Sustainable bonds' participation in global capital markets is on the rise, but time is ripe to go farther. Labeled finance has prospered and gone into greater detail. It is not only Green bonds anymore. Specialization helps issuers and investors to tailor projects and portfolios to their needs, but it is not sufficient. Sustainability has to go from a piecemeal approach to fully embedded in mainstream finance. And a revamped finance approach cannot be expected to lead the overall sustainability agenda, but the other way round. It is imperative to define such a comprehensive program first with clear goals, policies and incentives attached. Only then sustainable finance - including ESG finance - will be set up for impact to make significant contributions to its execution. The Covid-19 pandemic a remainder that disaster could happen overnight, the clock is ticking. Many environmental, social and governance problems (with financial repercussions) have to be tackled. There are only ten years left to stop the climate warming tragedy on the horizon, according to the 2018 Intergovernmental Panel on Climate Change report. Correctly pricing carbon is urgently required, boosting the role of sustainable finance, but chances of timely implementation remain low.
In H1 2020, capital markets raised $275 billion of new sustainable financing. That includes Sustainability bonds, syndicated loans and equity capital issuance tied to sustainability outcomes, according to Refinitiv´s Sustainable Finance Review. In that period, close to $200 billion in sustainable bonds were issued globally. It was an increase almost half year over year while doubling the amount raised in H1 2019.
While Green bonds are the most mature sustainability-labeled product, a more widespread financing palette comprises several other types of sustainability debt instruments to cater to specific purposes. Social bonds fund projects that address social challenges. Sustainability bonds intentionally mix Green and Social projects. Issuers of Sustainability-Linked bonds are committed explicitly to future improvements in sustainability outcomes in a predefined timeline. These are forward-looking performance-based instruments. Their objectives are (a) measured through predefined Key Performance Indicators (KPIs) and (b) assessed against predefined Sustainability Performance Targets (SPTs).
Issuance of Green bonds stayed solid despite the COVID-19 pandemic, but Social bonds and other environment-focused Sustainable bonds both experienced dramatic growth. Much of this growth happened when the pandemic was at its worst. In Q2 2020, $130 billion was raised, the highest quarterly amount ever, as stated by Refinitiv´s figures.
Nonetheless, those numbers pale relative to global bond issuance that also boomed and surpassed $20 trillion in H1 2020. The size of the bond markets (in terms of USD equivalent notional outstanding) is approximately $128.3 trillion as of August 2020, according to ICMA estimates. This consists of $87.5 trillion sovereign bonds (including supranational and agencies) and $40.9 trillion corporate bonds. Cumulative issuance of Sustainable (Green, Social and Sustainability) bonds will only surpass the $1 trillion mark this year.
Financial markets have a role to play in building a more robust ecosystem. The Covid-19 pandemic showed how much value lies in resilience. Relative to the Great Financial Crisis (GFC) in 2007-2009, while the real shock has been far more devastating, this time no financial crisis occurred. Against the odds, finance was a source of confidence amid disruption. The US lost 8.5 million net jobs throughout the GFC. In comparison, just in April, 20.5 million net jobs were destroyed. That was more than 14% of the US civilian payroll, an unprecedented sudden blow. It took the Great Depression (1929-1932) almost a year and a half to create similar damage. Financial markets suffered a heavy dose of initial turmoil, but they absorbed the shock very fast. One key element: there was no banking crisis. Macroprudential regulation and special buffers incorporated by post-Lehman legislation limited bank risk exposure ex-ante and added extra layers of capital and liquidity requirements that provided a safety cushion. Basel 3 type normative coupled with rapid well communicated Central Bank (plus fiscal) intervention proved extraordinarily resilient to face the public health crisis impact. Financial markets recovered strongly starting on March 23rd pari passu the world entered severe lockdown. They improved further in April despite initial jobless claims increased by the millions. Net credit was not destroyed but expanded. Bond issuance skyrocketed (even in emerging markets). Stockmarkets records - above pre-pandemic levels - came later on. Finance, this time, was not the problem to solve but a working solution to stabilize the real economy. Ironically, despite the right timely response, finance is not on a sustainable track. Excesses and fragilities are plenty. It has many sustainability blind spots. While effective, monetary and fiscal policy paths are stretched to the limit. Real debt is escalating crisis after crisis against a backdrop of aging demographics. However, finance proved a powerful tool as it was able to absorb, recover, and adapt to the Covid-19 (temporary) shock. But threats loom large. And broader changes are overdue.
Transformative action is urgent. Financial markets do not adequately reflect transition risks. Nonetheless, there is a growing mass of sustainable investing assets that considers ESG factors in portfolio selection and management. According to the Global Sustainability Investment Alliance, in the five major world markets, they stood at $30.7 trillion at the start of 2018, a 34 percent increase since 2016. As a proportion of total managed assets, they range from 25 percent in the US to around 50 percent in Europe and Canada, and 63 percent in Australia/New Zealand. It is a challenge to leverage such interest and dynamics into a critical force for sustainable change.
Sustainable finance through ESG integration should reduce risks and capture business opportunities, but is not a panacea yet. Though raising awareness is a necessary step, the current ESG framework requires further conceptual and operational improvement. Relevant weaknesses remain in risk disclosure and material factors identification, investment metrics, and data collection. Many investing approaches belong in, sometimes unreliable or even conflicting. As a consequence, they do not guarantee fully achieving the desired impact.
The role of sustainable finance is set to grow in the future as investments to mitigate and adapt to climate change strengthen. The European Union Recovery Plan signals the political will to build back better after the pandemic. Economic and financial policies are starting to incorporate more sustainability parameters. The Network of Central Banks and Supervisors for Greening the Financial System (NGFS) has established that monetary and financial authorities have to integrate climate risks into their policy frameworks. With extreme shocks growing more commonplace it is essential to preserve policy space to face increasing stress and unexpected blows. A reassessment of financial assets value is due according to changes in climate policies, new technologies and growing physical risks. Operating and financial business models have to calibrate risk exposure to the most severe shocks. The energy transition requires adequate carbon pricing, and the current low level of international oil prices favor the removal of fossil fuel subsidies and the imposition of carbon taxes with moderate political costs. Accelerating the meaningful adjustment will diminish the disruption. And setting strong pricing signals will accelerate sustainable finance´s predominance as a potent weapon for change.
