Can finance be a partner in tackling climate change ?
Its third anniversary was on last December, but it will be many years before many more birthdays before it achieves its target to “limit global temperature rise to 1.5°C”. The Paris Climate Agreement – the first universal climate agreement adopted on conclusion of the COP21 Forum held in France at the end of 2015 – is nonetheless already delivering on its initial promises: “It has boosted responsible finance. COP21 has finally brought the stakeholders of the financial world together to address climate change”, says Dominique Blanc, Head of Research at Novethic, the Caisse des Dépôts et Consignations subsidiary that specialises in responsible investment and the accreditation of so-called SRI (Socially Responsible Investment) products.
The hosting of the fourth Climate Finance Day in Paris on 26 November this year reflects the commitment of the industry; a commitment that is confirmed by a number of key figures: the global green bond market (see inset below) is delivering spectacular year-on-year growth, setting a new record of $155 billion in 2017, and the British ratings agency Moody’s forecasts a figure of 250 billion for this year; that’s 60% growth. In France, there are now more than 400 SRI funds, and again the market is growing strongly*.
(*) For more details, see statistics on ISR funds compiled by Novethic : www.novethic.fr
“At Societe Generale we are talking rather less about responsible finance and more about positive impact finance.”
DENIS CHILDS, Head of environmental and social consulting and positive impact finance at Societe Generale.
Climate finance: a key cornerstone of the COP24 action plan
One of the major successes achieved by the Paris Agreement has been the drawing in and the engagement with the banking sector, especially given the substantial need for funding: the International Energy Agency estimates that the energy sector alone will require annual investment of $3,500 billion over 30 years to keep rising temperatures to below 2°C. The OECD quotes an overall figure of $6,800 billion dollars per year. ‘Climate finance’ is also specifically referred to as one of the challenges of the ‘Katowice plan of action for a just transition’, which was adopted at last year’s COP24 in Poland. So it goes almost without saying that financial institutions are being called upon to play a crucial role in combating climate change over the coming years: “Fulfilling the Paris Agreement will require far-reaching transformational change of existing economic models and significantly reducing the carbon content of financial portfolios, which are currently very high in terms of greenhouse gas emissions. That transition will be difficult to achieve. But then, Rome wasn’t built in a day. The responsible finance market is relatively new, and its reach and depth will be greater the more it is supported by society and business...”, explains Alain Grandjean, economist and founder of Carbone 4, the specialist energy transition and climate change strategy consulting firm.
Encouraging the ecological transition and making it socially possible
Responsible finance: at its most basic level, this term describes the integration of ethical environmental and social challenges into the processes of financial asset management. Although the current preoccupation with climate is its main driver today, “we don’t reduce the definition of responsible finance to the low carbon transition alone”, says Denis Childs, Head of Environmental and Social Consulting and Positive Impact Finance at Societe Generale. “People talk in terms of a ‘just transition’, because although it’s about encouraging the ecological transition, that transition must also be made socially possible by supporting changes in business and management practices”, continues Dominique Blanc. ESG (Environmental, Social and Governance) criteria are therefore commonly used by the financial community to measure and assess these types of investment: “This analytical framework complements the financial analysis, without conflicting with it to provide another insight, which was not taken into account by traditional market operators until now”, continues the Head of Research at Novethic.
“More and more research is demonstrating that including ESG criteria as part of management can improve financial performance, especially by making it possible to take all risks fully into account.”
ALAIN GRANDJEAN, Economist and Founder of Carbone 4.
Financing a real and sustainable economy: that is what clients now expect
Having emerged in the 1990s alongside a few products designed to support the nascent sustainable development movement, responsible investment became progressively more mainstream as the new millennium approached. While the Global Compact launched by the United Nations in 2000 encouraged companies to adopt a more responsible attitude – structured around compliance with human rights, international employment standards, and environmental and anticorruption measures – the Equator Principles set out to improve banking industry regulation in this area. By 2003, many financial institutions had introduced rules to incorporate employment, social and environmental criteria in project funding decisions. The Equator Principles were to become a key benchmark for this responsible finance movement that expanded massively during the 2010s against the background of the climate crisis. Undoubtedly the global financial crisis of 2008 dented the confidence of the finance industry. That same industry is now anxious to move on and finance the real and sustainable economy of the future.
Global acceleration in sovereign green bond issues
One symbol of the increasing attractiveness of responsible finance has been the emergence of new market stakeholders who have seized on these tools and embraced this paradigm of longer-term thinking: pension funds, insurers, asset managers, etc. “ESG analysis is now being introduced more widely”, notes Dominique Blanc. Insurers have clearly identified that climate poses a significant level of financial risk to their businesses, so they are naturally open to the idea of adopting these tools”. With current funds under management of around €1,700 billion, life insurance represents a significant volume of assets for responsible finance, for example. This then is a fast-expanding market which also offers “investors the opportunity to diversify their exposure”, as Moody’s pointed out in a recent survey (9 June 2018), which was particularly optimistic about the increase seen in sovereign green bond issues worldwide. “For the issuer, they can offer benefits to new investors, in terms of easy access, as well as benefiting reputationally themselves, while the costs to be met in terms of due diligence and reporting are very low”, adds Alain Grandjean.
“Fulfilling the Paris Agreement will require far-reaching transformational change of existing economic models. (...) That transition will be difficult to achieve. The responsible finance market is relatively new, and its reach and depth will be greater the more it is supported by society and business...”
ALAIN GRANDJEAN, economist and founder of Carbone 4.
Moving from a mindset based on resources to one based on results
In practical terms, this means a complete range of products, from equities to private equity and loans, all of which are subject to the same prioritization of clear signposting and transparency. In November 2015, and then again in September 2016, Societe Generale launched two ‘positive impact’ bond issues, each of €500 million. It was a world first and it has delivered the identical results in terms of efficiency and return as traditional investments. “More and more research is demonstrating that including ESG criteria as part of management can improve financial performance, especially with regard to risk management”, affirms Alain Grandjean. “The quest for ecological performance is not incompatible with financial yield”. For Denis Childs, the problem lies in the issue that, "you have to stop seeing impact as something non-financial, when it plays a full and integral part in transitioning the economy. Especially when, in some cases, you can see that there is a direct financial value on which it is possible to structure credit”. The task now is to structure the appeal of these products, which are still largely underrepresented within portfolios at present: green bonds represent only a very marginal proportion of global bond outstandings – below 1% – despite the dynamic growth of this market. Denis Childs is calling for a complete change of perspective: “We have to move from a mindset of resources to one of results. The world of finance still revolves around investment and the resulting cash flow, but we now have to move towards the concept of impact and solutions that redefine the risk/reward ratio. It can surely be no coincidence that people at Societe Generale are talking rather less about responsible finance, and more about positive impact finance”.
Becoming a positive contributor to the environment
These green bonds are just the tip of the iceberg, because in reality, banks are working on their financial ‘responsibility’ approaches in a number of different ways: “There is an important need to support our clients, whether in terms of transactions specifically, or within their general area of business, but in either case, we seek to analyse the environmental and social impacts of our deals in as much detail as possible”, explains Denis Childs. Societe Generale places great importance on this type of reporting. Every year, between 100 and 200 financial opportunities are subject to this kind of detailed analysis, and the amounts involved can be in the billions of dollars”. The challenge then is to ensure that the funds released by the bank are used in accordance with the AMC (Avoid, Mitigate, Compensate) methodology. Except that this approach, which has been in place for several years now, contents itself with addressing the problem only from the flip side of the argument. “In this instance, it’s about limiting negative impacts”, continues Denis Childs. “What we want to demonstrate now is that we can also be positive contributors to the environment!” That willingness is reflected in the 2020 renewable energy funding target of €100 billion announced by Societe Generale in December 2017.
“COP21 has boosted responsible finance. It has brought the stakeholders of the financial world together to address climate change.”
DOMINIQUE BLANC, Head of Research at Novethic.
Green bonds: the rise of a new form of financial responsability
In 2007 the European Investment Bank initiated the first green bond issue. The following year, the World Bank followed suit: the Green Bond adventure had begun, and would continue to grow consistently, given a significant boost by the COP21 Climate Agreement.
A green bond works in exactly the same way as a traditional bond: the financial market stakeholder borrows from investors for a shorter or longer period in order to fund the project in return for interest on the loan. It is in the signposting of this finance where the minor revolution of green bonds is having its effect: unlike the traditional bond market, which pays little regard to how funds are invested, the prime criteria applied by green bonds are focused on ensuring that the funds generated are invested in green activities.
However, the absence of any harmonised regulatory framework can sometimes impact negatively on this nascent market. “The environmental integrity of these green bonds has yet to be guaranteed, so there is a real need to implement demanding and detailed standards”, takes up Alain Grandjean. “But this is a problem that the European Commission is now actively working on. In the meantime, the growth of this market reflects the growing awareness among financial market stakeholders of the challenges ahead”.
In 2017, green bonds with a total value of €15 billion were issued in France by a range of different entities. From the national rail operator SNCF to the energy provider ENGIE and the French Development Agency (AFD), many organisations have now taken up the challenge of issuing green bonds. And these issues have a real benefit in terms of exposure and visibility: when EDF became the first major company to launch a green bond issue in 2013, the high-profile offer allowed it to raise €1.4 billion to fund renewable energy projects.
“For EDF, a significant player in the nuclear industry it’s also a way of boosting its green credentials and promoting the diversity of its energy investments. Other companies, such as Paprec [the specialist recycling company that successfully raised up to €800 million in green bond debt this March - ed.] are also looking to raise their profile this way”, says Dominique Blanc. Underlining the emerging success of these green bonds, 2017 also saw the French State launch its first sovereign green bond, becoming the second national government in the world, after Poland, to do so.
Launched in January 2017 with an initial value of €7 billion, the total rose to €14.8 billion this summer following the issue of a fourth tranche. Figures like these underline the high level of demand from investors, together with the particularly strong predisposition of France to be pioneers on this issue, having a financial ecosystem that particularly favours green bonds. It is the leading issuer of green bonds in Europe and the world number three in the sector.