Harriet Rogers, Banking and Finance Associate at Howes Percival LLP, considers recent trends and future developments in relation to green finance:
In biblical fashion, 2020 saw the rise of a pandemic, record wildfires, locust plagues and human rights controversies on a global scale. Therefore, it is perhaps no surprise that environmental, social and governance (ESG) factors have been propelled into focus within the finance sector. Green finance, once dismissed as a whimsical, anti-capitalist ideal, is now rapidly gaining momentum within the sector. Recent regulatory and market developments mean that fiscal policy is responding at a rapid pace. This will put the spotlight on businesses to integrate material and transparent environmental and ethical policies.
As recently as 2007 (notably, the year that saw the introduction of green bonds), a report by DEFRA concluded ‘the environment did not feature highly in people’s priorities when considering financial products, even among the most engaged’. Much has changed since then.
The last decade has seen consumers and investors shift their attention on financial returns to incorporate socio-political considerations. The 2015 Paris Agreement marked the mobilisation of key industry players, which has driven rapid diversification of the financial products and services available. Green finance is now a well-established concept and encompasses a range of financial products across the banking, investment and insurance sectors, including:
- sustainability-linked loans
- sustainability-focused financial instruments, including green bonds, climate bonds, sustainability bonds and, in late 2019, the world’s first climate resilience bond
- ESG funds
- climate-risk insurance
- financial products at the consumer level, such as ‘green’ credit cards.
The proliferation of such products indicates that green finance is here to stay. Recent market developments demonstrate that the focus on ESG finance is gaining momentum.
Ian Ilersic, a Partner in the Banking and Finance team at Howes Percival said: “I’m confident that the 2020s will see sustainable investment become the norm, and environmental, social and governance factors become truly integrated in the financial sector. The pace of change will be rapid.”
The UK Government’s recent Budget saw Chancellor Rishi Sunak announce a number of green incentives and restate plans to establish a ‘world leading’ sovereign green bond.
On February 3 this year, HM Treasury published a press release announcing that the UK has joined the International Platform on Sustainable Finance (IPSF), whose members include public authorities in China, Hong Kong, Japan, Singapore, Switzerland and the EU, and represents 50% of the world’s population. The aim of the IPSF is to scale up the mobilisation of private capital towards environmentally sustainable investments.
A number of the largest institutional investors have pledged to withdraw from non-green investments in the coming years; in October last year, the University of Cambridge committed to pull out of all direct and indirect investments in fossil fuels by 2030.
Increased consumer demand for sustainable investment options led over 250 European funds to rebrand their investment profile as sustainable in 2020, according to Morningstar. The total assets invested in such funds reached in excess of €1 trillion by the end of 2020. In addition to ‘rebranded’ funds, 2020 also saw a proliferation in the number of new ESG funds in Europe.
Whether or not all of those funds actually align with sustainable development goals (SDGs) established by the UN has been challenged. In a phenomenon known as ‘greenwashing’, some funds have been accused of misrepresenting or overstating the environmental or ethical benefit of their investment products.
Part of the difficulty lies in the rapid growth of the market and the fact that a number of ESG variables are difficult to quantify. With global attention shifting rapidly towards sustainable and ethical finance, it should come as no surprise that EU regulations are responding to such trends. On March 10 this year, the EU’s Sustainable Finance Disclosure Regulation (SDFR) came into force. The UK has pledged to align with SDFR post-Brexit. The SDFR imposes disclosure obligations upon market finance participants, which will see asset managers required to publicly disclose information regarding the risks and adverse impacts of their investment decisions, as they relate to sustainability factors.
The regulation currently applies to asset managers, but it is likely to affect the wider market. Businesses, banks and investors alike can expect to feel increasing pressure to integrate ESG factors within their business models and to demonstrate the ‘on the ground’ impact of their ESG policies.
The sharpened focus on ESG factors is also beginning to influence loan pricing. The Loan Market Association (LMA), Europe’s leading loan market authority, has published a set of Sustainability Linked Loan Principles, which have been applied to some loans to implement step-ups or step-downs in the applicable interest rates depending on how the borrower performs against agreed sustainability criteria. To date, this has primarily been integrated in relation to larger loans, but it is likely that the practice will filter down through the market over time. In short, adhering to green principles will increasingly affect the cost, and indeed the availability, of borrowing.
Whilst much remains to be seen, it is clear that the importance of ESG factors is growing and that this is going to impact multiple stakeholders, including borrowers, lenders, and investors.
Howes Percival has a dedicated Banking and Finance team. If you would like to get in touch in relation to any of the issues raised in this article or any other banking and finance matters, email firstname.lastname@example.org or email@example.com or call 01604 258020.