INSIGHT

Green finance

Climate Change Energy Environment & Planning Financing

Balancing added costs against a broadening investment base and access to greater capital

Australia's 'green finance' market continues to grow steadily in response to global environmental challenges and to support sustainable development. Innovative financial products continue to be developed to direct capital towards green projects and to promote sustainability causes or ESG-related performance targets. These financial products include green bonds, green loans and sustainability-linked loans (or SLLs).

A 'green bond' is a debt security issued into domestic or offshore capital markets, with the money raised to be invested into green projects. Typically, green bonds are purchased by institutional investors with mandates to invest capital into the green economy. Green bonds are like other bonds issued into the relevant capital market, but with additional features that allow them to be marketed as a 'green bond'. Those additional features are increasingly becoming standardised, albeit by the market rather than regulation. The International Capital Markets Association (ICMA) has developed a set of 'Green Bond Principles' which are voluntary guidelines outlining recommend transparency and disclosure principles for green bonds. The four key principles under the Green Bond Principles are (1) the net proceeds of the bond issuance are to be used for green projects, (2) the issuer is to provide clear communication of the process for project evaluation and selection, (3) the net proceeds of the bond issuance are to be managed and tracked for the specified green purpose, and (4) the issuer is to have ongoing reporting obligations.

Australia's cumulative green bond issuance has grown to A$15.6B, which makes it the tenth largest market globally behind China (USD$91.5B) and Japan (USD$12.4B).1

Alongside green bonds, a market for green loans is emerging. Similar to green bonds, the use of proceeds of a green loan is for green projects. A set of Green Loan Principles has been established, and those are similar in nature to the Green Bond Principles. The key difference between green loans and green bonds is that they are in loan format rather than bond format.

Sustainability-linked loans are emerging in Australia

Separately, a market for SLLs is developing in Australia and offshore. An SLL incentivises the borrower to meet agreed sustainability or ESG-related performance targets. Unlike a green bond or green loan, the money borrowed does not need to be used for green purposes. Rather, the borrower is given a reduced interest rate if it meets the agreed targets.

The target that may be agreed can vary, from performance objectives such as greenhouse gas emissions and sustainable sourcing, to matters relating to employment targets. An SLL takes the form of a bilateral or syndicated loan in a form typically seen in the loan market, but with features that address the sustainability requirements.

Similar to green bonds and green loans, the market has developed a set of principles for SLLs. These principles have been driven by the Loan Market Association, and include:

  1. the borrower to clearly communicate its sustainability objectives and how those objectives align with the sustainability performance targets (SPTs) identified in the SLL;
  2. ambitious and meaningful SPTs should be identified and negotiated between the borrower and the lenders target setting;
  3. where possible, a borrower under an SLL should maintain records in relation to SPTs and provide information to lenders; and
  4. the need for external review / audit is to be negotiated by the borrower and lenders.

Key risks and opportunities

The key opportunities for entry by Australian corporates into the green finance market include:

  • Diversified investor base: Green bonds may attract a broader investor base for the issuance than typically available to a corporate, as they are typically held by institutional investors with mandates to invest in green projects.
  • Access to additional capital: Similarly, as investors and banks continue to get pressure from their stakeholders to mitigate climate change impact within their own organisations, there is a significant and growing pool of capital looking to get exposure to green and sustainable investment.
  • Social responsibility and promoting sustainability: Green finance is one of the many ways Australian corporates can work towards positive environmental and climate change solutions and see tangible impacts within their businesses.
  • Pricing advantage: The incentive-based structure of SLLs allows borrowers to benefit from a reduced margin if their sustainability performance targets are met. Stronger demands for green bonds into the future could see green bonds trading at a premium in the secondary market.

On the flipside, the risks to consider when entering this market include:

  • Regulatory and political uncertainty: Conflicting political discourse around climate change and renewable energy in Australia hampers our attractiveness as a destination for foreign green investment, which may include green finance.
  • Costs: There may be additional costs involved in verification and regular reporting compared to standard bond issuances or loans.
  • 'Green washing': Corporates risk losing integrity and brand credibility if they are unable to perform and meet their sustainability targets or portray their products or policies as producing positive environmental outcomes when in fact they do not.

Key questions

  • Does your organisation have a robust ESG mandate that can be supported by green finance?
  • Is there potential for new projects to be financed by the green finance market, or for established projects to be refinanced into the green finance market?
  • Would raising green finance help your organisation demonstrate its commitment to green or sustainability-linked targets?
  • What are the additional upfront and ongoing costs in putting in place a green bond, green loan or SLL, and are those costs acceptable by reference to the benefits?
  • Has your organisation developed a green finance framework that sets out how an issuance would comply with the industry standard, such as the Green Bond Principles and Green Loan Principles?

Climate change guide

This insight is part of our climate change guide for legal and compliance teams in Australia