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Green capital: driving sustainable growth

Michael Wilkins, Head of Sustainable Finance at S&P Global Ratings writes about the latest developments in the green bonds market and its connection to climate reporting

Ambitious climate objectives have created the impetus for some US$90 trillion to be targeted for global sustainable development investment before 2030. Yet a critical question remains: “Where will the money come from?”

As political drive swells, sovereign green bond issuance will likely play an important role in 2018. However, if global warming is to stay below 2°C above pre-industrial levels, mobilizing private sector finance will be crucial.

The global green bond market: is it enough?

By mid-2017 U.S. corporate issuers had gone to market with US$18 billion of green bonds, a symptom of greater proactivity on carbon mitigation emerging at the state, municipal, and corporate levels. This was part of broader, strong growth in the global green bond market: last year, annual issuances exceeded expectations to reach US$155.5 billion, a 78% increase from 2016, which was fueled by the awareness that, aside from the obvious environmental value, there could be other benefits for “issuing green”.

As the transition to clean energy continues, the number of renewable energy projects worldwide is increasing at pace, thereby disrupting the traditional grid. This has created a bigger appetite for investments in sustainable assets and green bonds.  

Climate-aligned bonds not only include green bonds but also those that,  while not labelled green by the issuer, are committed to environmental initiatives. These include decarbonization projects, such as wind and solar power, energy-efficient buildings and green public transport, as well as climate-resilient infrastructure. 

Altogether, the climate-aligned bond universe is valued at US$895 billion dollars (green bonds inclusive). Yet, even when taking into account the “non-labeled” bond market, this still falls short of the trillions required to finance a sustainable economy. In order to enable more capital for sustainable projects, private green finance is reaching beyond bonds to new instruments and asset classes.

Enabling alternative green financing

The integration of green and conventional financings – through means such as green loans and green securitizations – is crucial to further scale the sustainable finance industry. The rise of green structured products has already begun. In 2017, U.S. issuer Fannie Mae issued a record US$25 billion green mortgage-backed security MBS program, which aims to improve the energy and water performance of U.S. properties. Going forward, there are many driving forces in place for these types of alternative green finance, including; shifting capital allocation in asset management; increasing environmental regulation; a growing awareness of climate risk exposure; and heightened environmental, social, and governance (ESG) compliance mandates. 

Sustainability reporting: helping investors make better decisions 

Moreover, the development of green financing is given added value if investors are able to evaluate a company’s performance – including their sustainable actions and impacts. This is why ESG risk mitigation and reporting is of particular interest for private capital mobilization for green projects. A key enabler of green financing is the presence of enhanced climate-related corporate financial reporting, which provides visibility to investors when comparing companies’ performance on green targets and their exposure to environmental and climate (E&C) risk. 

The Financial Stability Board (FSB) addressed the lack of an international standard disclosure or reporting mechanism last year, with their Task-Force on Climate-Related Financial Disclosures’ (TCFD) recommendations. The TCFD provided a voluntary framework for environmental risk disclosure under the brackets of: governance; strategy; risk management; and metrics and targets. Since then, there has been significant corporate momentum to improve climate reporting. In December 2017, the TCFD announced that 237 companies, representing a combined market capitalization of over US$6.3 trillion, had adopted its recommendations. This total includes over 150 financial firms managing assets of more than US$81.7 trillion. 

Ultimately, enhanced corporate ESG disclosure could provide investors greater clarity around any given company’s exposure to climate change.  ESG factors are incorporated into S&P Global Ratings’ credit methodology and, when material and visible, can have positive or negative ramifications for ratings. 

Increased visibility over environmental risk should enable higher levels of capital for sustainable infrastructure – whether under the mechanism of a green bond or sukuk issuance, or with a green loan or securitization.  And given the vast levels of capital required for sustainable development projects, mobilizing all forms of green financing is crucial.

The author of this post is Michael Wilkins, Head of Sustainable Finance at S&P Global Ratings. Opinions represented in this blog may not necessarily represent the views of CDSB.