The trend towards a sustainable growth and funding strategy has been on the increase across all industries. Investors, banks and other market participants increasingly demand that environmental, social and governance (ESG) targets also become part of a company’s corporate finance strategy.
For this reason, the last few years have seen the emergence of many different green finance instruments that relate to various ESG topics or targets in their structure and design.
Including sustainable financial instruments in a company’s overall corporate strategy meets the governance requirements of the market and ensures access to a large investor base. Simultaneously, sustainable funding strategies may receive favorable terms if their margin is linked to sustainable objectives.
The dynamic development of the green finance market is also apparent in the market data. For instance, in the first nine months of 2020 already 97 ESG-linked and green loans as well as promissory notes with a total volume of EUR 47.5bn were issued in Western Europe. In the same period, also 438 green, social and sustainable bonds with a total volume of EUR 166bn were issued in Western Europe. This is an incredible increase of 272 and 152 percent, respectively, of the total volume in the period from September 2016 to September 2020. This also means that the persisting corona crisis has not put a dent into the green finance market.
The development makes clear just how significant this new finance segment has become and shows that it is by far not a fluke but rather, a newly established form of funding.
The green finance market has taken on many different forms, which cannot be defined uniformly, and which cannot be delimited that clearly. For instance, among bonds, green bonds are now wildly popular. They are used to finance specific green (i.e. sustainable) projects. Projects that are eligible for such funding specifically include those that offer clear advantages for the environment, for instance because they combat climate change or preserve natural resources. Green bonds are very often issued by governments, utility companies and banks.
Social bonds that finance projects with a positive social impact are another category of bonds that are experiencing an increase. Specific project objectives could for instance include the promotion of socio-economic development. Typical issuers are state-run development banks, commercial banks and municipalities.
An increasing number of issuers also issue sustainability bonds, which combine green and social projects.
Process guidelines meant to improve transparency and market integrity have been developed for all three types of bonds, the so-called Green and Social Bond Frameworks.
Even in the area of corporate loans and promissory notes, various structuring possibilities have become common in the market. Starting in 2016, green loans were mostly used to fund sustainable projects. Measuring whether the loan adhered to the criteria of sustainability generally happened by looking at how the loan was used or in combination with an external ESG rating.
In the meantime, ESG-linked loans have also become a fixed item when it comes to raising funds for operational aspects. In practice, these structures take on many forms. For example, a margin downgrade could be tied to pre-defined sustainability performance indicators, which are generally derived from the company’s sustainability strategy. As an alternative, the margin could also be linked to the adherence to external ESG ratings. Past transactions in this segment demonstrate an increasing tendency to structures with relevant ESG ratings.
In the meantime, green and ESG-linked loans have also joined the popularity ranks of traditional green and ESG-linked promissory notes. The range of green financial instruments is by far not exhaustive but is constantly evolving.
For instance, Dürr issued a convertible bond with an ESG component in September 2020. The machine engineering company hedged the bond’s interest rate risk with an interest rate swap, which itself was linked to the ESG rating of the company.
This transaction once again shows how flexible market participants can be, which makes the green finance market so attractive to a variety of companies in very different industries. Important issuers from past transactions not only include (development) banks, governments and utilities but also retail, clothing and consumer goods companies.
It is interesting to observe that companies are increasingly integrating green finance instruments into their existing financing structure. In that respect, this segment has become a real financing alternative that creates versatile funding solutions and structures.
KPMG’s Debt Advisory team offers independent advice on the possible use of green financial instruments in your company’s funding structure.
Author: Thomas Dorbert, Head of Debt Advisory, firstname.lastname@example.org
Source: KPMG Corporate Treasury News, Edition 107, December 2020