How to measure the greenness of finance

Some $90 trillion of investment is needed in the next 15 years to achieve global sustainable development and climate objectives, according to the Group of Twenty’s Green Finance Synthesis Report.

The Organisation for Economic Cooperation and Development (OECD) estimates that over $800bn needs to be invested every year until 2020 in renewable energy, energy efficiency and low-emission vehicles alone. To put that into perspective, global investment in clean energy was less than $300bn in 2016.

So, how do we bridge that gap?

Green bonds, just one financing tool that funds environmentally friendly businesses and assets, are growing in popularity and volume. Issuance of green bonds doubled to $82.6bn in 2016 from 2015 levels, supported by the successful negotiation of the Paris Agreement, increased national initiatives to establish green bond principles, and strong issuance from China.

In 2017, it is expected the market will achieve the issuance milestone of more than $100bn worldwide in a single year, supported by continued strong volumes from Asia and the entry of new sovereign issuers.

Green bonds are gaining traction in the Middle East also with the National Bank of Abu Dhabi issuing a $587m five-year green bond in March – the first ever green bond from a Middle East issuer. NBAD will use proceeds from the bond issue to fund energy efficiency and renewable energy projects, which it will select in accordance with its Green Bond Framework.

However, despite significant growth, the green bond market remains relatively small, representing only 1.4 per cent of a $90 trillion global aggregate fixed-income market. And still falls short of the trillions of dollars required to achieve sustainable development.

So far, the drivers of the sustainable finance industry have been a mixture of retail demand, increasing regulation, portfolio decarbonisation commitments, and a growing awareness of climate risk exposure. S&P Global Ratings views the emergence of new instruments that integrate green finance and conventional financing, such as green loans and green securitisations, as crucial to the further development and scaling up of the industry.

Transparency, governance over the use of proceeds as well as green quality will also play an increasingly important role in investment decisions. Methods for assessing this ‘green’ quality of an investment will also bring visibility and enable price discovery for investors. In addition, we believe creating trusted benchmarks for investment in climate-resilient infrastructure, renewable energy and clean transport will enable higher levels of investment in clean energy.

Furthermore, the ability to compare investments based on the environmental benefits they deliver to a wider stakeholder base will enable investors to rank and therefore price green securities according to their environmental quality. But how do you assess the ‘greenness’ of an investment?

Up to now there have been few market standards that allow investors to benchmark pricing of financial instruments based on their level of greenness, in the same way that credit ratings facilitate the pricing of credit risk through a risk premium or spread over the risk-free rate.

In our view, this has inhibited market growth in the green finance sector.

In April, S&P Global Ratings launched a tool that provides investors with the globally recognised level of information transparency they need. The tool facilitates identification of the green contribution of a financing by highlighting the portion of funds dedicated to green investment and assessing its environmental or resilience impact. Importantly, the tool can be used for any type of financial instrument including stocks, bonds, loans and securitisations.

The tool, called The Green Evaluation, considers three core environmental KPIs in the areas of carbon, water and waste. These KPIs are weighted and combined to form a net benefit ranking. We then put together the combined environmental or resilience impact for each financing with a transparency and governance assessments to form the overall Green Evaluation score. The final score (on a scale of 0 to 100) is translated to a final Green Evaluation rating which ranges from ‘E1’, which contributes the most to meeting climate change targets, to ‘E4’ which contributes less. In just over a week since the tool launched, S&P Global Ratings assigned its first Green Evaluation of E1/87 – the strongest on its scale – to a private placement to partially fund the Cross Sound Cable undersea cable project in the US.

As the world of sustainable finance expands beyond green bonds, it is essential that investors are able to compare the environmental quality of a financing irrespective of asset class. Tools like Green Evaluation lay the foundation for comparing sustainability and are applicable to a wide range of financing methods.

These tools are designed to enable investors to easily identify projects of high environmental quality, make more informed investment decisions, and avoid being ‘green-washed’.

It is hoped that, over time, green analytics can start to more consistently impact pricing and create demand for sustainable finance of all kinds, making a meaningful step towards the trillions of dollars required to fund green projects.

Michael Wilkins is the managing director of S&P Global Ratings