This week’s roundup of trends in sustainable finance looks at forthcoming ESG regulation, growth and evolution in the green and sustainable bond markets and the collapse of the Bonn climate talks due to disagreements over climate finance.
Debate over ESG ratings may be moot as regulation looms
The EU has published its Sustainable Finance Package, with a series of legislative and non-legislative announcements. It is likely to be the final set of major releases on sustainable finance under this Commission. While it has the publication of the draft Delegated Act on ESRS, some detail on transition finance, as well as new and updated taxonomy criteria, it’s the section on ESG ratings which is of most interest.
Consultation on the draft reported market demand for improved ESG ratings as one of the key data points for investment decisions. Currently, around a third of consultation answers assessed the quality of ESG ratings as not good enough, illustrated by the low correlation of results from different providers.
The new approach will mean a forced separation of ESG ratings providers and their ESG scoring businesses. The goal is to prevent over the conflict of interest issues that have dogged the large consultancies that provide advice and audit services. Not only that, but ESG ratings providers will need to be authorised and supervised by the European Securities and Markets Authority (ESMA). In a statement the EU said: “This will also ensure the quality and reliability of their services to protect investors and ensure market integrity.”
The introduction of rules within the EU bloc is a major shift in the market and will have global repercussions, although think-tank E3G has warned the EU is lagging behind jurisdictions like the UK, Japan and Southeast Asia when it comes to transition finance. Within the EU regulations around transition are split across a number of regulations, while other jurisdictions are moving forward with policy approaches such as transition planning, transition taxonomies, and sector pathways.
Transparency demands continue
While there’s been a lot of debate about the efficacy of ESG metrics, Ben Caldecott, of the founding director of the Oxford Sustainable Finance Group called for more academic freedom and protections for ESG researchers in the FT. He warned that financial institutions, and backers of ESG researchers, have been reported in “trying to change the results of research before publication, or have attempted to prevent it from being published at all, to protect their products and services.’
He’s calling for protections for academic freedom, including whistleblower protections and an end to data provider demands for review before the publication of academic analysis. Given the political battle being fought over ESG, its vital that independent research and analysis continues to be carried out, in order to understand the impact of the use of the investment lens.
Bond markets continue to grow and evolve
While appetite in the sustainable and green bond market may have dropped off this year, a new German 30-year green bond was massively oversubscribed and data from Bloomberg reported that May 2023 was the most active month in the green bond market since 2017, with the sale of $62.3 billion in sales. Meanwhile BNP Paribas has projected that 2023 could see the strongest performance yet in the green and sustainable bond market, suggested full year sales of around $600 billion.
There is also continued focus on the potential within transition, with news that Blackrock has launched a Transition Materials Fund, where the goal is to focus on the materials required for effective transition. This means the shovels in the goldrush, or the infrastructure need for transition – with a particular focus on mining, metals, cement and construction. It will be an Article 8 fund under new EU Sustainable Finance rules.
In a letter to clients, the asset manager pointed out that the share of countries committed to net zero has swelled from less than 10% to 95% of global emissions and stated: “In the beginnings of a tectonic shift of capital, investors have moved their money into sustainable investments at six times the growth rate of traditional investments, with assets globally now totalling $4 trillion across all ESG categories.
According to Blackrock, the new fund will hold a concentrated portfolio of 30-60 global companies across a range of market caps, in categories including “Emissions reducers,” or materials companies with plans to reduce emissions intensity or dedicating more than 30% of capex into carbon reduction strategies; “Enablers,” including companies that generate a significant proportion of revenues from lower carbon end markets, or from solutions that help materials companies reduce their own emissions, and; “Green leaders,” including materials companies in the 1st quartile for the MSCI Carbon Emissions Score in their industry.
At the same time, new financial mechanisms continue to be developed. Guy Carpenter, in collaboration with Dr Franziska Arnold-Dwyer from Queen Mary University of London, recently announced the proposal of a Climate Resilient Development Bond (CRD Bond), a new re/insurance structure designed to address climate risk at scale.
The proposal is to use the capital stack approach, accessing different elements of the financial markets for different parts of the mechanism, to create a final product that can address resilience issues. It uses the same model as proposed for city cooling, the Cool Capital Stack, launched by Arsht-Rock at COP27.
The goal is to provide community-wide coverage, with municipalities able to secure cover from an insurer on a multi-year basis. The outline proposes a mix of community-based insurance, stacked investment, and advanced funding for loss prevention measures, leveraging what Guy Carpenter describes as an enhanced insurance-linked security (ILS) structure with cover offered on a parametric trigger basis.
The use of parametric insurance is a growing focus on the nature and biodiversity space, as it remains challenging to create financial mechanisms that can work in the modern financial markets, especially with their short term focus on financial payback.
Cross border standardisation a signal for climate finance as Bonn talks struggle
The Australian government signed a Joint Statement with New Zealand following a meeting between Treasurers and Climate Change Ministers. The Statement agrees to accelerate climate action by identifying shared economic opportunities to navigate a successful transition to net zero.
Yet the climate negotiations at Bonn have struggled, with states continuing to disagree even about the agenda for the negotiations. An agenda was only agreed on the second to last day of the meeting and left a difficult path towards negotiations in Dubai at COP28. Climate finance remains the central issues that is unresolved, with a lack of trust between parties underscored by wealthy nations failure to provide promised funds for mitigation and adaptation.
