The green future of sustainable finance

The appetite for sustainable finance is growing across the globe as more corporations and governments tap into green capital markets to meet their environment, social and governance (ESG) goals – and the mounting expectations of investors.

While the European market continues to lead the way, Asia-Pacific is gaining ground thanks to the increasingly green ambitions of centres like Singapore and Hong Kong and the overwhelming acknowledgment of a carbon-constrained future.

Last year, global issuance of ESG-themed bonds exceeded US$1 trillion (A$1.4 trillion), according to Climate Bonds Initiative, a UK-based not-for-profit that aims to mobilise the US$100 trillion (A$143 trillion) global bond market for climate change solutions.

In Asia-Pacific, ESG-themed bonds made up 15 per cent of bond offerings for the year and, as the market continues to mature, accountants face fresh challenges in managing and integrating ESG data into overall financial performance.

In broad terms, ESG-themed bonds are financial instruments linked to sustainability. The majority are classified as “use of proceeds”, and are issued to fund specific green, social or sustainability projects.

However, sustainability-linked bonds (SLBs) are also growing in popularity. Performance-based instruments, the interest margins of SLBs, vary according to the issuer’s performance against predetermined, measurable ESG targets.

In June last year, for instance, Australian conglomerate Wesfarmers issued the first SLB in the local market, raising A$1 billion in a transaction that was over-subscribed by approximately 2.5 times.

The interest rates are linked to Wesfarmers’ progress against two sustainability performance targets, and a step-up of 25 basis points will apply on the SLBs’ trigger dates if the targets are not met.

While Australia’s ESG-themed bond market is expected to grow by about 25 per cent to more than A$25 billion this year, China remains the region’s largest issuer.

Last year, its green bond issuance grew just over 230 per cent year on year to US$60.5 billion (A$86.8 billion), according to Bloomberg. The market looks set to develop further with the country pledging to reach carbon neutrality by 2060.

 

"Climate risk is now globally recognised as financial risk, and it’s driving investor decisions. Debt and equity investors realise that we need that level of disclosure transparency, so that people can make the right decisions."

 

In Singapore, green finance forms part of the Green Plan 2030, and will support the city state’s ambition to become the centre for environmentally sustainable finance in Asia.

The government’s 2021 budget included plans to issue green bonds for S$19 billion (A$19.6 billion) worth of infrastructure projects, including the Tuas Nexus integrated water and solid waste treatment facility.

The government is also helping companies to access ESG financing through the Green and Sustainability Linked Loan Grant Scheme for corporations and banks, which aims to reduce issuance costs.

Hong Kong is also increasing its presence in the ESG sector. In 2020, green bond issuance reached US$2.1 billion (A$3 billion), according to data from the Climate Bonds Initiative.

“Hong Kong, and much of Asia for that matter, is riding on the global trend of sustainable finance and investment in terms of how society should allocate capital for a more sustainable future,” says Felix Lam CPA, head of investment stewardship for Asia ex-Japan at JP Morgan Asset Management.

“Hong Kong is an important centre for finance and investing,” adds Lam.

“It’s also a major gateway to Asia, and to China in particular, and this is one of the market forces behind Hong Kong’s sustainable finance industry.”

Investor demand is a key driver of sustainable finance growth across Asia-Pacific.

Results of the latest Global Private Equity Barometer, Winter 2021-22 from Coller Capital, for instance, shows about a third of Asia-Pacific private equity investors had declined to invest in a fund due to ESG concerns. In Europe, the proportion rose to 56 per cent last year, up from a third five years ago.

“Investors are pushing for greater transparency around ESG,” says Terence Jeyaretnam, Oceania climate change and sustainability services partner at EY.

“Regulatory bodies are also wanting more information.”

From 6 April this year, for instance, it became mandatory for Britain’s largest businesses to disclose their climate-related risks and opportunities, in line with Task Force on Climate-related Financial Disclosures (TCFD) recommendations.

The New Zealand Government has also passed legislation making climate-related disclosures mandatory for some organisations.

“Climate risk is now globally recognised as financial risk, and it’s driving investor decisions,” says Nancy Wang, director sustainable finance at ANZ in Hong Kong.

“Debt and equity investors realise that we need that level of disclosure transparency, so that people can make the right decisions.

“Companies across the globe also want to demonstrate an alignment between their sustainability strategy and capital structure,” adds Wang.

“That’s a very powerful story for them.”

While the sustainable finance market continues to grow across the region, there are obstacles for companies and investors to navigate.

Sean Kidney, Climate Bonds Initiative CEO, says a key barrier is education about opportunity in the market.

“We’ve got the investors onside, but markets aren’t as rational as they make out that they are,” he says.

“Organisations are slow to get their act together and slow to notice a change, and that’s the case everywhere.

“We’ve shown now with the green bond market that green investments are lower-risk and have lower volatility,” adds Kidney.

“That’s why investors like it and it keeps growing well. The corollary is if you’re not green, you’ll clearly have more risk to volatility and more risk of some sort of default or downgrade going forward.”

The lack of a universal green definition, or taxonomy, across global markets presents another barrier to growth. It can also amplify the risk of greenwashing of financial products, where environmentally friendly, sustainable or ethical practices are overrepresented.

 

"Green investments are lower-risk and have lower volatility. If you’re not green, you’ll clearly have more risk to volatility and more risk of some sort of default or downgrade going forward."

 

Jeyaretnam says the assurance process can enhance investor protection from greenwashing.

“When you think about where ESG information has been focused over the past two decades, it was generally about telling a good story about corporate social responsibility,” he says.

“Today, it’s about core risks and opportunities to business, so you have to put some controls in place to manage inherent biases. 

“I don’t see [sustainability assurance] as that different to financial assurance,” adds Jeyaretnam.

“In financial assurance, you are required to look at how the information is presented outside of the financial statements to ensure that the narrative is consistent with the performance of the organisation financially. We’d have similar conversations with organisations regarding sustainability performance.”

The newly formed International Sustainability Standards Board (ISSB) also aims to deliver a comprehensive global baseline of sustainability related disclosure standards to help investors and other capital market participants make more informed decisions.

“With ISSB accounting standards, you’d not only to have to integrate ESG reporting with financial reporting information, but you’d also have to talk about ESG data governance, and that has to be at the same level as financial data governance,” says Jeyaretnam.

“I think a new challenge for organisations will be how they manage this, outside of things like Excel spreadsheets.”

Integration across ESG and financial disclosures is one of the factors currently reshaping corporate reporting. Lam says it may present a greater challenge for smaller companies with fewer resources, and he recommends focusing on the materiality of ESG.

“ESG encompasses many areas, such as human rights, climate change and social impact, but when we are assessing materiality, we look at how these factors impact the financial performance,” says Lam, who is a member of CPA Australia’s ESG Centre of Excellence.

“ISSB will hopefully help to bring a more united framework and ideally a reporting standard to certain material issues, particularly around climate change. I think this will help accountants to understand how they can integrate both financial materiality and ESG materiality.”

Since 2020, several regulations on disclosure of ESG information have been announced by financial regulatory bodies in Mainland China. Dr Ruoyu Weng, director at China’s Xiamen National Accounting Institute, says the regulations are a positive signal of mandatory ESG disclosure and that relevant accounting skills may require further development.

“As a comparatively new concept, ESG needs both applied research at the technical level and theoretical construction to ensure its sustainable development in China,” says Weng, a contributor to the ESG Reporting White Paper 2021, created by CPA Australia and Xiamen National Accounting Institute.

 

"ESG encompasses many areas, such as human rights, climate change and social impact, but when we are assessing materiality, we look at how these factors impact the financial performance."

 

“At the technical level, the related skills of asset managers and accountants need to be improved. More importantly, at the theoretical level, the theory of sustainable development, economic externality and corporate social responsibility fit with the ESG concept of advocating business for good, which is the theoretical basis from which ESG can absorb rich ideological nutrients.” 

As the sustainable finance market continues to grow across Asia-Pacific, so too will the requirements for ESG disclosure.

“I think there’ll be a test for the accounting profession around how ESG data is measured, managed and reported and how it’s integrated into financial performance,” says Jeyaretnam.

“If you look at the climate-risk space, we’re starting to have guidance around how it may impact contingent values, stranded assets and write-offs, so there’s a bit of learning to do in terms how that intersects with financial reporting.

“I think accountants can bring a lot to the ESG field in terms of better data governance and better hygiene in data management,” adds Jeyaretnam.

“So, I actually think it goes both ways – accountants will have a lot to learn, but also a lot to bring.”

Sustainable finance is playing a vital role in supporting – and accelerating – the move to a low-carbon economy. Its transition finance segment can help businesses in hard-to-abate sectors, such as aviation and petrochemical, to reduce their emissions.

Transition bonds remain a nascent segment of the overall ESG-themed bond market, with only three transition bonds issued in the third quarter of 2021, at a total of US$930 million (A$1.3 billion).

Castle Peak Power Company, for instance, issued a US$300 million (A$430 million) Energy Transition Bond last year, with the proceeds earmarked for construction of a gas turbine unit at a power station in Hong Kong.

Emily Tonkin, executive director sustainable finance at ANZ in Sydney, expects the transition label to mature in the loan market before growing in the bond market.

“The transition-labelled bond market is still very much in its infancy, with issuers typically using ‘green’ or ‘sustainability linked’ instead,” she says.

“We may need to see a few more large global transactions go through with a transition label before it really takes off.

“When we talk to customers in high-emitting sectors, they are very keen to hear about what’s happening with this product. I think we just need to get a bit more momentum in the transition label as we think there is still a great opportunity for this type of product.”

Dr Ruoyu Weng, director at China’s Xiamen National Accounting Institute, says transition finance has the potential to facilitate real change in the global economy, but that it requires mandatory standards that underpin tangible contributions towards a future energy system.

“As capital providers examine their options for accelerating progress on climate change mitigation, transparent criteria in managing continued funding to hard-to-abate sectors will play a crucial role.”