Market we know today. They created trust in the market by providing mandatory insight into the allocation of capital and taught investors to take an active role in looking at what is behind a company’s investments.
Today’s investors are ready to make their mark on the future by using their reserves to build a more sustainable world. That being said, there are some limitations to the use-of-proceeds format. As I mention in the article, issuers can find it hard to identify sufficient critical mass of suitable projects or they might lack scale and/or capacity to effectively implement accurate tracking and reporting processes. Non-use-of-proceeds instruments like Sustainability-Linked Bonds allow them to look past these limitations. The fact that a company is not obliged to exclusively use the funds raised for specific projects is counterweighted by the expectation that the same company will have to commit to tangible and ambitious sustainability goals.
Investors are starting to gauge how this holistic dimension can come into play and new standards are being promoted to mitigate the risk of abuse. In addition, non use-of-proceeds instruments refer to science-backed indicators, which can have a spill-over effect on use-of-proceeds instruments.
With a year of uncertainty in all industries, what does the future hold for the Sustainable Finance Market? Do Green Bonds really have fierce competition?
There are a lot of signs pointing towards Sustainable Finance becoming mainstream. Finance is already becoming part of the solution and we now have the opportunity to work closely with policy-makers, regulators and market participants to solidify its role.
Whatever the future holds, the opportunity that specific financial products provide for both issuers and investors to future-proof their business models and their portfolios is too important to let pass. We can expect both standardisation and innovation to progress the market. There is after all no contradiction between the two.
If you would like to learn more about the topics discussed in this interview, you can read the whitepaper in full here.