While the past year and a half has been a wild ride from all angles – as the pandemic rattled our planet – it was also a dynamic time for sustainable debt markets, including record issuances and growing popularity of social and sustainability-linked bonds.
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As Scotiabank's Sustainable Finance group reaches the one-year mark since the Canadian-based Bank formally accelerated its sustainable finance mandate, members of the team reflect on industry trends, and what lies ahead, including the prospects for transition finance and the improving diversity among sustainable capital issuers.
Record growth in unusual times
The numbers definitely indicate a trend, notes Melissa Menzies of Scotiabank's Sustainable Finance group. She points to dramatic data that reveals how global sustainable debt markets raised more than USD$750 billion in 2020, up more than $160 billion from 20191. The data highlights skyrocketing growth among specific instruments, including 100% year-over-year growth in sustainability-linked bonds and sustainability bonds.
And the future appears bright. With sustainable debt totaling $1.3 trillion since the market's inception, and issuances already exceeding $450 billion in 2021, at Scotiabank, we are anticipating over US$1 trillion of issuance of sustainable debt (bonds and loans) this year.
Bob Nguyen, Managing Director and Head, Corporate Fixed Income Origination, observes that the sector's recent performance mirrors the growth of Scotiabank's own dedicated group over the past year. "It's an exciting time, since we've doubled our team size, increased the range of financing products and advisory services we provide, and really grown our transaction volumes," recounts Nguyen. He notes that this recent growth builds upon the Bank's extensive experience delivering sustainable finance solutions to government and corporate clients.
The market likes linked instruments
Focusing on the most recent events, Melissa Menzies and Sean Locke, another member of the Sustainable Finance group at Scotiabank, see the market's growing interest in sustainability-linked instruments among the top recent trends. With use of proceeds instruments, proceeds must be used to fund eligible green and/or social activities and projects, while sustainability-linked products contain a linkage between pricing and pre-established sustainability targets, where there is no restriction on the use of proceeds.
Menzies explains that "This instrument is making the market more inclusive, since it's attractive to private or public sector issuers who may not normally be capital-intensive businesses or have large green expenditure plans. Instead, it's opening up the market to organizations in a wider range of sectors that want to start reducing their emissions or other material ESG factors by setting ambitious targets."
She points out that sustainability-linked products are an excellent way for a company to align its sustainability strategy and financing program. "And, it creates an extra incentive for the company to exceed its sustainability targets, since these instruments do reward outperformance by the issuer."
Aligning reporting frameworks
Just as global accounting and reporting standards brought clarity and transparency to investors, there is optimism that current initiatives to standardize green and sustainable reporting approaches will also have a positive impact.
Locke points to the EU Taxonomy regulation, to create a European-wide classification system for sustainable activities. This near-finalized framework would provide corporations and investors with guidance on economic activity that qualifies as environmentally sustainable. It will complement the EU Green Bond Standard, to improve the effectiveness, transparency, comparability and credibility of Europe's green bond market, and expand upon existing Green Bond Principles.
"We're hopeful this harmonization of definitions in the EU will spur more interest and issuance in Europe and ultimately trickle down to other markets," says Locke. "However, there is also the possibility of unintended consequences, as it could slow activity among issuers and investors who must adapt to the stricter requirements."
Similarly, rising momentum to align various corporate reporting standards for sustainability disclosure could also impact the marketplace. With public and private sector organizations increasingly frustrated by the vast array of corporate reporting standards, discussions are underway among the CDP, CDSB, GRI, IIRC and SASB to develop a comprehensive, corporate reporting system. "These efforts will likely be welcomed by corporates, since it will enable better 'apples-to-apples' comparisons in sustainability reporting," says Menzies. "However, there is much work to be done to agree upon a shared methodology, since current methodologies among the framework- and standard-setting institutions have different impacts on the way each issuer reports performance, as well as how investors interpret and apply this information."
Big words and events move markets
In a market that thrives on 'buzz', Menzies and Locke point out that upcoming, high-profile climate meetings – and the resulting pronouncements from global political and business leaders – will also drive the sustainable debt markets.
Among the milestone moments, with the U.S. rejoining the Paris Agreement, the world will turn its attention to the UN Climate Change Conference (COP26) in Glasgow in November 2021. "These events really galvanize the international community, and they inspire a lot of collaboration and commitments at the sovereign and corporate levels," opines Locke.
In particular, COP26 could spark even greater excitement around the multiplying 'Net Zero emissions by 2050' pledges made by corporates and governments. "We've already seen more than 130 countries commit to net zero goals, so this summit could be the catalyst to bring the other half of the world on board," predicts Menzies.
At the same time, she cautions that, beyond the hype, everyone must focus on the underlying meaning of 'net zero' and how they can actually get there: "We're showing our clients that there are lots of ways to model it and set interim targets once you define it, but it's important to recognize that it won't be an easy path, and targets and strategies will have to evolve."
The future of transition finance
While Menzies and Locke describe many clear trends, they say there is less clarity regarding the near-term scenarios for transition finance in the Americas. They note that, despite some transition bond issuances in Europe and Asia, there has been muted interest in North and Latin America for this instrument that enables issuers to direct the use of proceeds to transition projects.
Locke explains that some market participants may be deterred by the lack of clear standards for acceptable use of proceeds. He adds that Scotiabank is a member of the Canadian Standards Association Working Group, to set a national, transition finance taxonomy. "In the meantime, many domestic and global leaders in the resource intensive sectors, including energy and mining firms, are being very thoughtful in the way they develop robust transition strategies," says Locke. "This takes time, and they don't want to rush a transaction to market that could impact their credibility or bring reputational risk."
Menzies agrees, noting that many issuers are opting for sustainability-linked instruments as a first step. This enables them to address holistic sustainability targets rather than focusing on specific transition projects: "For that reason, the sustainability-linked bond or loan model suits a lot of issuers, and they may choose those vehicles, before they decide to build out a transition finance framework or explore some hybrid form of financing down the road."
Putting new trends in motion
Despite the uncertainties, Scotiabank's Sustainable Finance group has been busy helping an increasingly diverse selection of clients participate in these unfolding opportunities. For example, the Bank has served as lead arranger for over $50 billion of labelled sustainable bonds, and participated in over $100 billion labelled sustainable bonds and loans.
"Given the historical concentration of carbon-intensive industries in the Americas, we're really pleased with our efforts to partner with these clients and help them transition to a lower-carbon economy," says Locke. He points out that, in parallel to the sustainable finance services they provide to corporate and institutional clients, Scotiabank has committed to meeting its own Climate Commitments, and recently launched the Scotiabank Climate Change Centre for Excellence and a Net Zero Research Fund. The Bank also supports a wide range of industry, academic and government collaboration, including a partnership with the Institute for Sustainable Finance at Queen's University.
"Looking back over the recent intense months, with record growth for sustainable debt markets, there is great opportunity to help our clients respond to the future-forward trends we see," concludes Bob Nguyen. "In particular, we're applying fresh thinking and developing innovative solutions to engage a broader spectrum of companies in meeting their sustainability challenges."
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1 BloombergNEF, January 14, 2021
