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Strategy and innovation
Green finance and the future of business sectors.
Central banks and regulators have already acknowledged the serious consequences of the impact of climate change on the economy, and they are also urging the financial sector to incorporate environmental risks into the comprehensive risk management of its activities.
The underlying reason is the substantial impact that climate change and other environmental effects have on the value of assets and the continuity of certain businesses. The risks are no longer limited to environmental risks: they are financial in nature and end up having a systemic impact upon credit, insurance, the market and transactional risks.
Therefore, the green financing paradigm shift in banking is already a reality and a necessity, and in Europe there a real convergence between economic policies and the financial sector is beginning. There is a clear commitment from governments around, which are all aligned on climate risk and that the financial and insurance sector must anticipate the impact of climate change on the economy. Additionally, all central banks are working on climate risk analysis and the European Central Bank environmental stress tests are planned for next year. And to the foregoing one can add the response of private capital, which is constantly increasing investments with environmental and social criteria.
And this is already being noted: The entire European recovery program, Next Generation, has a sustainable component. The sustainability evaluation will be included for all projects financed.
The 3 major objectives of the EU's Sustainable Finance Plan:
1. Redirect capital flows towards sustainable investments.
And as a result of this, a system for classification of all EU economic activities into sustainable (green) activities and unsustainable (brown) activities depending on whether or not they contribute to a future decarbonization of the economy. This taxonomy seeks to facilitate investors' valuation and orientation in order to decide their investments.
2. Include sustainability in risk management.
Include sustainability in market studies and in ratings. Clarify the obligations of institutional investors and asset managers. And include sustainability in prudential requirements.
3. Encourage transparency and long-term perspectives.
Reinforce the dissemination of information about sustainability and the development of accounting standards. Promote sustainable corporate governance and reduce short-term perspectives in capital markets.
New responsibilities of executives and advisors
Companies must make their strategic decisions not only in financial terms but also in terms of their environmental and social impact and their impact on people. Executives must get companies to focus on creating long-term sustainable value rather than creating short-term financial value.
To have companies to focus on creating sustainable long-term value rather than creating short-term financial value, taking into account risks to sustainability. And there will be legal bases that require companies to take responsibility for the adverse impacts that their global activity may have human rights and the environment, both for their direct operations and in their value chain.
Green financing: Framework of sustainable bonds
The sustainable bond market has expanded since 2017 and now has a volume of 1 trillion euros with 64% being issued by European countries, 56% being bonds issued in euros and 67% being green bonds.
Four types of products exist:
1. Green Bonds:
Its inflows are utilised exclusively for financing environmentally focused projects. Initially considered to be a marketing tool, green bonds have become the oldest and most prevalent type of sustainable bond.
3. Social Bonds:
Its inflows are utilized exclusively to finance projects that seek to achieve a positive social outcome. Last year, with the COVID crisis, they have experienced a big push forward, especially in Europe. They have reached the threshold of €130 billion, 1/3 of all sustainable bonds in 2020.
2. Sustainable Bonds:
They finance environmental and social projects. They mix the two foregoing types.
4. Bonds linked to Sustainability:
These are not limited to a specific environmental or social project, and instead these can be utilised for any type of activity as long as there is a resulting environmental or social improvement. The first bond linked to sustainability was launched by the Italian group ENEL in 2019. They amount reached €2 billion in 2020.
They work exactly the same. What makes them different is the issuer's commitment to dedicate them to environmental or social purposes. What counts is that commitment and its tracking such that a bond is considered to be sustainable.
The disadvantages of sustainable bonds, as compared to traditional bonds, are the additional time spent preparing them (documentation), establishing criteria and thresholds for projects, selecting and supervising them, adhering to a second-opinion process and monitoring the decline of the revenue and its anticipated impact over the bond's lifetime.
But the benefits are that they communicate the issuer's sustainability objectives, fund its transition, diversify its investor base, and attract new investors. They may also offer potential cost advantages (reduction of sales expenses, marketing, etc.). And for the investor there are secondary liquidity advantages because sustainable bonds are highly sought after in the market and are more easily resold than traditional bonds.
A new taxonomy: green or brown
The Taxonomy published by the EU refers to a European Commission regulation of the integration of sustainability factors, risks and preferences for the control and governance requirements of the applicable products.
This means that it is a new classification of economic activities which contributes to the environmental objectives of the EU and that this list of assets allows investors to understand whether an activity contributes significantly to the sustainability objectives of the Union European in a much more objective manner.
Today it is the first taxonomy applied globally to this area and it will influence all future ones. It is also expected to last a long time. This taxonomy has identified 6 environmental objectives:
- Mitigation of climate change.
- Transition to a circular economy.
- Sustainability and protection of bodies of water and marine resources.
- Adaptation to climate change.
- Prevention and control of contamination.
- Protection and restoration of biodiversity and ecosystems.
For an economic activity to be aligned with the taxonomy, it will have to demonstrate that it satisfies at least one of these 6 environmental objectives. In which case it will be a green activity (or investment). Otherwise, if it does not meet any of the 6 objectives, then it will be a brown activity.
In order to provide a couple of specific and relevant cases, energy generation activities that use fossil fuels are not considered within this taxonomy. This leaves out natural gas, even though it is the best substitute for coal and has much lower emissions.
And regarding nuclear energy, which has a very low level of carbon emissions, it has also been excluded from the taxonomy due to its risk and the waste that it generates. But this case is still being debated today.
A new scenario for sustainable finance and insurance
The EU taxonomy right now it is running in parallel with the COVID crisis and the Next Generation plan, to help financial agents identify the risks and opportunities of sustainable investment. Keep in mind that 30% of Next Generation plan bonds will be green bonds.
The taxonomy is also a response to the accusations of "green washing" against some large companies which tried to mask activities with obvious negative environmental impact using "green" marketing. On the other hand, with the new taxonomy the bond market will be much more transparent and rigorous from now on, companies will have to very clearly establish their environmental objectives and financial products which aim to be sustainable will have to specify the specific investments by the funds and how they align with the European Union's objectives.
New classificationThis new classification of economic activities contributing to the environmental objectives of the EU and this list of assets allows investors to understand in a much more objective manner whether or not an activity contributes significantly to the European Union' sustainability objectives.
Finally, the taxonomy does not prohibit the financing of the excluded activities (natural gas, for example), but it does prohibit that it be done through green or sustainable funds, such that in the long term the cost of financing for these projects will rise and their liquidity will decrease... therefore the cost of this capital will increase and those who invest will face increasing reputational and regulatory risks.
Prepared information from the Green Finance Conference for CFOs organized by the Franco-Spanish Chamber of Commerce and Industry and by Bankinter, which included the following speakers:
- Senén Ferreiro Páramo: Partner-Director of Valora Consultores. President of the Franco-Spanish Chamber of Commerce and Industry's Commission for Sustainable Transformation and Green Finance.
- Muriel Larrieu: Deputy General Director of Credit Agricole in Spain. Vice President of the Franco-Spanish Chamber of Commerce and Industry's Commission for Sustainable Transformation and Green Finance.
- Francoise Rameau: CEO of Crédit Agricole Spain and Portugal.
- Rafael Duarte González: Director of International Banking Relations at Bankinter.
