Banks help engineer the low-carbon economy
When ALD Automotive, a leading worldwide vehicle leasing company, raised EUR 500m through a Positive Impact Bond in October 2018 to buy ‘clean energy’ cars, it took a pioneering approach by selecting the cars with the lowest CO2 emissions over their entire lifecycles from their manufacturing to recycling.
Surprisingly, electric vehicles are not always the cleanest – when considering the sources of electricity used and manufacturing process, electric propulsion can have a bigger carbon footprint than a combustion engine.
Such a holistic approach illustrates how banks are helping to engineer the transition to a low-carbon economy by working with companies from all sectors, even the carbon-intensive. Through fast-evolving ‘green’ financial products and services, they are encouraging companies to analyse what is most material to their carbon footprint and then reduce it.
What started in 2003 with the Equator Principles’ narrowly-focused, defensive approach to manage the environmental and social risks of project finance, has evolved into a proactive drive to encourage borrowers to adopt business models and practices suited to carbon reduction. Banks are increasingly arranging bonds and loans that require a company not only to improve environmental performance, but also to have its progress monitored.
“There is a trend among banks to support the low-carbon transition,” observes Sandrine Enguehard, Head of Cross-Product ‘Impact’ Structuring at Societe Generale CIB. “We are keen to promote the best clients for tomorrow. And, of course, the best clients for tomorrow would be the ones successfully engaged in the transition. So, this is part of our assessment now, based on our assessment of the most responsible way to operate in each sector.”
But what is the financial benefit for companies? There is no evidence to date that green bonds lead to consistently lower financing costs or that impact/green loans are more creditworthy. Indeed, the European Commission’s Action Plan on Sustainable Finance illustrates the dilemma faced, as proposals to reduce the bank capital needed to back loans if they fulfil environmental criteria are being challenged due to the lack of evidence that they improve the borrower’s creditworthiness.
That said, banks offering impact or sustainability performance-linked loans will aim at rewarding the borrower for progress such as meeting carbon reduction targets through lower interest margins. On the bond market, a green bond tends to attract greater attention from investors than a normal bond, which may benefit a company that is either new to capital markets or a relatively unknown borrower.
What is truly innovative about the way banks are developing sustainable finance is how they are integrating borrowers’ long-term targets and then monitoring progress towards those targets. Having defined their material carbon-related risks, companies can work with their banks to identify the key performance indicators that will be used to monitor their progress towards targets. Any reductions in interest margin depend on meeting those targets.
Including all sectors
To help reduce carbon emissions on the scale required, banks must provide sustainable finance solutions not only for the more environmentally-friendly sectors such as renewable energy but also for the less clean sectors which have a decisive role to play in the transition. The latter includes sectors such as automotive industry in the case of ALD and even shipping, which is responsible for about 2.5% of global CO2 emissions, according to the International Maritime Organisation (IMO), the United Nations body responsible for the world’s shipping.
The IMO has put a cap on sulphur levels – which are extremely high in shipping’s bunker fuel – from 2020. Further, the IMO wants greenhouse gas emissions from the sector to be cut in half by 2050 compared to 2008 levels. Yet achieving these targets will require big changes in shipping technology. LNG-powered ships are one way to solve this problem as Brittany Ferries’ ‘Honfleur’ will show when it starts to sail from Caen-Ouistreham to Portsmouth in the spring of 2019. Honfleur will be the first LNG-powered ferry to be commissioned by Brittany Ferries, and the first transaction under the European Union’s Green Shipping Guarantee Programme. Societe Generale led the 2017 Euro 142.6 million lease financing of Honfleur, paving the way for further funding of LNG-powered ships.
But if the trend towards banks championing the transition to a low-carbon world is to get stronger, new standards and frameworks defining what is ‘green’ are urgently required. There is a substantial amount of work underway through initiatives such as the Green Bond Principles, the Green Loan Principles and the taxonomy of sustainable economic activities launched by the European Commission in July 2018, with more called for by the UNEP FI Positive Impact Initiative. “The lack of standards means that every new impact loan transaction is a new product, an innovation,” explains Enguehard. “We need some wide principles so that growth can accelerate.”