Getting Ready for the ESG-ness of the Market

Green bonds, blue bonds, social bonds, gender bonds, climate-awareness bonds, sustainability-linked loans—environmental, social, and governance (ESG) debt instruments are taking the world by storm and present unprecedented opportunities for project financing.[1]

Between 2011 and 2021, ESG financing experienced a compound annual growth rate of 52 percent across all investment types. ESG financing now represents about 12 percent of renewable energy investments—up from just 5 percent a decade ago—and is on track to meet all renewable energy development financing needs by 2044 (see figure below).[2] In other words, in about 25 years, ESG will be a requirement for financing renewable energy, which is leading the inevitable global clean energy transition. The upshot? Any company looking to the market for financing should act now.

ESG financing now represents about 12 percent of renewable energy investments—up from just 5 percent a decade ago—and is on track to meet all renewable energy development financing needs by 2044.

Why now?

Increased demand for ESG financing is not wholly driven by environmental, social, or governance consciousness, but also by mounting evidence that ESG actions can improve the bottom line. For example, diversity and inclusion in firms are positively correlated with improved performance. Worldwide, companies where women make up more than 20 percent of managers generate 2 percent higher returns on investment than other companies. An ESG focus can also mitigate risks: Litigation and insurance costs due to environmental impacts, worker injury, and diversity in hiring spurred the U.S. utility industry to prioritize these issues.[3] Lawsuits against U.S. power utilities over wildfires and outages prompted companies to better manage vegetation and bury transmission lines underground.

Of course, we are also seeing a paradigm shift. There is growing consensus that the world needs to be cleaned up and that markets and market players have the money—and perhaps the responsibility—to help finance it. Extreme water stress in the U.S. Pacific Northwest and Southwest (contributing to the scarcity of baseload energy), the impacts of winter storms like Uri, and the increasing range and damage of wildfires, tropical cyclones, and heat wave activity are becoming the norm rather than the exception. These environmental threats are exacerbating other longstanding problems: the UN Intergovernmental Panel on Climate Change’s newest report confirms that heat waves, storms, and rising sea levels disproportionately contribute to food insecurity, malnutrition, migration, and the growing risk of gender-based violence in sub-Saharan Africa, Asia, and Central and South America. The estimated annual global infrastructure investment gap to address these challenges is $3 trillion, which cannot be filled by public sector funds alone.

There is growing consensus that the world needs to be cleaned up and that markets and market players have the money—and perhaps the responsibility—to help finance it.

Time to make it count

At the moment, there are no universally accepted standards for measuring and reporting on ESG metrics, leading to confusion (and possible malfeasance). Energy projects across the globe are facing lawsuits accusing them of misleading or incomplete metrics and false advertising, such as greenwashing fossil fuel resources. If one of the goals of ESG management is to mitigate risks, metrics or disclosures that create further exposure are counterproductive.

The recently launched International Sustainability Standards Board should help clear up the cacophony of national, private, and nonprofit standards. At COP26, the International Financial Reporting Standards (IFRS) Foundation announced the creation of this sustainability accounting body, which plans to introduce a global standard for company disclosures in June. With its international clout, the IFRS can clear a path for one widely shared standard—clarity that will become ever more crucial as all finance is likely to become ESG finance. The boundaries between financial and sustainability reporting will blur. Emissions reductions and diversity targets will show up in shareholder value right alongside sales.

The boundaries between financial and sustainability reporting will blur. Emissions reductions and diversity targets will show up in shareholder value right alongside sales.

Will you be ready?

How can companies prepare for this inevitable shift? Worsening climate change and rising carbon taxes are bound to intensify the “ESG-ness” of the market. Are businesses properly interweaving ESG into the fabric of their processes and planning?

Companies need to know today the business changes, metrics, and disclosures that will be required tomorrow. Their definitions of ESG must be comprehensive and standardized, running the gamut from the gender lens to net zero emissions. ESG gaps must be promptly diagnosed and corrected with cost-effective, actionable plans that can be monitored for reporting. Companies will likely need support from multidisciplinary teams with the technical and managerial acuity to embed ESG into their DNA. However, few companies have the insight or bandwidth to design and implement plans that include tangible results for waste management, biodiversity, inclusion, and transparency all at once, while also focusing on core business goals. Are you ready for what’s next?

Written by Scarlett Piantini Gil, with contributions from Mariana Vazquez del Mercado Castro, Sebastian Walter Young, and Mikael Matossian.

[1] While all bonds require borrowers to meet criteria set forth by their lenders, ESG bonds are unique in that their performance is linked to some form of environmental, social, and/or governance criteria, often associated with the Sustainable Development Goals.

[2] Tetra Tech calculations using BloombergNEF data on sustainable finance and 2021 global new investment in the energy transition.

[3] Sample U.S. utility trade association sustainability disclosure: Electric Company ESG/Sustainability Quantitative Information (pgecorp.com)