Will COP26 galvanise green finance?
Expectations are running high for the UN’s COP26 climate meeting in Glasgow that starts this week. In particular, bankers and investors hope that "finance day" on Wednesday will give a snapshot of the key issues that will shape sustainable finance in a critical decade for the planet.
Countries’ Nationally Determined Contributions to reduce emissions and adapt to the impacts of climate change are the main focus of COP26. Greater clarity could unleash a new wave of green sovereign financing and sustainability-linked debt from the world’s highest emitting companies.
Thomas Hohne-Sparborth, head of sustainability research at Lombard Odier, speaks for many sustainable finance people when he says that the time for generalities is over. “We need to understand from governments with net-zero targets exactly how they plan to do that. At the moment, there's a bit of an attitude of setting the targets and figuring everything out later but these two things go together,” he said.
“There’s a few high-level routes that you can follow to net zero. We can get there either by putting more emphasis on technology or putting more emphasis on behaviour change. That's a democratic choice, but it's material for us to understand where we should be allocating our capital. Basically, what is the plan that needs financing? That's a very key thing that we would like to start coming out of COP."
US$1.325trn of ESG debt has been issued so far this year which consists of US$855.34bn of ESG bonds and US$469.88bn of ESG loans, according to Refinitiv data, which is nearly double the US$754.3bn of ESG debt in full-year 2020 (US$542.7bn of bonds and US$211.7bn of ESG loans). US$442bn of green bonds have been issued in 2021 so far, compared to US$252bn in 2020, US$65bn of which is green sovereign issuance, compared to US$15.9bn in 2020, the data show. Green bond issuance is expected to hit an annual US$1trn of issuance by the end of 2022, according to a Climate Bonds Initiative survey.
But sustainable financing needs to continue to rise exponentially to fund the transition to a low-carbon economy. And that's a big ask.
Mitch Reznick, head of research and sustainable fixed income at Federated Hermes, is hopeful but not naive. "I'm optimistic that COP26 will be a push for sustainable finance," he said. "[But] it's difficult to imagine that it's going to be as big a push as the capital markets need because of limits in some countries' ability to deliver on expectations and promises. I have my doubts that some of those nations that benefit the most from the fossil fuel industry will really make a genuine effort to support a green transition."
Flurry of announcements
Governments are putting together concrete green spending plans similar to Saudi Arabia’s recently announced pledge to spend US$190bn annually to eliminate 278m tonnes of CO2 emissions per year, and more sovereigns are developing green frameworks to issue green bonds in the coming year.
A wave of announcements from corporates committing to a greener future is also expected, particularly from high-emitting sectors, which should result in more companies issuing sustainability-linked bonds and loans. US$70.3bn of SLBs have been raised this year, compared to US$8.19bn in 2020, and US$423bn of SLLs have been issued, compared to US$160bn last year.
“For sustainability-linked bonds, the COP is going to bring a lot of opportunities because I truly believe there's going to be some pretty impressive updates in strategies and KPIs coming from various sectors, especially fossil fuel heavy sectors," said Anjuli Pandit, head of sustainable bonds for EMEA and the Americas at HSBC.
Some companies are postponing announcements until after COP26 to get more airtime and ensure they are in line with competitors. Such announcements could continue into the first quarter of 2022 as companies in hard-to-abate sectors, including smaller oil and gas companies, mining, aviation and shipping companies, target the transition finance market.
Some of these high-emitting companies are now considering turning all of their debt into sustainability-linked loans or bonds (with the cost of borrowing determined by key performance indicators linked to emissions) in a bid to gain investors’ approval.
“We will definitely see more of the heavy fossil fuel-related sectors coming to market. Also more issuers from high-emitting sectors are considering committing to move their entire debt portfolio to SLBs in order for investors to take their strategy seriously," Pandit said.
Greenest of the green
More clarity on countries’ NDC and energy transition spending will encourage banks to channel more lending to the greenest areas, which will help to clean their balance sheets as they continue work to get a handle on their indirect financed Scope 3 emissions.
Banks are expected to target pure renewable energy development as a profitable area that allows them to highlight their green credentials. Other priorities include financing electric vehicles and associated infrastructure and creating new green products around carbon credits and carbon sequestration, as COP26 offers the prospect of progress on carbon pricing.
"One of the key fears out there is obviously greenwashing, so financial institutions are going to want to have some very clear rules around what actually constitutes green. Banks definitely have the capital, it's ready and it's there but I think they're going to invest in the transition towards very green sectors,” said Trevor Allen, a sustainability research analyst at BNP Paribas.
Finance day at COP26 is expected to revolve around banks and other financial institutions discussing the hard reality of achieving their net-zero strategies, and critically – and controversially – the role that nature-based solutions, such as carbon credits and offsetting will play.
More detailed announcements are expected from banks next year when they have finished the complex work of understanding and tracking Scope 3 emissions. That work will define how they report and allow them to make commitments against those targets.
"The number one KPI investors would like to see from banks is how they are transitioning their entire lending portfolio to increase the share of green, social and ESG lending over conventional. There’s also added pressure on how they’re phasing out exposure to certain lending sectors like coal,” Pandit said.
