Aligning finance with purpose

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Companies need to pull every lever they can to help them meet their sustainability objectives: tapping sustainable finance can help align their financing strategy and their investors with their ESG goals. Mark Nicholls reports

The clock is ticking on corporate sustainability goals. Under pressure from customers, regulators, employees and investors, companies recognise that they urgently need to reduce their impacts and demonstrate their contribution to addressing the world's sustainability challenges. Given this urgency, they need to use every tool they can to drive progress.

Sustainable finance is becoming an increasingly powerful lever in this effort. With investors joining the dots between environmental, social and governance (ESG) performance and financial performance, there is growing demand for debt instruments linked to corporate sustainability goals.

Leonie Schreve"If anything, the COVID pandemic has only pushed sustainability higher up the agenda of both corporates and investors, adding a focus on social issues to existing concerns about climate change," says Leonie Schreve, ING's Netherlands-based global head of sustainable finance. "There's a push from all sides: investors, regulators, customers. But what we're seeing now, through sustainable finance, is the coming together of sustainability, corporate strategy and funding."

There has been an explosion in the issuance of sustainable debt. According to Refinitiv, around $750 billion of sustainable bonds and loans was issued in 2020. Of that, sustainable bond issuance was up 96% on 2019, to $544 billion.

A key benefit of such products for the issuer is that they can align financing directly with sustainability goals and overall corporate strategy – leading to conversations between treasury and sustainability functions that might not have been taking place before.

"In the past, we saw a lot of companies putting out sustainability targets, but there often wasn't a connection with the rest of the organisation or real integration with strategy," Schreve says. "By tying sustainability into the financing structure, it helps promote the agenda internally, as well as sending a strong message to the outside world."

Typically, structuring sustainable debt products will involve dialogue with financiers and investors to identify the most material ESG factors against which progress will be measured, and a process of agreeing stretching but achievable goals. Working with external stakeholders can provide a sense-check as to the relevance of key indicators.

Some products, such as sustainability-linked loans, tie the interest paid by the issuer to the achievement of pre-agreed targets. This creates a financial incentive for improved sustainability performance and a penalty for declining performance.

These links tend to spur more rigorous accountability and transparency, issuers say. According to a recent survey by ING of 450 companies and 100 institutional investors, 73% of companies which have issued sustainable finance products say the process helped them put robust metrics in place. For those with closely integrated finance and sustainability teams, that figure rose to 81%.

Ana Carolina Oliveira"Compared with the voluntary disclosure of ESG metrics, companies are required to disclose ESG information to their investors," says Ana Carolina Oliveira, ING's head of sustainable finance for the Americas. "This creates this element of enhanced transparency."

Such metrics need not be restricted to companies' direct operations. For many companies, their value chains represent their largest environmental and social impacts. Research from Scope Ratings found that an average of 60% of the environmental impact of companies in the MSCI World Index was in their supply chains; for companies in the food sector, that figure rises to 88%.

Schreve gives the example of a €300 million sustainability-linked loan from ING to Dutch dairy firm FrieslandCampina, linked to reductions in greenhouse gas emissions in its supply chain and increased traceability of raw materials such as palm oil, soy and pulp and paper. "Its ambitious KPIs are tied into its whole value chain," she notes.

Sustainable finance issuance offers an additional benefit for corporate issuers: strong investor demand means that sustainable debt often prices tighter than equivalent conventional paper, says Schreve. "It's in the interest of the issuer to put out debt in a green or sustainable format because of this enormous investor interest."

This demand notwithstanding, investors have specific preferences. For example, they want to see green and sustainable debt issued in line with the leading industry standards, such as those from the International Capital Markets Association. They also want to see efforts that go beyond business as usual, says Oliveira. "'Additionality' is an important word: they want to see clear incremental improvement and ambitious targets."

"It's about transparency and disclosure," says Stephen M. Liberatore, head of ESG/impact, global fixed income, at Nuveen, a $1.2 trillion investment manager. "We want investments to be quantifiable in terms of how the proceeds are being used and what the outcomes are."

"If an issuer is coming to market with a security that delivers some kind of social or environmental impact, they need to be ready to prove that," he adds.

Strong demand from investors, alongside clear benefits to issuers, mean that sustainable finance is expected to grow strongly in coming years – helping companies meet their sustainability goals more quickly. "Tying together corporate sustainability with treasury goals, investment plans and enhanced transparency is only going to accelerate the sustainability agenda," says Oliveira.