HSBC: If Sustainable Finance is to Really Work, Mainstreaming Needs to be the Priority in 2018

If volumes are anything to go by, 2017 was a watershed year for green bonds, with the market seeing more than USD130bn of these securities issued globally. Emerging markets saw their fair share of firsts, including Latin America’s first sustainability bond, and the first green bond in Africa, while China continued to dominate the supply pipeline

Feb 2, 2018 // 9:22AM

For Daniel Klier, Group Head of Strategy and Global Head of Sustainable Finance at HSBC, those successes are certainly encouraging – but more needs to be done to mainstream the asset class and convince corporate treasurers to take the plunge if climate change mitigation targets are to be achieved. Klier speaks with Bonds & Loans about what banks, investors, and governments can do to help, both in Latin America and further afield.

Sustainable finance is very well suited to infrastructure, and there is a huge need for infrastructure in Central and South America. To what extent do you see sustainable financial instruments playing a meaningful role in funding initiatives that plug the continent’s infrastructure deficit?

Between 2008 and 2013, the average annual investment in infrastructure ranged from 2.4-3.2% of the GDP, far from an estimated need of 6% included in a World Bank publication, according to the Development Bank of Latin America (CAF), and far form 7.7% levels in East Asia. Public-private partnerships (PPPs) account for about 40% of Latin America’s infrastructure investments, and they depend heavily on government support: about a third of their financing comes from public sources, and about half of all deals receive some type of government guarantee.

Furthermore, in Latin American countries, more than half of the population is not part of the regulated financial system; the immediate and basic needs such as health and sanitation, education and other political and social difficulties are the priority of the public expenditure to attend.

The shortage in infrastructure investment, the state of financial markets in the region, and the unlikely scenario of seeing investments in infrastructure from traditional sources exceed 1.5-2.5% of GDP in the near future, makes the private sector and the development of financial funds, green bonds, microfinance, credits for sustainable projects essential for incentivising the development of low carbon and resilient infrastructure. Latin America countries’ commitment to the 2030 Agenda for Sustainable Development also makes this more urgent to prioritise sooner rather than later, especially given the long-term nature of infrastructure projects.

There seems to be growing support for the development of a local currency green bond market in Mexico among other countries in the Americas and beyond, but with so much liquidity for these instruments located in countries in Europe and the US, do you see any liquidity challenges or mismatches preventing their development? What do you see as some of the barriers to the development of viable local currency markets for sustainable finance instruments?

Mexico and Latin America are not the exception, there is ample liquidity in the local market as well so this should not prevent the market from developing. Institutional investors are committed to supporting the growth of sustainable green bond markets. Labelled green bonds issuance increased USD5.8bn in the last year for a total of USD7.5bn, including two bonds issued by sub-sovereign entities – Mexico City and La Rioja Province in Argentina – and the largest issuer in the Region, Mexico City Airport. Brazil and Mexico, the two regional leaders in green finance, have created local green bond market development councils and international development banks are also playing an important role in the issuance of green bonds. Issuance of green bonds in Latin America is increasing and local investors are ready to invest in green bonds from the region, the table is set.

One barrier to local currency market development is that, unlike institutional investors, local emerging markets investors are in the very early stages of ESG integration and the development of dedicated green investment commitments. As responsible investment practices – ESG risk assessment and best-in-class security selection, climate finance targets, and portfolio decarbonisation – gain traction with EM investors, demand for sustainable finance instruments should deepen.

Governments are often one of the biggest drivers when it comes to incentivising market activity to help combat climate change. If you could hone in on three things governments are doing well when it comes to fostering the development of a sustainable finance market, what would they be? Similarly, what could they be doing better in 2018 and beyond?

The development of policies and regulatory frameworks which enable and facilitate business engagement on sustainable finance activities is key. This includes incentives for businesses to invest in green markets and push forward the consumption of green products.

Within developed countries there are macro-economic, social, industrial and environmental public policy opportunities to enable the consumption of renewable energy and create a competitive framework to boost the development of green products. In emerging markets, there is an opportunity to create environmental frameworks and policies to increase the private investment on renewable energy, and a few notable examples can be found in Mexico, Costa Rica, and China.

In January of 2016, the Mexican government began the process of deregulating its electricity market. With this new reform, the electricity market in Mexico will open to competitive distribution and generation as more developers enter the space to sell electricity to CFE and other Electric Service Providers (ESPs) via the newly established wholesale marketplace. For commercial, industrial, and institutional (C&I) customers with high electricity consumption in Mexico, this is outstanding news. The primary result of the reform will be the expanded capability to sign bilateral renewable power purchase agreements (PPAs) directly with independent power producers in order to source electricity for Mexican operations. For example, thanks to this initiative, 50% of the energy consumed by HSBC Mexico will be generated through renewable sources, which will lead us to decrease from 3.2 CO2 to 1.7 CO2 tons per colleague within the country.

Costa Rica meets a huge amount of its energy needs using hydroelectric, geothermal, solar, wind, and other low-carbon sources. Costa Rica aims to be entirely carbon-neutral by 2021, and has put in place an ambitious plan to achieve that.

China adopted a policy-based approach to sustainable banking to help tackle profound environmental problems and support the transition to a green, inclusive and resilient sustainable growth path. The People’s Bank of China (PBOC), China Banking Regulatory Commission (CBRC), and Ministry of Environmental Protection jointly issued the “Green Credit Policy” in 2007, followed by CBRC’s “Green Credit Guidelines” and a monitoring framework to guide the implementation. At the end of 2015, CBRC’s green credit statistics for the top 21 Chinese banks – accounting for around 80% of total banking assets – show the majority have adopted E&S risk management practices, and Green Credit now makes up approximately 10% of these banks’ portfolios. Building on this experience of greening the banking system, the People’s Bank of China (PBOC) is leading efforts to green the whole financial system in China beyond banking.

Overall, governments should cascade and communicate the economic benefits of developing green business to create more awareness for the importance to act on climate. In the end, we need consumers to change behaviour. Transparency and disclosure is another area governments should focus on. One of the major concerns of investors is the lack of credible and consistent disclosure. Governments can be a force for good by making disclosure of data such as carbon footprint, building efficiencies and the like mandatory. While this could create added burdens in the short term, the long-term gains are immense – and make this worthwhile for both borrowers and society as a whole.

Green bonds don’t necessarily deviate much from conventional bonds, and are increasingly well understood by developed market investors. But once you start moving away from green bonds and embrace slightly more complex financing structures to fund initiatives, does the ‘green’ element make them more challenging to execute or market to the right investors? Here we’re thinking about loans / structured finance deals, securitisations, and the like.

The hardest work on the green agenda was about the definition of green. Now that this has been established through the development of the green bond market, it has become more straightforward to apply to other products.

Two challenges remain. The first is the appropriate pricing of the loan or structured product. There’s still a lot of work to be done to factor ‘greenness’ into cost of capital calculations and credit risk. Some investment houses have dedicated green mandates looking to gain exposure to green investments, but for others it comes down to the economics of the transaction and the cost of capital. The second is standardization. Green bonds, loans and other structured products depend on highly standardized disclosure-based credible data, ideally with a third-party opinion. We will only see product classes such as Green MBS or ABS take off if the underlying loans are highly standardized and the data collection process is streamlined.

What kinds of concerns are you hearing from treasuries – whether they be government, quasi-sovereign, FI or corporate – when it comes to going down the sustainable finance route? What would you say is the biggest unknown for them? How have their concerns changed over the past few years?

By now, many treasurers see the benefit of issuing “green” to diversify their investor base and put additional spotlight on a company’s sustainability activities. Companies generally benefit from ring-fencing a pot of capital for environmental activities to ensure these projects don’t compete with general capex. The general concern that issuing green is more expensive has largely disappeared. The pricing of green bonds is now generally in line with conventional bonds.

Having said all this, there remains a big gap in know-how across the industry, in particular with corporate treasurers. The additional disclosure can appear quite cumbersome and more work is needed to make companies comfortable with the additional requirements.

2017 was a significant year for sustainable finance – with a number of records (particularly in terms of volumes) having been broken. What kinds of trends and themes do you believe are likely to dominate the sustainable finance market in 2018?

2018 will be the year of “mainstreaming sustainable finance.” So far, we have seen many governments and financial institutions come to market. We have seen impressive growth in the green bond market but with 2% of the total bond market being green, we certainly will not achieve what is required.

If we want to have real impact, we need to turn this into a mainstream asset class, broaden the reach to transition sectors, and make capital available for riskier projects. In 2018, we should see many more corporations, states, municipalities in the market. The investor appetite is there, it is now our job to bring capital to the right projects.

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