Sustainable finance is a rapidly growing sector, with international policy initiatives giving rise to changing attitudes in the investment and lending community.
The financial sector plays a key role in mobilising the capital required to fulfil the global sustainability agenda.
Increasing stakeholder pressure
Clients are increasingly concerned with climate change and resource scarcity and are looking for ways to invest in clean, sustainable initiatives. Banks will, and should be at the forefront of the promotion of industry standards in this area.
Financial institutions are also facing a continuously increasing stakeholder pressure. This reflects the expansion of the global awareness of ESG-related issues. Thus, companies and financial institutions increasingly expect the financial sector to contribute to sustainable development.
A risk and a global market opportunity
It is widely acknowledged that resource efficient companies produce higher returns and that companies which proactively manage ESG issues are better placed than their competitors to generate long-term tangible and intangible results.
By virtue of their role as financiers of the real economy, banks are exposed to credit, reputational, legal, operational and market risks that are driven by environmental and social issues that affect their clients and customers.
These risks can stem from the impact that clients have on the environment and society, such as pollution, natural resource depletion and health and safety concerns for communities and employees. They can also stem from the physical impacts that environmental issues such as severe weather events, water stress and fluctuating ecosystem services can have on client performance and success. These non-financial circumstances increasingly present new and diverse opportunities and challenges and directly influence the financial results of companies and financial institutions.
On the other side, this offers banks an opportunity to help bridging the finance gap to move to a low carbon economy, e.g. by providing finance capital to clients, including governments, businesses and supranational institutions.
A crucial role for lenders
Crucially, from an environmental perspective, the negative impact of climate related risks on existing lending can be mitigated by the opportunities presented by the decarbonisation of the economy.
For some lenders, the green loan is simply another product available to customers with no added incentive other than that it enables the borrower to meet the green objectives that it has set for itself. However, others have opted to create products which, often in line with their own institution’s commitments, incentivise sustainable behaviours. This may for instance be done by way of a margin ratchet which reflects the borrower’s compliance with defined sustainability criteria (the so-called 'positive incentive loans').
The transition towards green finance and ESG-linked agenda's
With the introduction of green debt financing products, such as green home mortgages and ESG-linked revolving credit facilities, banks and other financial institutions have started a process of transformation towards inclusion of sustainable finance into their business.
We observe that, as the green loans industry evolves, different institutions are taking differing approaches to commerciality of these products.
At the same time, also companies are not only increasingly talking about how to address issues of sustainability but are also starting to put it into practice. The importance that investors are increasingly placing on companies with a strong ESG-linked agenda, wakes companies up to the potential of sustainable finance.
Financial institutions can play a role as catalysts of this transition, offering their customers the opportunity to transform their businesses into a sustainable and environmentally friendly business model.
Lenders increasingly realise that there is a client interest in sustainable finance products, which will only grow as the regulatory environment changes and the technology advances. Thus, both lenders and clients are searching ways to access and benefit from sustainable finance products.
Sustainable policy within the own organisation
There are also various ways that lenders can drive the development of sustainable finance within their own organisations. This may include setting up a green council with committed employees working on an ESG-agenda, establishing a green framework for a lender’s sustainable finance model and creating innovative sustainable finance products that also help encourage top-down support from executives.
A well thought-out ESG agenda is not only about making a company more sustainable but also about making it more efficient and profitable while effectively managing risk.
Addressing legal and compliance aspects of sustainable finance
Proactively addressing legal and compliance aspects of sustainability provides a better safeguard against lender liability and other risks. It also improves the overall resiliency of banks.
Legal and compliance teams have a key role to play, not just to assist with integrating sustainability considerations in regular compliance processes but also to understand and anticipate how the normative landscape is evolving in alignment with fast-moving stakeholder needs and expectations.
Essential considerations for legal and compliance teams include:
- assessing the relevancy of, and ensuring conformity with, sustainability regulations and standards;
- integrating sustainability requirements into transaction based advisory services;
- supporting the development of internal sustainability policies and ensuring alignment with relevant regulations; and
- supporting awareness within the own organisation.