With each participating country setting its own emission-reduction targets, the Paris Agreement has driven a meaningful shift in the international business landscape over the recent years. More organisations are actively addressing their longer-term exposure to risk and opportunity as relates to decarbonization and to climate change, with increasing recognition that environmental impact carries real cost.
In the near future, finance will become synonymous with “low-carbon” finance, with an estimated US$6.9 trillion per year of climate-aligned infrastructure spending required to meet the Paris Agreement’s goals of keeping global temperatures from exceeding 1.5°C – 2.0°C above pre-industrial levels.
As but one indicator of the path of travel for climate finance, the Net Zero Asset Managers initiative – an international group committed to supporting the goal of net zero greenhouse gas emissions by 2050 or sooner – has 236 signatories with US$57.5 trillion in assets under management (AUM).
Most major lenders have articulated ambitious net zero emissions targets with sustainable debt (environmental, social and governance) surpassing $1.6 trillion in 2021, more than doubling what it was at the end of 2020.
What does this all mean for organisations seeking financing today?
Historically, “green financing” was generally determined based on jointly defined and agreed upon criteria between the lender and borrower – such as whether or not the use-of-proceeds were being used to finance assets in certain green categories. Once a financing was determined as meeting such criteria, ongoing verification of the “greenness” of financed assets was limited. Whilst stipulating that the use-of-proceeds is for developing, constructing or operating a green asset is a good start, assets within any particular asset class can vary significantly in terms of actual environmental impact.
For reference, the amount of emissions reductions ultimately achieved by the thousands of assets financed under the Kyoto Protocol crediting mechanisms varied from over 100% of emission reduction targets to well below 50%, some consistently and some with great volatility. Any emission reductions are positive, but when managing a book of carbon credits or marking the impact of green finance, there is significant risk and opportunity that arises from being able to predict and ultimately quantify the outcome.
Similarly, credit rating agencies who rate green financings largely performed up-front tests of whether assets were deemed to meet ESG requirements, with infrequent and manual verification. As high quality and accessible data was historically sparse, sustainability claims implied by green ratings have been challenging to verify in a cost-effective and reliable manner.
Whilst efforts to verify environmental claims have been implemented and improved over decades, the practises and technology necessary to measure and report the environmental impact of financing in a cost-effective and scalable manner has been inadequate.
However, with the impetus of the Paris Agreement together with domestic and cross-border climate finance frameworks around the world, the effort to improve the verification of green finance has increased alongside the increased commitments to green finance. Some efforts are large and lumbering, some or narrow and tactical, and in the aggregate, things are altogether moving in a positive direction with respect to verified green finance.
An increasing number of corporations are publicly announcing voluntary sustainability goals, and along with that, efforts to steer inadvertent or intentional greenwashers toward genuine and lasting impact are on the rise. Whether it’s the corporate beneficiaries, the providers of green finance, the regulators, the ratings agencies, the standards bodies; there is a resonating voice in the market demanding better, more transparent and more cost-effective verification. Financing that is billed as ESG or climate-positive, must measure claims in a credible and verifiable way.
Today, borrowers, lenders, rating agencies and other stakeholders are able to benefit from far more data-rich measurement, verification and reporting solutions, not only reducing cost and reducing the need for site visits, but also creating significant financial optionality for assets that can bring this data more quickly into green finance markets. With digital solutions that are now available, we are starting to see standards and ratings protocols that apply to green financing adapt, increasingly requiring more regular assessments, more robust reporting, and higher quality data.
The vulnerability felt worldwide over the COVID-19 pandemic seems to have instilled in many people a greater sense of the real risk imposed by climate change, and the need for sensible action. This is not due to a direct cause-and-effect relationship between COVID and climate change, but rather COVID has demonstrated that humanity can indeed mismanage global risk and suffer at scale.
The challenge of getting qualified parties out in the field to verify the greenness of assets, which is costly and difficult at the best of times, has increased materially over COVID (site visits have shifted from difficult to hard or to impossible), further shining a light on the need for alternative and ideally digital verification solutions.
In a world that requires increasingly evidence-based environmental claims, verifiable impact data is beginning to allow for access to better ratings and therefore better debt – be it cheaper, longer-dated or more sculpted to the borrower’s financial reality. With better financing comes growth, strength and longevity as an organisation, whether it is a corporation, financial institution or government entity.
The growing shift toward green financing doesn't just affect developers and operators of definitively green assets. With government and industry commitments toward net-zero greenhouse gas emissions, taking a “business as usual” attitude toward finance will place borrowers and lenders at risk, particularly those with a capital-intensive physical or even virtual (i.e. digital or computational) footprint. Increasingly, the question of getting better finance as mentioned above will give way to the question of accessing financing at all.
Again, finance is on its way to becoming synonymous with green finance.
Much of the trend toward green finance can be said to be taking shape in the voluntary markets. Given ESG goals announced by financial institutions, individuals sitting at a debt capital markets desk are now under great pressure to find sustainable initiatives and to make evidence-backed green loans.
There is a bottleneck tightening, with a large amount of capital set aside for green financing and not enough borrowers with qualified assets that have verification systems in place. A similar bottleneck appeared in the early years of the Kyoto Protocol markets, and as painful as it was then, it is far more severe this time around. Quality operators who can prove themselves worthy of green finance, with systems in place to report to financiers, are becoming prioritised.
This is an important time to reassess your ESG strategy, or to start developing one if your organisation hasn’t already. Assess the current state of your sustainability program, set meaningful goals and create a viable roadmap to achieve these targets.
This is vital in today’s business climate, not only to access financing, but to manage risk, increase shareholder value, stay competitive and for long-term stability and growth.
Given that many organisations simply have not captured quality ESG data, they have often relied on estimates and manual reporting of environmental impact. This will not serve these organisations well in the long-term as lenders and credit rating agencies are demanding data-rich, verifiable reporting.
An effective sustainability data management solution can provide automated and frequent collection of verifiable, auditable data. Aside from the benefits of accessing financing, this is also more efficient and cost-effective for your organisation compared to traditional manual checks. Importantly, given the growing types of financial instruments (e.g. carbon credits, carbon-related advanced payments, carbon options, etc.), having your carbon-relevant data on digital rails creates significant optionality.
Data is key in this rapidly changing environment and it is vital for organisations to prepare for these new market standards. Get your physical and your virtual house in order and know where you stand with respect to verifiably green operations.
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