Banks have joined in the fight against climate change. Last month, 130 lenders with US$47 trillion of collective assets, or one-third of the global banking sector, launched the Principles for Responsible Banking, committing to aligning their goals with the Paris Agreement on climate change.
At the launch on September 22, United Nations’ Secretary-General Antonio Guterres described the principles as “a guide for the global banking industry to respond to, drive and benefit from a sustainable development economy”.
“When the financial system shifts its capital away from resource-hungry, brown investments to those that back nature as solution, everybody wins in the long term,” he was quoted as saying.
The principles were founded by a core group of 30 banks in collaboration with the UN Environment Programme Finance Initiative, in line with the thinking that the private sector plays a major role in helping governments realise the Paris accord’s aim to limit global temperature increase to 1.5 degrees Celcius. The UN estimates that its Sustainable Development Goals, a 2015 blueprint to address global challenges, including those related to climate change, could potentially unlock $12 trillion in business savings and revenue annually, and create 380 million jobs by 2030.
On the asset management front, fund managers are beginning to acknowledge growing demand from investors for more products that comply with environmental, social and governance (ESG) criteria.
“More investors see the value in assessing ESG risks and we have seen an increase in the number of dedicated ESG funds looking at opportunities in emerging markets,” says Herry Cho, head of sustainable finance Asia Pacific at ING Bank, which recently published its first progress report on its commitment to steer its 600 billion euros ($659 billion) lending book towards meeting the Paris accord goal. The report addresses developments and climate alignment for the sectors in ING’s portfolio that are most intense producers of greenhouse gas emissions, including power generation, fossil fuels, automotives, shipping, aviation, steel, cement, residential mortgages and commercial real estate.
Paul Lukaszewski, head of corporate debt for Asia and Australia at Aberdeen Standard Investments, echoes Ms. Cho’s sentiment. “Signatories to the Paris accord have begun to make significant regulatory changes in order to meet the targets it spells out,” he says.
He predicts that recent initiatives such as the European Union’s Sustainable Finance Taxonomy, and the Task Force on Climate-related Financial Disclosure reporting, will drive “significant change” on climate disclosure that will impact investors and issuers.
Although Europe appears to have taken the lead in creating initiatives around climate change, industry players are confident that Asia will play a bigger part in green financing in the future.
In fact, according to Mr. Lukaszweski, Asia is currently ahead of the US in terms of green bond issuance, at 32% versus 16%. He says Asia has significant infrastructure needs, which he believes will prompt growth in green financing.
“With the green bond market having established critical mass, we are now seeing a broad global trend in terms of aligning local and regional frameworks. While Asia is lagging other regions in terms of green investment strategies, it is poised to catch up quickly given the strong push from multilaterals and government-linked investors in the region,” he says.
Ms. Cho cites several data that underscore the appetite for green bonds in Asia, including from the Climate Bonds Initiative, which says green bond issuance in the Association of Southeast Asian Nations, or ASEAN, more than doubled in the last two years, from $2.3 billion in 2017 to over $5 billion in 2018.
Sustainability and social bonds also grew in Asia, with total issuance increasing from $1.2 billion in 2017 to $6.7 billion in 2018. Green and sustainability-linked loans in Asia also rose from $11.8 billion in 2017 to $13.6 billion last year.
Leon Kamhi, head of responsibility at Hermes Investment Management, says changing societal attitude is driving continued demand for green finance. “Making money without paying mind to the wider societal ramifications is no longer acceptable, and society is placing increasing pressure on the investment industry to drive genuinely sustainable growth in the economy,” he says. “Rather than being viewed as a ‘nice-to-have’ aspect of investment, green finance is increasingly becoming the investment industry’s social licence to operate.”
Ms. Cho agrees, noting the several major firms have joined the green financing fraternity, including HSBC Global Asset Management and GAM Investments. Ratings agency Moody’s Investors Service’s acquisition of a majority stake in ESG ratings and research firm Vigeo Eiris in April 2019 also illustrates the industry’s seriousness in casting a wider net to include ESG in investment decisions.
“For many investors, the conversation has moved away from whether ESG can harm performance to focusing on how to implement ESG integration and further embed it into investment decisions across asset classes,” Ms. Cho says.
She notes that according to investment research firm Morningstar – which owns 40% in ESG rating and services specialist Sustainalytics – two-thirds of sustainable funds domiciled in Europe beat the average performer in their category of asset class, and over 34% of sustainable funds were in the top quartile of their category in the first half of 2019, with some 63% making it into the top half.
“Contrary to popular opinion, this suggests that there is no systematic performance penalty associated with sustainable investing and possible avenues for outperformance based on reduced risk or added alpha when looking at investments made in the sustainable economy,” she says.
Taking the lead
Governments are beginning to realise that the cost of being unsustainable and harming the environment far outweighs the short-term financial benefits. However, there is still a conflict between regulation and enforcement.
Mr. Kamhi is of the opinion that well-intentioned though governments may be, they have difficulty implementing climate-friendly initiatives for fear of increasing the cost to consumers. “They have to find a way to break the trade-off, which can be done – one way they could do this is to tax carbon and return the proceeds to the citizen,” he says “I think that governments could do more to educate the population on what causes carbon emissions and what doesn’t. On the whole, people want to do the right thing but they just need to know how.”
Mr. Lukaszewski observes that companies are becoming increasingly invested in tackling climate change alongside the Paris accord signatories, which have implemented regulations to drive their obligations under the agreement.
“Stewardship and sustainability are themes increasingly impacting corporate and investor behaviour. With the green finance market now firmly established and a push underway to harmonise standards, we believe the next leg of this journey will potentially be driven by retail investors who increasingly want to also play a part in driving for climate change solutions,” he says.
Initiatives by central banks to increase the impact of lenders in combating climate change include the Network of Central Banks and Supervisors for Greening the Financial System, which was established in December 2017. Eight Asia Pacific regulators have signed on to the initiative, including the central banks of Australia, China, Hong Kong, Malaysia, New Zealand and Thailand.
“Soft and hard regulations for green financing are expanding across the globe and coordinated national strategies are expected to embed sustainability into financial policy. Of course, this is happening at different rates depending on the country,” Ms. Cho says.
Green bonds are basically debt issued to fund sustainable ventures. The growth in global demand for energy has prompted institutional investors to look towards more ESG-friendly investment options in the form of equity. But the bond market is much larger, with a potentially deeper pool of investors to tap. And Asia is ripe for the picking in both the energy and bond space.
In an article published in Forbes magazine on August 28, Miriam Tuerk, chief executive officer and co-founder of Clear Blue Technologies, writes that demand for energy in Asia in 2018 drove half the global growth in natural gas, 80% growth in oil, and over 100% increase in coal power. Last year alone, she says demand for energy in Asia grew by 2.3%, 70% of which was met with fossil fuels.
Mr. Lukaszewski sees a correlation between energy needs in Asia with green investment opportunities. He believes that sustainable investment is at a tipping point in Asia, where regulation is being ramped up, and the issuance of green bond is increasing. “Multilaterals and government-linked investors are catalysing sustainable investment strategies. Home to half the world’s population, emerging Asia has tremendous infrastructure needs and green finance will play a pivotal role in financing these projects on a sustainable basis,” he says.
“Most importantly, Asia will offer investors who participate in this transformation the opportunity to earn attractive financial returns while having a dramatic positive impact,” he adds.
Christina Figueres, former head of the United Nations Framework Convention on Climate Change, estimates the global green bond market will reach $1 trillion by 2020. Ms. Cho is among those who see this as a rather optimistic prediction, though she acknowledges that the market for green bonds has deepened.
Citing Bloomberg data, she says green bonds made up 87% of sustainable bond issuance in Asia last year. “Given green bonds by and large still rely on bond fundamentals, green bonds are susceptible to negative yields also. However, green bonds will increasingly be used as a strategic tool as green/sustainability issuances clearly decrease execution risk, which becomes evident when markets are more volatile,” she says.
Sustainable investing has also been a subject of interest in Islamic finance, particularly since it’s in line with the principles of creating a sustainable economy while conserving the environment and benefitting society as a whole that guide Islamic finance.
In 2017, Malaysia, currently the world’s largest Islamic bond market, developed a framework for green sukuk, or Islamic bonds, in a collaboration between the country’s securities regulator and central bank and the World Bank to support such domestic offerings. Securities Commission Malaysia announced several incentives under the framework to attract green issuers, including tax deductions on issuance costs and tax incentives for green technology energy, transportation, building and waste management.
Mr. Lukaszewski expresses optimism about the future of green sukuk. He notes that Indonesia issued the first US dollar sovereign green sukuk in 2018 and followed up with another offering this year, while Maijid Al Futtaim in the United Arab Emirates became the first company to issue a US-dollar green sukuk this May.
“Given the success of these transactions and the continuing growth of the conventional green bond market, we expect green sukuk issuance to grow meaningfully as well,” he says.
The long game
Ms. Cho believes that Asia is on the right track in growing its green economy, with government and quasi-government green bond offerings setting the benchmark for the private sector and encouraging them to follow suit.
She says policy support has increasingly focused on education for green and sustainable finance, financial subsidies of green finance instruments and compensation schemes, project guarantees and project development for green projects.
In the private sector, Mr. Kamhi says clients are constantly encouraging asset managers to be more progressive in considering environmental and social issues. “Companies might be held back if investment managers demand quarter-on-quarter returns at the expense of investing in the long-term future of the company. To be green and sustainable requires long-term investment but we believe it gives you a good return over time,” he says.
He urges the industry to consider the environmental and social impact of investments, and to look at returns holistically rather than only from a financial perspective. “This approach delivers returns that are not only beneficial to society, to customers, to employees and so on, but is also beneficial in terms of returns to the shareholder. Doing so would result in a complete paradigm shift,” he says.
The fact that emerging-market companies continue to lag behind developed markets on disclosure practices could be a drawback. But according to Mr. Lukaszweski, “one should not confuse being at an earlier stage of development with ill intent”.
“We frequently engage with various stakeholders to drive for improved disclosure practices and we see similar opportunity with respect to driving for improvement of ESG disclosure across Asia,” he says. “Studies have shown that better ESG performance often leads to higher credit ratings and tighter spreads, so helping companies along this journey translates to attractive investment returns as well as positive impact.”