GARP SCR Ch5: Green and Sustainable Finance: Markets and Instruments

Sustainable finance

Any kind of financial activity that takes sustainability into account, across asset classes, products, and services.

Green finance

Sustainable finance focused on environment-related risks and opportunities—often, but not necessarily, climate change.

Climate finance

Financial flows related to adaptation and/or mitigation climate change projects.

Green bonds

- Pioneered by multilateral development banks

- Bonds whose proceeds are earmarked for environmental projects that can, but are not required to, include climate-related goals.

- Combine several innovations: (1) separately labeled, (2) their proceeds are ring-fenced, and (3) the (planned) use of their proceeds is reported both to prospective bondholders ex ante and to current bondholders once projects are implemented

Social bonds

Bonds with earmarked proceeds for projects that will bring social benefits.

Sustainability bonds

A combination of green and social bonds, meant to simultaneously address both environmental and social objectives.

Green loans

Loans whose proceeds are used for environmental and climate-related projects.

Sustainability-linked bonds (SLBs)

Bonds whose coupons are linked to the issuer firm's achievement of pre-agreed sustainability targets (= KPIs).

Sustainability-linked loans (SLL)

Loans whose interest rates are linked to a company's achievement of certain sustainability targets (= KPIs).

Sustainable funds

Funds that consist of sustainable instruments (e.g. green bond funds) and funds with shares in sustainable companies.

ESG integration

Involves using and collecting data on material ESG issues, integrating it into investing or lending decisions, and engaging with investee companies.

What's the largest single-actor group providing climate financing?

- According to the CPI's definition, it's development banks—national, bilateral, and multilateral (USD 364 billion annually, on average).

- Commercial banks account for a somewhat smaller proportion

- *Note: For cross-border investments and financial flows , the large majority of financing is domestic (84% of financing from domestic sources)

Where's the majority of climate finance flowing to?

- The vast majority of financing is related to climate change mitigation, not adaptation, with large portions flowing into renewable energy generation (e.g. wind and solar) and low-carbon transport (such as EV)

SDG bond

Bonds that are linked to UN Sustainable Development Goals.

What are the four core components of the Intl. Capital Market Asso. (ICMA) Green Bond Principles?

1. Use of Proceeds → All designated Green Projects should provide clear environmental benefits, which will be assessed and, where feasible, quantified by the issuer.

2. Process for Project Evaluation and Selection → The issuer of a Green Bond should clearly communicate to investors

3. Management of Proceeds → The net proceeds of the Green Bond [...] should be credited to a sub-account, moved to a sub-portfolio or otherwise tracked by the issuer in an appropriate manner, and attested to by the issuer in a formal internal process linked to [...]lending and investment operations for Green Projects. [...]

4. Reporting → Issuers should make, and keep, readily available up to date information on the use of proceeds to be renewed annually until full allocation, and on a timely basis in case of material developments. The annual report should include a list of the projects to which Green Bond proceeds have been allocated, as well as a brief description of the projects and the amounts allocated, and their expected impact. [...]

When were the Sustainability-Linked Loan Principles launched?

- Launched in 2019

- Launched by three loan-market umbrella organizations:

1. the Loan Market Asso (LMA),

2. the Loan Syndication and Trading Asso (LSTA), and

3. the Asia Pacific Loan Market Asso (APLMA)

When were the Sustainability-Linked Bond Principles launched? Who developed it?

- Launched in 2020

- Developed by Intl. Capital Mark Asso (ICMA), same body that published the Green Bond Principles

Which country became the first to issue a SLB?

In 2022, Chile became the first country to issue a soverign SLB

Green or ESG indices

Stock market indices that include companies according to various sustainability performance standards.

Green labels

A standardized recognition/confirmation/certificate that a financial product, project, or organization has a measurable positive contribution to the environment, climate change, renewable energy, or other types of recognized green/sustainable activities.

Green car loans

Loans that are dedicated to financing environmentally friendly cars, such as electric vehicles.

Green mortgages

Mortgages for energy-efficient homes.

Sustainable credit cards

Credit cards that donate a percentage of purchases to environmental charities (thus are more aligned with philanthropy than with the financial system per se).

Data providers that offer services in ESG scores and ratings:

- Incl. Bloomberg, Refinitiv, MSCI, Sustainalytics, FTSE, ISS, and Vigeo Eiris

E.U. Taxonomy

- A European Union framework (first published in draft format in March 2020) that sets performance thresholds for economic activities, by sector and subsector, to determine which investments are environmentally sustainable.