The rise of sustainable finance is propelling more companies to adopt environmentally friendly and sustainable practices. Sustainable finance is the process of taking environmental, social, and governance (ESG) considerations into account while making investment decisions. This growing practice is leading to more long-term investments in renewable energy projects for businesses, governments, and individuals.
In 2021, sustainable debt issuances more than tripled the previous year to $190 billion. Sustainable-related equity funds also experienced an increase in inflows to $25 billion. Overall, these funds now have nearly $150 billion in assets under management.
The growth of the sustainable finance market indicates a larger shift among institutions, funds, and investors. They are recognizing the power of companies and projects that emphasize sustainable business practices. This is reflected in the continued growth of the sustainable finance sector and the creation of new debt mechanisms to address gaps in the market.
While there are many types of sustainable finance vehicles, green bonds, green loans, sustainability-linked bonds, and transitional bonds are the most commonly used. These financial vehicles use performance-based or activity-based environmental, sustainability, and governance benchmarks to determine success. Companies are incentivized by discounted rates to reach these key performance indicators.
This loop makes sustainable financing more attractive than traditional debt as inflation and interest rates continue to rise. Companies, governments, and individuals are able to lower their cost of borrowing by adopting environmentally friendly products, processes, and projects. The current health of the market and powerful feedback loop signals a promising long-term future for renewable energy.
Types of Sustainable Finance
Sustainable finance allows companies and projects to obtain private capital for initiatives that accomplish environmental, social, and governance goals. Fidelity found that half of the ESG investments worldwide outperformed the market from 1970 to 2014. BlackRock also found that during the COVID-19 pandemic, more than eight out of ten sustainable investment funds performed better than share portfolios not based on ESG criteria.
Green bonds are fixed-income securities issued by companies, organizations, and governments. They specifically finance projects with positive environmental impacts like renewable energy, energy efficiency, clean transportation, and responsible waste management. From 2017 to 2021, the green bond market experienced a 49% growth rate leading some analysts to predict the market annual issuance to exceed $1 trillion by 2023.
Green bonds are similar to normal bonds, but require additional steps for issuers to complete. First, issuers must detail the use of funds, outline the eligibility of the project, and state the intended ESG outcomes. Then issuers are subject to sharing scheduled updates to green bondholders through impact reports and progress updates.
While green bonds are still a nascent market, they are experiencing rapid adoption around the world. In September 2021, Walmart closed its first green bond offering that raised $2 billion for projects that made its facilities more energy efficient, improved waste recycling, and increased water conservation. In 2020, Apple leveraged green bonds to fund numerous projects that prevented 921,000 metric tons of carbon emissions from being released every year.
Green loans are personal loans that finance energy-efficient product investments. These loans allow people to invest in products like solar panels, battery energy storage systems, and heat pumps that lower energy bills and reduce energy consumption. Green loans may also have lower interest rates than traditional loans due to the environmental benefits of the investments.
Green loan requirements are similar to green bond requirements. The borrower must detail the use of proceeds, the evaluation and selection process, the management of the proceeds, and how they plan to report performance metrics. These principles create standardization across sustainable finance mechanisms that improve reporting and transparency in the market.
There is an estimated $33 billion in outstanding green loans with the market outpacing the growth of green bonds. With a rapidly growing market, green loans have expanded from personal to business cases. This has led the International Monetary Fund to leverage green loans for developing countries to spur renewable energy infrastructure development.
Sustainability-linked loans are a more flexible form of green bonds. These loans enable companies to set key performance indicators related to sustainability goals. If a company reaches its target benchmarks, it receives an incentive in the form of a discounted rate.
While green bonds require the proceeds to fund green projects, sustainability-linked loans carry no restrictions on the use of proceeds. Sustainability-linked loans reduce reporting requirements by incentivizing companies to reach agreed-upon key performance indicators that result in discounted rates. These reasons are driving the explosive growth in the market for sustainability-linked bonds.
In the first half of 2021, sustainability-linked bonds reached $350 billion in issuances. This greatly exceeded the $197 billion of issuances in the full year of 2020. North American companies are the main driver behind the rapid adoption of sustainability-linked bonds.
Transition bonds provide financing for climate transition-related activities. While green loans, green bonds, and sustainability-linked loans provide capital for green projects, not all industries qualify for these sustainable finance vehicles. Transition bonds serve these industries like fossil fuel energy companies and heavy-polluting sectors.
Transition bonds enable companies to obtain financing to fund initiatives that would reduce their carbon emissions and improve their environmental friendliness. This may take the form of transitioning a diesel-fueled fleet into an electric one or establishing a best-in-class environmentally conscious supply chain. While many companies are unable to become fully green, transition bonds incentivize them to take steps toward reducing their environmental impact.
The transition bond market is relatively nascent as governments begin committing more support and resources toward issuance. As companies and governments commit to net-zero emissions, many heavy polluting industries will rely on transition bonds to reduce their overall environmental impact. This is a key reason analysts are predicting the transition bond market to rapidly grow over the next decade.
Powering Renewable Adoption
The increase in sustainable finance activities shows the commitment of governments, companies, and investors to a net-zero emissions future. The current energy crisis raised questions about a net-zero future as nations increase fossil fuel production to meet demands. However, companies and projects continue to adopt and leverage sustainable finance mechanisms to fund environmentally friendly initiatives.
The Rise of Sustainability-Linked Loans
The United States sustainability-linked loans market experienced 292% growth in the first quarter of 2021 compared to the full year of 2020. This translated to an almost $52 billion increase in the volume of loans as investors signaled confidence in sustainable initiatives. This explosive growth signals healthy confidence and demand for a sustainable future.
The increased adoption of sustainability-linked loans is a reflection of two important factors–companies’ commitment to net-zero emissions and rising interest rates. With interest rates on the rise, sustainability-linked loans provide companies with a way to lower the cost of borrowing by hitting sustainability benchmarks to achieve a discounted rate. This incentivize also rewards companies that commit to net-zero emission and environmentally friendly projects and initiatives.
While the short-term energy market is reliant on fossil fuels to meet demand, sustainable finance is powering the long-term net-zero future. The rapid adoption of sustainability-linked loans signals the strength in the market and investor appetite for ESG-driven companies. As demand grows for these financial products, more innovations and vehicles will develop to continue driving renewable adoption globally.
Room for Growth
Sustainable finance will play a key role in a renewable future for emerging markets. Developing nations are mostly responsible for the current acceleration in the adoption of sustainable finance vehicles. While this is a strong signal for a net-zero future, it also highlights the immense room for growth of sustainable finance in emerging nations.
Emerging nations rely more on cheap power generated from fossil fuels like coal than renewable energy. This is largely due to the cost of transitioning and the variability of renewable energy production. As sustainable finance continues to develop, expanding further into emerging economies will drive more renewable adoption.
Sustainable finance will fuel renewable adoption across emerging nations as green bonds, sustainability-linked loans, and transition bonds evolve. In order to address the inherent credit risk of emerging nations, these funding vehicles must develop new mechanisms to reduce exposure for investors. As these methods are created, sustainable finance will begin to capture more emerging market traction, drive more growth, and increase investor confidence in a renewable future.
Sustainable Finance Powers Renewable Adoption
Sustainable finance is one of the pillars for driving renewable energy adoption and creating a net-zero future. Sustainable finance enables companies, individuals, and governments to use proceeds toward projects and initiatives that reduce carbon emissions and energy consumption. The rapid growth in sustainable financing signals the commitment of the market to realizing a net-zero emissions future.
Sustainable finance provides companies and individuals with a powerful alternative to traditional loans. In the current high-interest rate environment, sustainable finance incentivizes the adoption of renewables and environmentally friendly initiatives through lower interest rates. This creates an enticing reward for companies and individuals to improve sustainability while reducing their cost of borrowing.
Sustainable finance serves as a benchmark and key indicator for the global commitment to a net-zero emission future. While the energy crisis has driven concerns, the rapid adoption of sustainable finance highlights the dedication to fighting climate change. As the market continues to mature, sustainable finance will create more mechanisms to address emerging markets to drive more adoption of environmental, social, and governance sustainability practices.