Financing Opportunities for Effective Sustainability
Introduction
Financial services that integrate sustainability—such as green loans, sustainability-linked loans, and supply chain finance—enable companies to pursue environmentally beneficial projects and incentivize sustainable practices across their value chains.
With regulatory pressures and market incentives favoring green finance, companies that proactively adopt sustainability practices not only reduce their environmental impact but also achieve financial gains, positioning themselves as leaders in the transition to a sustainable future.
Today we will dive into the trends, opportunities, options and challenges of Sustainable Finance with an expert in the field.
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Rado Georgiev - Strategic Sustainability Advisor at BNP Paribas
Rado Georgiev has a comprehensive background in corporate sustainability, sustainable investing, and ESG advisory roles. Throughout his career, Rado has worked for organisations such as Sustainalytics, ING, SASB and Northern Trust Asset Management, gaining a unique perspective on the integration of sustainability in financial services. Rado's extensive experience and strategic vision uniquely position him to offer valuable perspectives on generating value through sustainability in the financial sector.
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Key Takeaways
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Sustainable?Finance – trends and drivers
Q: Hello Rado, thank you very much for your time and availability. Let's start with the big picture.
Where are we right now in terms of sustainable finance trends? What’s the situation in the market?
A: Thank you for inviting me! OK, I will try to build the picture of what is going on.
Sustainable finance trends are closely aligned with broader corporate sustainability trends since finance essentially fuels the global economy. Any sustainability transitions in the economy will be reflected in sustainable finance.
One significant trend we’re observing is the climate transition, which is well advanced. Sectors like the automobile industry have surpassed the tipping point of transition. Every major OEM (Original Equipment Manufacturer) is heavily investing in electric vehicle (EVs) technology and enhancing their EV capabilities. Similarly, the power generation sector has been transitioning from fossil fuels to clean or low-carbon technologies.
COP 28 last year saw countries commit to tripling renewable energy usage by 2030. The low-carbon transition is accelerating and is expected to extend to traditionally challenging sectors like aluminium, cement, steel and aviation.
We now have low-carbon steel production in Europe and developments are underway to manufacture low-carbon cements. Similarly, regulation is incentivizing the expansion of sustainable aviation fuel (SAF) production capacity which is expected to contribute to an 80% average fuel-related emissions reduction for airlines.
Technological advancements such as green hydrogen are making transitions across sectors ever more accessible and affordable.
Q: You mentioned that sustainable finance trends parallel broader sustainability trends. What’s the relationship between the two?
A: Banks finance the real economy and so sustainable finance, corporate sustainability and sustainable investing are interconnected and shaped by the same societal transformation. It’s a constant feedback loop where each influences the other. Societal trends and changes, like the impacts of physical climate change that we’re starting to see, raise awareness in the finance sector, pushing for more significant efforts towards the transition.
For instance, inclusive finance is an emerging sustainable finance trend that aims to ensure that environmental initiatives like the energy transition take place in a way that leaves no one behind. The transition must be equitable, offering reskilling opportunities and ensuring income security for those in transitioning sectors.
In another example, technology and innovation are impacting both corporate sustainability and sustainable finance practices. They are critical, especially as we approach milestones like 2030, when we’ll critically assess our progress in the climate transition. Startups and small enterprises are driving much of this innovation, and there’s a growing recognition within the finance world of their role and sustainable finance needs. As time runs out, the importance of accelerating the transition through technological advancements becomes increasingly evident.
Q: Some readers may have some skepticism, so an interesting question could be: Why? What are the primary drivers behind banks offering sustainable finance services? What is the benefit for a bank?
A: Several factors drive sustainable finance growth. There’s peer pressure, as it’s become market practice for banks to offer green services of some type. Having a well-established sustainable finance practice is a way for a bank to demonstrate leadership and attract business from companies in need of transition finance.
Supervisors, like central banks, are increasing focused on supervising and stress testing the way commercial banks manage environmental risks.
This development started with the release of the TCFD climate-risk framework and its endorsement by the influential Network for Greening the Financial System (NGFS), a group of over 100 central banks and supervisors that aims to accelerate the scaling-up of green finance. Its members include most central banks in the EU, including the European Central Bank (ECB), and those in some of the world’s largest economies. There are initiatives to ensure commercial banks increase their funding for “green” and allocate more collateral against environmentally risky economic activities. For example, the European Central Bank’s Guide on climate-related and environmental risks provide a framework for classifying environmental risk drivers of credit, market, operational and other financial risk types.
Such frameworks incentivize the reallocation of finance to greener sectors, as sustainable assets are considered less risky. EU-based commercial banks are now required to disclose their Green Asset Ratio (GAR), a measure of their share of loans and securities that are aligned with the requirements under the EU Taxonomy. And there are incentives to grow this ratio.
These incentives play a crucial role. Green financing options encourage companies to invest in sustainable projects. This not only benefits the environment but also reduces the financial risk associated with unsustainable projects.
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Types of financial services that integrate Sustainability.
?Q: Now that we have a better understanding of the landscape and the main drivers, we could go into the sustainable financial services options that exist in the market.
Can you elaborate on the different types of financial services that integrate sustainability?
A: Sure! Sustainable finance includes a wide range of financial services designed to support and promote sustainable business practices, but at the end of the day, there are two main types of finance we typically distinguish between: use-of-proceeds and sustainability-linked finance. ?
Q: Can you explain what “use-of-proceeds” finance entails?
A: With use-of-proceeds finance we know that the company will use the funds for a green purpose. This includes products like loans or bonds, where the financing proceeds are allocated specifically for environmentally (or socially) beneficial projects.
For example, if a manufacturing company wants to purchase electric delivery trucks, we can provide a green loan that offers a discount on the interest rate because it’s used for a sustainable purpose, aligned with the EU Taxonomy.
Q: And what about sustainability-linked finance? How does that differ?
A: Sustainability-linked finance is used for general corporate purposes such as meeting operational needs like salary payments. The bank may not know how the financing is used. Finance provides the client with funds without specifying exactly how they will be used. Again, this can include various banking products such as loans, bank guarantees, supply chain finance, and receivables finance.
While sustainability-linked finance offers companies more freedom and broader application, the financing cost changes based on the company’s performance on a set of sustainability-linked KPIs, agreed on between the company and its bank in advance. Here, we don’t track the use of funds directly but instead monitor whether the company has reached its performance targets on specific sustainability KPIs (Key Performance Indicators).
Q: Could you provide some specific examples of how these financial services are applied?
A: Certainly. Let’s consider again the example of a manufacturing company. They might use a green loan to purchase electric trucks, directly reducing their carbon footprint and benefiting from lower interest rates due to the green classification.
On the other hand, for general operational needs, they might secure a revolving credit facility tied to sustainability targets, such as reducing electronic waste or achieving net zero emissions.
In this case, we work closely with the client to define relevant targets.
The KPIs must be material and core to the company’s sustainability strategy while the performance targets must be quantitative, benchmarkable and ambitious.
The benchmarks we use include industry standards, materiality frameworks and peer practices ?to ensure they are meaningful and challenging.
For example, if a company aims to reduce its water usage in electronics production by a certain %, we’ll assess if this target is ambitious relative to their peers and industry norms. Then we stablish KPIs are monitored annually, and performance against these targets can lead to financial rewards (interest rate discount) or penalties (interest rate premium), depending on the results.?
Sustainable Finance in the Value chain.
Q: In previous conversations, we have talked about the paradigm shift in the European Union, which with legislation such as the CSRD and the CSDDDD extends the perspective of sustainable business management to the entire value chain.
What challenges do companies face in aligning with the CSDDD and CSRD requirements?
A: One major challenge is the ability to influence suppliers who may not have a direct contractual relationship with the company, and thus fall outside its control. While large companies like IKEA can mandate sustainability practices from their suppliers due to their bargaining power, smaller companies may struggle to exert the same level of influence. This is where innovative financial solutions come into play.
Q: How can financial services help companies integrate sustainability within the supply chain?
A: Integrating sustainability within the supply chain through financial services is crucial for enhancing overall corporate sustainability. By offering financial incentives tied to sustainability performance, companies can encourage suppliers to adopt better practices and pass on these to the next supplier tier. Sustainable supply chain finance plays a pivotal role in this integration. Banks can help by offering faster payment conditions and better pricing for suppliers that reach certain sustainability goals.
Q: Can you provide an example of how this works in practice?
A: For instance, a company might establish an agreement with the bank to offer its suppliers faster payment terms if they meet specific sustainability targets. This could include reducing their carbon footprint, improving labor conditions, or adhering to environmentally friendly practices. In return, the suppliers benefit from improved cash flow, and the company ensures that its supply chain aligns with its sustainability goals.
One of the main challenges of the process is the varying levels of sustainability maturity among suppliers. Not all suppliers may have the resources or capabilities to meet stringent sustainability criteria initially. To address this, companies can provide support through training and capacity-building programs, helping suppliers understand and achieve the required standards.
Another challenge is ensuring transparency and accuracy in reporting sustainability performance. Implementing robust verification mechanisms and third-party audits can help maintain integrity and trust in the system.
Q: One last question, to close the conversation.
Rado, what is your advice to businesses that are trying to effectively generate value through sustainability?
A: Make sure that sustainability is embedded in your corporate strategy, and not a separate strategy. It needs to be part of the corporate targets and goals.
I think it's important to be bold, to draw the dot on the horizon, and to very clearly communicate to internal and external stakeholders what it is that you want to be as a business in 10, 20 and 30 years from now, even if you don't know how to get there.
First, work out where you want to be and then backcast the plan to get there. If you, as a business, are intentional and communicate transparently about your intention, you instill trust in your stakeholders and you will get there step by step. You'll be able to work with the type of internal and external stakeholders who will enable you to reach your goals because they will be attracted to your mission and vision.
The other piece of advice would be to make sure that you have a well-structured internal governance. You may have the best strategy in the world, but if you don't have very clear governance with roles, responsibilities, and consequences for meeting and not meeting certain ambitions, if you don't have that in place, if you don't have the management system and oversight, then it's just words.
Q: Thank you very much, Rado!
A: It has been a pleasure.
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