All you need to know about green finance

The whole world is talking about green finance. Before companies and other borrowers take part, they ask a fundamental question. Why should we use green forms of financing? There are various reasons for this. Those who use green finance appeal to new investor groups and thus expand the financing basis – and there is really no shortage of green investors. Institutional investors such as pension funds, municipalities, federal states or foundations in particular prefer to invest where this investment also generates ecological or even social returns. Private individuals are also becoming increasingly interested in sustainable investments.

Another reason is the image effect. Those who engage in green financing benefit from a brand upgrade – they are seen as good. As the market for green financing in Germany is comparatively young, media attention is currently high. This enables a company to position itself as a sustainable player. The reputational gain has a positive effect on investors and attractiveness for customers and (potential) employees. Young professionals in particular look closely at those hiring.Credible, sustainable commitments can make all the difference.

How green is green?

There is currently no legally binding criteria that lists what is necessary for truly green financing. Therefore, most investors and borrowers are relying on a voluntary guideline, the International Capital Market Association (ICMA) Green Bond Principles. These guidelines are trying to establish standards on the way in which revenue may be used and how the reporting should be. One of the standards is that an independent agency must examine the project before it can be labeled as green. These agencies include ISS-oekom, Cicero, Vigeo Eiris and Sustainalytics. They certify that the project is sustainable and thus confirm that the investments actually benefit the environment.

Based on the Green Bond Principles for bonds and promissory notes, there are Green Loan Principles for loans, issued as a framework by the Loan Market Association. Even if it is voluntary, companies and other issuers should adhere to these standards for issuing green bonds and green loans. The guidelines guarantee the integrity and transparency of green products, regulate the selection process for a project, the disclosure and control of the use of funds and the reporting requirements. Those who adhere to these standards appear on the radar of green investors.

What can be green financed?

As a general rule, the more the economic process and economic structures are changed towards a climate-neutral and environmentally friendly economy through the use of financial resources, the greener the financing will be. In a narrower sense, this means investments that promote renewable energies and thus conserve resources. In a broader sense, projects that mitigate the negative impacts of climate change are also considered green. These include the more efficient use of energy, clean transport, water and waste management. Many companies are already acting more sustainably and greener than they are aware of. “No company can avoid dealing with sustainable or green financing – it is an important development. Anyone who is already taking a closer look at this now will have a decisive advantage later,” says LBBW advisory expert Martin Amann.

How can instruments be green financed?

The market for green financing has been growing for years. There are green options for loans, bonds and promissory notes. In 2013, green bonds of USD 13bn were issued worldwide; by 2018 it was USD 182.2bn.

For large-volume financings, more and more products are available that impressively demonstrate the innovative capacity of banks. In addition to

• green bonds, there are also
• green promissory notes and
• green loans.

Is green worth it?

Green financing incurs additional costs as a result of increased transparency and reporting requirements. It must be proven that the funds actually make a positive contribution to climate and environmental protection. This usually requires an independent agency to audit and certify the project.

These additional costs mean that many companies waver between “in theory, yes” and “in practice, no.” A survey conducted by the trade magazine “Der Treasurer” showed that 58% of those responsible for finance interviewed were fundamentally interested in green finance, but that only 2% had actually taken concrete action.

Raking in the “greenium”

Green financing for companies can also pay off in terms of business. The image effects and the additional degree of financial security provided by a broader investor base are undisputed. This can be a convincing argument, especially in times of economic slowdown. But the question of interest rate advantages is less easy to answer.

LBBW analyst Martin Dresp does not exclude that investors with an impressive green profile will accept a somewhat lower return. “This could give issuers an additional incentive to issue green bonds instead of conventional bonds,” he writes in the “Green Financing on the Move” LBBW study. The first examples of this can already be seen. Sweden’s largest forest owner, Sveaskog, which is committed to sustainable forest management, issued a green bond in 2016 and managed to achieve a financing advantage of 8 bp. This advantage of using green financing instruments is called a “greenium” (green premium).

This greenium could become even more relevant due to new political activities. The EU Commission’s action plan presented in March 2018 is aiming to steer more cash flow towards sustainable investments. The European Union also intends to introduce a catalog of criteria for green finance. Discussions are currently underway as to what further incentives can be created for green finance in the European Union. This could result in a more or less gentle pressure towards green financing. This would give a head start to companies and other bond issuers who are already dealing with the topic. Especially since the EU is very strongly oriented towards the already established Green Bond Principles for possible binding rules.

Irrespective of this, green finance offers companies the opportunity to use the current trend towards sustainable action to their own advantage. The examples of electromobility or the energy transition in the utility sector impressively demonstrate how the concept of sustainability can quickly and effectively include various industries. “Climate change and rising resource consumption will lead to changed business models and corporate strategies in the medium term,” says LBBW analyst Dresp. “Green finance can help to initiate a process of rethinking that is likely to start in the near future anyway.”