Financing the sustainable development goals

May 2021 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

May 2021 Issue

The adoption of sustainable finance continues apace and proved a shining light in a year otherwise dominated by the pandemic in 2020.

Refinitiv recently reported that global sustainable bond issuances were over $544bn for 2020, double the previous year. Debt instruments with sustainability metrics made a major contribution toward the pandemic response and recovery. More broadly, the pandemic underscored the importance of environmental, social and governance (ESG) and sustainable practices that will add further impetus to the adoption of sustainable finance, which will become mainstream finance in perhaps as short a time frame as within five years.

2020’s EU Taxonomy Regulation was a milestone, introduced to help reorient capital flows toward sustainable investments by establishing a unified classification system for sustainable activities (the regulation is also EU retained law in the post-Brexit UK). The European Commission will publish delegated regulations across the six environmental objectives, namely: climate change mitigation, climate change adaptation, the sustainable use of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems.

For an investment to qualify as being environmentally sustainable, the underlying economic activity must be ‘environmentally sustainable’ under the taxonomy. This means that the relevant economic activity must make a substantial contribution to one or more of the above stated environmental objectives, cause no harm to any of those same objectives, and be aligned to the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

The Taxonomy Regulation will change almost every aspect of financial institutions’ relationships with customers, borrowers, issuers and depositors or investors. The regulation is driving a step change in behaviour as the market moves toward the Paris Agreement’s goal to limit global warming to 1.5 degrees Celsius, compared to pre-industrial levels.

2021 is the year of COP26. Delayed by the pandemic, the meeting to be hosted by the UK in Glasgow in November is slated as one of the most important meetings in human history. COP26 is even more relevant since president Biden, who, hours into his administration, recommitted the US to the Paris Agreement.

All these developments point to greater transparency that allows regulators, investors and society to expect capital to measure, disclose and be held accountable for the environmental impact the underlying economic activity has on the environment and its impact on the climate.

But what about the sustainable development goals (SDGs)? Adopted by the UN General Assembly in 2015, the 17 SDGs set out a framework to address our greatest challenges.

However, progress is lagging with only nine years left to achieve the SDG goals. The UN calculates the gap as an enormous US$2.5 trillion per annum – the great achievement of sustainable bond issuances in 2020 represents only 20 percent of the noted annual need.

The SDGs include the environmental and climate impact that to-date has been the focus of green finance, but truly sustainable finance should look beyond the impact on climate and affordable, clean energy. How can capital be mobilised to support the other SDGs? Some of the goals, such as clean water and sanitation and industry, innovation and infrastructure, have a nexus with existing financial products and traditional infrastructure finance. Finance also already supports access to decent work, economic growth, sustainable cities and communities, and access to quality education and healthcare where financing social infrastructure is well established.

Mexico’s recent €750m SDG bond demonstrates some of the real potential in this space. The bond is the first ever sovereign SDG bond and benefitted from a UN alignment letter noting Mexico’s commitment toward the SDGs.

The SDGs include aspirational goals such as no poverty, zero hunger, quality education, gender equality, reduced inequality and responsible consumption and production. How can all these goals be financed? Do the infrastructure and finance sectors have a role to play in contributing to these goals?

Mobilising mainstream private finance to support all the SDGs is a challenge to which a number of global investors and financial institutions are publicly committed. So, what are some of the next steps?

Lies, damned lies and statistics

Industry knows how to measure financial performance, but the SDGs are focused on non-financial metrics. While developments such as those under the EU Taxonomy Regulation bring discipline to avoid greenwashing, more data is required. SDG outcomes require measurable and transparent goals based on verifiable datasets. In February, a watershed moment was reached when the trustees of the IFRS Foundation, based on market feedback at the end of 2020, took the first steps to create a Sustainability Standards Board that would sit alongside the International Accounting Standards Board. Great steps have been taken in the space of non-financial reporting by other international organisations, including the International Organisation of Securities Commission (IOSCO), the Global Reporting Initiative (GRI), the Integrated Reporting Council (IIRC), CDP and the Sustainability Accounting Standards Board (SASB), but now is the time for us to embrace the 17th and final SDG: collaboration. It is hoped that these organisations and others can now help promulgate the new standards that corporates will be held to that focus, not just on their financial impact, but their overall value impact.

From stockholders to stakeholders

The role of business is starting to shift. It is no longer enough to focus on an economic return, corporates need to look to generate a wider ‘dividend’ for all stakeholders. This includes shareholders, employees, customers, suppliers and the environment. For example, some sustainable financiers expect luxury brands to impose greater accountability on suppliers in developing countries before being willing to invest in sustainable products of those luxury brands. Expecting borrowers to have robust gender employment policies and equal pay commitments could become the norm, not to lower the cost of debt, but because it is the right thing to do and the shareholders of public companies expect it. Some lenders have stepped away from some carbon-intensive industries. How long will it be before we see lenders refuse to support businesses that do not uphold respectful and equal workplace policies? Equity investors have a role to play here as well and there is an increasing shift toward the view that what is good for people or the environment is good for business. Businesses are repurposing the term ‘PPP’ and in 2021 it now stands for prosperity, planet and people.

Long term impact investing

Armed with robust data, innovative new financial products that drive better focus on the SDGs are likely to emerge. The recent ISDA paper ‘Overview of ESG-related Derivatives Products and Transactions’, highlights some really exciting products that deliver long-term change. SDG three on good health and wellbeing is an example of how we must change our thinking. Take the issue of respiratory illnesses in cities due to poor air quality. When people are sick they need healthcare and when the system is under pressure we need more healthcare and bigger hospitals. However, treating the symptoms of poor air quality is not the same as focusing on the causes. We need a financial system that supports and values social benefits (for example the reduction in traffic, improvements in urban design and better living standards, or the switch away from the internal combustion engine), which contribute to better health and ease the strain on the health system. What financial instruments are needed to finance this change? Mexico is paving the way and other countries and cities are moving forward too.

Red tape and regulation

Innovation always challenges regulation. Sometimes it oversteps the mark, but in general innovation forces further adaptation and change. There are a number of opportunities for such change around local government, planning and public procurement, which has traditionally been a focus on raising and spending a tax dollar in return for goods or services. But there are more ways to procure goods and services than just spending money in a ‘linear’ manner. Following circular economic principles, it is easy to see how some of these wider, social dividends can be supported through new public-private partnerships. Take, for example, the average street. Lampposts, traffic signals, signage, drainage and pipelines represent street furniture that have real value to the private sector which, if it could have access to this infrastructure, it would probably be willing to ‘pay’ for its use by installing a multitude of valuable devices from WiFi, to camera systems, to air quality monitors, and so on. The private sector may be willing to provide those services free of charge in exchange for access to that infrastructure for its own commercial needs, such as a 5G network. But to offer these sorts of services requires leadership in the public sector that can help unlock some of the trillions of dollars of value the world is searching for to achieve the SDGs.

The post-pandemic future looks bright. All businesses and governments need to work together to ensure that it is also fair, equal and accessible: in short, sustainable.

Nick Merritt is a partner and global head of infrastructure, mining and commodities at Norton Rose Fulbright LLP. He can be contacted on +65 6309 5318 or by email: nick.merritt@nortonrosefulbright.com.

Nick Merritt

Norton Rose Fulbright LLP