This article was originally published as part of the 2022 CFO Insights Report from U.S. Bank.
Business demand for sustainable finance is soaring. According to one analysis, the sustainable bonds market hit $1 trillion in 2021 – and bonds are far from the only option on the table. Today, banks can offer businesses greater flexibility and a wider range of sustainable finance possibilities than ever before. Perhaps unsurprisingly, then, a new U.S. Bank survey of 750 U.S.-based finance leaders shows that 84% are open to raising sustainable finance. Yet just 31% have done so in the past three years.
For finance leaders exploring sustainable finance, what do they need to know about the fast-changing landscape, and how can they benefit from the options available?
For any established company, pivoting to a more sustainable model requires investment. It might involve the refit of energy-inefficient premises, acquiring new machinery that cuts carbon emissions and reduces wastage, or developing new, more sustainable products.
While specific needs vary between sectors and businesses, some of the drivers for the rise of sustainable finance are felt everywhere. They include fast-rising consumer expectations of sustainability, a factor driving consumer-facing firms to focus on their ESG credentials. Other enterprises are feeling political and regulatory pressure bite, especially as momentum builds on net-zero carbon-emissions targets. Shareholders and investors, current or potential, are also increasingly interested in sustainability.
Raising sustainable finance can be a powerful signal to those stakeholders that the company is committed to improving its sustainability profile. In addition, companies can often benefit from cost advantages compared with traditional finance options. In general, the price can be a couple of basis points lower than traditional finance. That is, in part, the result of banks’ own strategic commitments to sustainability, commitments that are now backed by a range of options to support businesses in delivering the changes they need.
Over the past decade, green bonds, issued by banks or other organizations to fund major investment projects, have dominated sustainable finance. These are likely to remain a critical part of the landscape.
However, for many situations, bonds are not appropriate. Even companies that have benefited from issuing bonds in the past may find new requirements emerging. In addition, companies now have access to a raft of sustainable finance products; these fall into two broad categories.
The first type is defined by rules on the use of proceeds. Companies are obliged to use funds raised on specific eligible investments; that is, on defined sustainability projects.
The second type comprises products structured to include a variable-pricing component, based on whether the borrower hits certain pre-defined KPIs or sustainability performance targets (SPTs). These products offer companies flexibility in how they use the finance raised, while building in a strong price-based incentive to deliver sustainability improvements.
Such SPTs have traditionally been based on levels of greenhouse gas emissions. But today, while emissions targets are still almost always included, more companies are also including KPIs on other ESG commitments. Retailers might target their use of plastic, for example, while manufacturers might focus on employee safety.
The emergence of these types of products reflects the recognition by banks that every business needs to create its own unique sustainability pathway. As such, banks are typically highly flexible in working with companies to identify the form of sustainable financing most appropriate for them.
Nevertheless, banks will sometimes push companies to be more ambitious, for example when agreeing on SPTs. Many targets will be based on companies’ existing commitments, backed by materiality assessments; however, in some instances, they must consider external factors. On greenhouse gas emissions, for instance, the Science Based Targets initiative (SBTi) is urging businesses to align their targets with recommended measures to limit global warming. While recognizing that some industries have more difficulty than others in incorporating radically different standards, lenders are still likely to challenge those that fall short. Lenders may also look at sustainability standards set by industry watchdogs for particular sectors.
For treasurers or CFOs seeking sustainable finance options in the future, there are three key steps to consider in preparation:
The sustainable finance market is still in its infancy, but it is maturing fast. It seems likely that the vast majority of U.S. businesses will have incorporated some aspect of sustainability into their financial and banking structures within the next few years. For finance leaders in any sector, there is no better time than now to start laying the groundwork for that shift.
We surveyed 750 senior finance leaders to see how they are navigating a new wave of unexpected challenges, including rampant inflation, talent shortages and supply chain bottlenecks. Explore their answers in the 2022 CFO Insights Report from U.S. Bank.