Sustainability in finance: working towards a low-carbon economy

Green bonds seem like the answer to our world’s need for a low-carbon economy. However, at a closer look they’re not as perfect as they seem. Photo courtesy of HotelManagement.net.

Written by Virginia Favaro

According to a London School of Economics study, “climate change could cut the value of financial assets by $2.5 trillion” if temperatures rose by 2℃ by 2100. “It makes financial sense to a risk-neutral investor to cut emissions, and even more so to the risk-averse,” said Professor Simon Dietz, environmental economist. It is only natural then that banks are starting to prioritize and integrate environmental protection and sustainability into their core businesses.

In order to do so, banks are starting to utilize instruments such as green bonds. Green bonds are similar to conventional bonds but the capital raised through this type of debt should finance projects that benefit the environment. They also have similar yields to those of conventional bonds, making them attractive to investors. Green bonds seem like the answer to our world’s need for a low-carbon economy. However, at a closer look they’re not as perfect as they seem.

Anyone can issue a bond and call it ‘green’. Even though many institutions such as the World Bank have started developing guidelines, no one has yet created a universally accepted definition. There is no way to guarantee that all the capital raised through these green bonds is going towards projects that protect the environment.

Stefan Reiner from Deutsche Bank, explains that “Deutsche Bank was one of the founders of the Green Bond principles”. These guidelines ‘define precisely how proceeds should be allocated’. However, these Green Bond Principles are simply encouraged and banks don’t have a legal obligation to follow them.

With yields being so similar to those of conventional bonds, it raises the question of whether green bonds are any different. Banks might have introduced them simply to meet ‘green’ targets and investors might be using them simply to feel better about themselves.

Despite the many issues, the market for green bonds is rapidly growing. Moody’s predicts that “Green bond issuance worldwide could cross $200 billion in 2017, doubling the 2016 record”. The financial services industry is starting to realize the potential it has to serve society and the environment.

A similar instrument, social impact bonds, are instead used to finance social projects. These can range from tackling low academic performance in city schools to high teenage incarceration. In the future, banks are hoping to also use these bonds for green opportunities.

However, social impact bonds run into the same issues as their green counterparts: they don’t have a set of specific standards to meet. Just a few years ago Lloyds’ social impact bonds were revealed to be repackaged loans that were already on their books. Lloyds was praised for its corporate social responsibility, but it channeled no new investments towards social projects. Banks seem to be using social impact bonds to improve their image in self-interest rather than adding value to society.

Banks are also expanding their clean energy targets by directly investing in renewable energy and low-carbon projects. Goldman Sachs plans to deploy over $150 billion in clean energy projects by 2025. To achieve that target, the firm has invested over $2.5 billions in capital across 35 clean energy companies and projects since 2012.

Furthermore, Goldman Sachs has financed renewable energy projects through IPOs, convertible bonds and other financial instruments. The renewable energy industry is showing great potential for investment banks, as costs for wind energy has decreased by 80% in the past several years, making ‘green finance’ far more attractive to a wider base of investors.

Bank of America is also working to stimulate $10 billion towards high-impact clean energy projects through the Catalytic Finance Initiative (CFI). Bank of America CEO Brian Moynihan said that “we [Bank of America] want to take a leadership role in helping remove barriers to investing in clean energy projects [..]”. The CFI aims to reduce the risk around renewable energy projects to increase the investor base for such projects.

Instruments like green and social impact bonds still need to be developed to harness their full potential. However, banks are realizing the importance of integrating environmental sustainability within their core business.

Tim Fresher, Goldman’s Chairman for the Asia-Pacific region, stated “As a company, if you ignore sustainability, you’re going to be worth less.”

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