Green finance has quickly become an effective tool in the global push to develop and fund clean energy solutions. With governments around the world focused on lowering carbon emissions, sustainable financing options are an increasingly popular mechanism in the pursuit of achieving climate change targets.
While the market is still very much in its infancy, the popularity of sustainable finance continues to grow. Green bond issuance, for example, doubled in value to US$82.6 billion in 2016 compared with 2015 as issuers looked to diversify their funding sources to help finance environmental projects. But even with the rapid rise in demand for green finance products, we are still only scratching the surface in terms of its scalability. This rings especially true when one considers that the International Energy Agency estimated in its 2016 world outlook that $44 trillion would be needed to decarbonise the global economy by 2040.
In many ways, the evolution of the green bond market bears striking similarities to that of the Islamic bond, or sukuk, market. Both expanded significantly over a short period as issuers and investors became more comfortable with their guiding principles.
A major supporting factor in the rising interest in green bonds was the successful negotiation of the UN COP 21 Climate Agreement in 2015, a pact that increased national initiatives to establish green bond principles. On the back of this development, we expect that this year the market for green bonds will surpass the milestone of $100bn in a single year.
The signs in the Middle East are also encouraging and demand for green finance is building good momentum. In late March, National Bank of Abu Dhabi sold a $587 million green bond, the first of its kind in the Middle East. In line with its sustainable aspirations, NBAD (now First Abu Dhabi Bank) said it would use the proceeds from the debt issue to fund efficiency and renewable energy projects.
The motivation to embrace green finance is straightforward. Besides portfolio diversification, many investors are under pressure from asset owners and shareholders alike to integrate environmental, social and governance principles into their investment decision-making process. For issuers, beyond being seen to be a good corporate citizens, green bonds, for example, can open up fresh capital flows in terms of new shareholders. It also sends a strong message as to a company’s core values and beliefs.
Green finance does not come without its own set of unique risks, however. One common concern is “greenwashing”, whereby a company or issuer will exaggerate their environmental credentials. While a set of Green Bond Principles was launched in 2014 to encourage transparency, disclosure and integrity in the market, more work needs to be done to protect this nascent industry’s reputation.
In this regard, S&P Global Ratings last month launched the Green Evaluation, a tool that provides investors with a globally recognised level of transparency in terms of green credentials. The tool facilitates the identification of the green contribution of a financing by highlighting the portion of funds dedicated to green investment and assessing its environmental or resilience impact. The tool can be used for any type of financial instrument including stocks, bonds, loans and securitisations.
It is only through this type of innovation that sustainable finance can deliver on its potential. By enabling investors to easily identify projects that have high environmental quality, the industry can make greater progress in improving transparency and building credibility. And as the shift to clean power gains traction around the world, so too then will green finance.
Karim Nassif is an Associate Director of Project and Infrastructure Finance at S&P Global Ratings, which is a member of The Gulf Capital Market Association.