As activity on international markets hits historic levels, interest in sustainable finance is continuing to rise. Some issuers and lenders are seeking clarification on the numerous financial instruments available to suit their requirements as possibilities to join the market increase.
Though they have similar names, several of the most well-known sustainable financing products are constructed differently. In this blog article, we define the most popular sustainable financial instruments, contrast them, and outline typical applications for each.
How does sustainable finance work?
Any financial service that incorporates environmental, social, and governance (ESG) considerations into company or investment choices for the long-term benefit of both customers and society at large is referred to as sustainable finance. It includes a wide range of diverse financial instruments, including loans and bonds with designated uses of proceeds, sustainability-linked bonds, loans, and revolving credit facilities (RCF).
There is almost no difference between conventional bonds and loans and sustainable ones (such as green, social, or sustainability bonds) when comparing their issuing procedures. The distinctions are less about the specifics and more about the overall picture, which is allocating funding to programs and initiatives that benefit society and the environment.
In the end, it is not necessary for a firm to be seen as “green” in order to join the sustainable bond or loan market; what matters most is how the funds are being utilized and their effect. Companies should, however, be conscious of the importance of sustainability to their operations and dedicated to making further advancements in related fields.
Employing Proceed Bonds
The issuers of use of proceeds bonds consent to using the money obtained to finance or refinance particular types of qualified projects or assets. The term “sustainable finance” broadly refers to the following uses of proceeds bonds:
Green bonds: The proceeds from these bonds are invested in programs that benefit the environment or the climate, such as purchasing renewable energy.
Social bonds: The funds are dedicated to initiatives that have a positive social effect, such funding the purchase of affordable homes for persons who have limited access to the housing market.
Blue bonds: The money is set aside for marine or aquatic initiatives, such as funding the conversion of fish stocks to sustainable levels.
Sustainability bonds: The money is invested in a variety of social and environmental impact initiatives. Additionally, these initiatives could be in line with the UN Sustainable Development Goals (SDG).
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The specifications for green, social, and sustainability bonds have been laid down by the International Capital Market Association (ICMA). The market expects issuance in conformity with ICMA principles and rules for a bond to be regarded credible even if the industry advice is optional. Please read the Sustainability Bond Guidelines, Social Bond Guidelines, and Green Bond Principles for additional information.
Green and Social Lending
Bonds and loans are similar; however, loans vary in how the money is raised. While money for loans comes from a bank, money for bonds comes from the investor market. Loans may be categorized as green, social, or sustainable, much like bonds.
Green loans: The money will be used for initiatives that help the environment or the climate, such retrofitting office buildings with green features.
Social loans: The money is set aside for initiatives that have a positive social effect, such educating disabled persons to become more employable.
Sustainability loans: A mixture of ecological and socially beneficial initiatives will be supported by the funding.
The Green Credit Principles and the Social Loan Principles, which provide a standard approach for usage throughout the green and social loan markets, were created by a coalition of worldwide financial organizations.
Loans and bonds that are linked to sustainability
The tying of the financial conditions to the accomplishment of predefined sustainability performance criteria is a crucial element of sustainability-linked loan (SLL) and sustainability-linked bond (SLB) agreements. The goals should be challenging and relevant to the operations and sustainability plan of the issuer or borrower.
The goals and the KPIs that support them should also be benchmarked, either internally against the company’s historical performance or externally against goals based on science or other unbiased evaluations like an ESG score.
The revenues from an SLL or an SLB may be utilized for broad company purposes, unlike labeled bonds or loans. Companies from traditionally non-green industries—or those without a portfolio of projects or assets that qualify as green or social—can access the sustainable financing market and a wider range of investors thanks to the flexibility of the sustainability-linked structure.
Structure of SLL and SLB
If the borrower falls short of the established sustainability performance objective, the interest rate of the loan for SLLs may rise, and vice versa. Revolving credit facilities may also be included under this heading as the same agreement—interest rates are paid depending on fulfilling sustainability targets—can be formed even if the money is only taken out as required.
In an SLB agreement, if the sustainability or ESG goals are not met, the bond’s coupon rate will rise, or the issuer may be required to pay a fine when the bond expires.
The terms of forward-thinking issuers’ usage of green, social, or sustainability bonds are likewise tied to the accomplishment of sustainability performance goals. Both issuers and investors are drawn to this hybrid “sustainability-linked branded bond” because of its increased reputation. By linking the coupon rate to sustainability goals, the issuer shows its dedication to sustainability. Investors can be certain that the money obtained will be used for initiatives that will benefit them while also encouraging corporate sustainability advancements inside the issuer company.
Driven by demands from regulatory and industry authorities, investors, shareholders, and, of course, customers, sustainable finance will continue to play a vital role in addressing environmental and social challenges. The development of sustainable finance has made it possible for businesses from various industries to obtain capital to support the financing of creative projects, programs, and activities aimed at advancing society and the environment. Companies must participate in sustainable financing if they want to be relevant and competitive. Understanding the financial tools available and selecting those that support them in achieving their strategic (sustainable) growth goals is the first step.