30 September 2021
In its latest report, WWF poses fundamental questions about the debt capital markets, examining their rapid progress in the last five years and anticipating their evolution through this crucial decade, write Margaret Kuhlow and Jochen Krimphoff.
"The fight against climate change and nature loss requires substantial investment to change the way we use and produce energy, how we get from one place to another, how we make and transport things, and how we grow the food we eat every day. Debt capital markets – and the industry's professionals – can help us save the planet... and ourselves. Can Debt Capital Markets Save the Planet? helps to chart the path." Margaret Kuhlow, WWF Global Finance Practice Leader
Why debt capital markets matter
Every day, about $1 trillion changes hands in the global debt capital market ecosystem, currently valued at $281 trillion: ten times the size of the US economy.
These debt instruments are loans and bonds, most of which are issued to raise capital for specific projects, offering the investor fixed income in the form of a coupon or interest payment. The original capital is paid back to the investor by the issuer on maturity.
Traditionally, debt capital has been utilised to fund a variety of economic activities on behalf of governments, local authorities, state owned entities and large corporations, and underwritten by the financial sector.
But we all know that our current way of life is unsustainable, and these traditional activities have created more harm than good for our natural world, pushing the planet's ecosystem to the brink of collapse, and putting the real economy and financial stability at risk.
The Intergovernmental Panel on Climate Change (IPCC) Working Group I report, Climate Change 2021: the Physical Science Basis, released in August 2021, was clear in its findings – 'unless there are immediate, rapid and large-scale reductions in greenhouse gas emissions, limiting warming to close to 1.5°C or even 2°C will be beyond reach'.
A significant innovation in debt capital markets came in 2007 when the European Investment Bank (EIB) issued the first green bond – a climate awareness bond or CAB. They were followed a year later by the World Bank, paving the way for a new type of labelled instrument that focused on ensuring the funds raised were directed towards green or sustainable activities like renewable energy or climate-friendly transportation infrastructure.
Green, social and sustainability labelled bonds now account for up to 20% of the total bond market in some countries, illustrating an increased appetite and ambition toward zero carbon and nature-positive debt capital markets. This trend is accelerating, and global, sustainable bonds are expected to reach $1 trillion: more than 10% of all issuances for the year. In some market segments, growth is even faster. For example, sovereign bonds labelled as green have grown fifty-fold in the past five years, now exceeding $100 billion. And the market for a new type of instrument - sustainability-linked bond issuance by large corporations - is expected to grow six-fold from $10 billion in 2020 to $60 billion in 2021.
The dark side of bonds
By 2016 green bonds had developed into a fast-growing market that reached $90 billion, prompting an examination of the integrity of green bonds, and a call for effective and credible standards for the green bond market. Moreover, while the impressive growth in green bonds caught the headlines of the financial news in 2016, fossil fuel bonds had silently attracted more than $400 billion.
Five years later, that gap between green and harmful is still evident in a 'business-as-usual' approach by many issuers, underwriters, and investors. While peak fossil fuel finance is happening and it's downhill for coal, oil and gas, almost $4 trillion in debt was raised by the fossil fuel industry between 2015 and 2020, facilitated by the top 30 investment banks. The fees earned on that underwriting was double the fees generated from facilitating green or sustainability debt instruments. That earnings differential does not support the shift we need to meet the sustainability challenge before us. Is the momentum starting to shift? Can debt capital markets save the planet?
Investor capital shift must accelerate
Rapid changes are underway in the minds of investors as financial institutions align themselves with Nature-Positive strategies and form alliances to articulate their pledges toward net zero to curb carbon emissions. Under the Glasgow Financial Alliance for Net Zero, 250 financial institutions from 32 countries, representing $88 trillion in assets, have committed to transforming the financial sector by 2050.
However, these long-term commitments are not yet reflected in action and the 10 largest global asset managers and the 10 largest banking underwriters remain more vested in fossil fuel bonds than they do in debt instruments labelled as green.
Using Bloomberg data, the More-Harm-Than-Good-Indicator (or Significant Harm Ratio) divides the volume of underwritten fossil fuel capital by the volume of green labelled capital. A ratio above 1.00 indicates more harm, and a ratio lower than one indicates a move toward more sustainable, net zero investment practices.
Of the 39 institutions in the WWF More Harm Than Good league table, more than half currently have ratios above 1.00 – with some having as much as eight times more fossil fuel than green debt – and of those with ratios below 1.00, only two are on track to reach net-zero fossil fuel finance.
So, while rapid change is happening faster action is needed from investor coalitions and the investment banking arms of the largest global banks.
Financial regulators, supervisors and central banks must also step up
Just as they recognised the devastating impact of the Covid-19 pandemic and activated their tool kits to mitigate the resulting economic devastation, governments, regulators, and central banks need to treat climate change and biodiversity loss with the same urgency in order to prevent the devastating impact these will have on economies into the future.
As stewards of the global banking system, central banks, regulators and supervisors have the ability to direct lending facilities, monetary policy, term funding facilities and direct stimulus toward more climate-friendly investment and greener debt capital policy.
The Network for Greening the Financial System (NGFS) now has more than 90 members, including central banks and financial regulators from nearly every G-20 country, and has formally recognised that environmental issues must be addressed to protect financial stability, and immense potential exists within the existing toolkit of central bankers.
Defining standards and a common language requires urgent action by governments
With the substantial shift in debt capital markets toward green and sustainable labelled bonds and loans, there is a growing imperative for globally accepted standards.
The prevailing standard in green bond market practice is the Green Bond Principles (GBP), established by the International Capital Market Association (ICMA). 97% of all issuances align themselves with the GBP's relatively flexible, principles-based process guidelines.
Other organisations have developed standards, including the Climate Bonds Initiative, ASEAN Capital Markets Forum, the International Standards Organisation and the European Green Bond Standard, some of which are more prescriptive, with much sharper definitions of what can be considered a 'green' investment.
Effective and science-based standards are urgently needed to strengthen the credibility of debt capital market instruments labelled as green or sustainable, including both use-of-proceeds and sustainability-linked loans and bonds.
The majority of loans and bonds issued within debt capital markets are issued as 'general purpose' bonds that tell us very little, if anything about their environmental impact. Mandatory impact reporting would bring the transparency required to build the confidence and integrity needed to accelerate growth in green-labelled issuances. This greater transparency would also provide investors with more information about the real impact of the funded asset or entities, and lead to better decision making.
Mandatory reporting criteria should extend beyond ESG disclosures and broad use-of-proceeds information but to the core of an investment, its direct impact on carbon emissions, and its impact on natural ecosystems and biodiversity. This is what investors want and need to know.
The journey to 2030
Can debt capital markets save the planet? is a platform for introspection within debt capital markets, examining progress and anticipating evolution through this crucial decade, painting five scenarios for the future, from business-as-usual to Nature-Positive and Net Zero debt capital markets.
It remains in the hands of those vested in debt capital markets to recognise the investment opportunities, as well as economic viability in clean energy, net-zero transport systems, Nature-based Solutions and ecosystem and environmental restoration, and pioneer a change in investment paradigm.
Margaret Kuhlow is Finance Practice Lead, WWF International
Jochen Krimphoff is Initiative Lead, Sustainable Bond Markets, WWF France