190312 setting up business
To all those ESG spouting businesses, please take care not to do a hard sell. Image Credit: Gulf News Archive

Sustainable bond issuance - including green, social and sustainability-linked - could collectively exceed $1 trillion in 2021, approximately a –five-fold increase over 2018 according to our estimates. Evidently, ESG has become mainstream.

Key stakeholders, including consumers and investors, have started pressuring companies to demonstrate their ESG credentials. Governments and regulators have also introduced enhanced standards and regulations to support increased disclosure and consistency of ESG reporting.

However, the sheer volume of ESG marketing and labelling, in combination with non-uniform sustainability commitments and reporting, has made it increasingly difficult for stakeholders to identify which claims are trustworthy and reliable and which are unreliable - or, in industry terms, “greenwashed”.

A survey by Quilter Investors found that when it comes to ESG investing, greenwashing was the biggest concern for about 44 per cent of investors. Investors looking to act more responsibly and maximize their environmental impact have become “increasingly sensitive” to the effects of companies potentially viewed as exaggerating their green credentials to capitalize on the growing demand for environmentally safe products.

Consistency in disclosure

A lack of reliable and comparable ESG metrics and reporting along with a lack of consistency in ESG terminology associated with various such investments have caused confusion for some sustainable debt investors. In the absence of a common standard and enforcement mechanism for instrument-level ESG disclosure, the quality and consistency of post-issuance use of proceeds and impact reporting is still highly unstandardized and fragmented across issuer types and regions making it difficult to compare and aggregate performance.

‘Sustainability washing’

Despite initial investor fears of greenwashing being quelled as the market becomes more mature, so called “sustainability-washing” concerns have become increasingly prominent as new types of sustainable financing, including social, transition, and sustainability-linked instruments, take root.

  • Social bonds: Social bonds, which finance projects with primarily social objectives, have raised concerns around “social washing”-- the risk that an issuer may be viewed as overstating or exaggerating the social impact of its financed projects.
  • Transition instruments: Issuers in energy-intensive, hard to abate sectors are increasingly leveraging sustainable or “transition” instruments to help them advance their contribution to a net-zero emissions economy. Such instruments are often characterized by a lack of clarity and common terminology on what is considered to be a transition activity or project.
  • Sustainability-linked instruments: The structure of sustainability-linked instruments, which allows issuers to use the proceeds for general corporate purposes, has elevated investor fears that proceeds may directly fund projects without a clear beneficial impact, making them a new platform for green or social-washing.

Investor scrutiny

It’s becoming clear that entities can no longer simply state their sustainability goals or long-term targets. We believe that companies that can substantiate their environmental claims and align financing with a business strategy rooted in long-term ESG goals, will be better fit to withstand potential reputational, financial, and regulatory sustainability-related risks that will evolve over time.

Global harmonization

While demand for sustainable financing instruments remains strong, concerns around the accuracy of issuer sustainability claims can have profound impacts on the integrity and development of the sustainable finance market. Increasingly, sustainable finance instruments will become more diverse and nuanced, in part to accommodate the new reality: that each sector, even those that are hard to abate, must contribute to decarbonization if the direst consequences in the recent Intergovernmental Panel on Climate Change (IPCC) report are to be avoided.

In response to this risk, a number of standards – and taxonomies - have recently emerged that attempt to help standardize the market and mobilize capital toward sustainable objectives. The International Capital Market Association (ICMA) and the Loan Syndication Trading Association/Loan Market Association/Asia Pacific Loan Market Associations have launched a set of principles to promote standardization and transparency for use-of-proceeds and sustainability-linked bond and loan markets (the Principles).

While the Principles are voluntary, an estimated 97 per cent of use of proceeds and 80 per cent of sustainability-linked bonds issued globally adhered to them in 2020 according to ICMA and Environmental Finance.

As green taxonomies continue to be developed, the challenge will be finding a way to maintain global harmonization. This will need to be a combined effort of industry organizations, governments, standard setters, consumers, and other stakeholders.