Sustainable finance could deliver a ‘premium’ as banks retrench from fossil fuels.
Global sustainable finance, including loans and bonds provided by corporations and banks, rose to $385 billion in the third quarter of 2024, up from just shy of $300bn in the same part of last year, according to ING’s Sustainable Finance Pulse report.
The Dutch bank’s credit strategist Timothy Rahill said he is “optimistic” that next year will hail a recovery in sustainable finance, following a dip in the second quarter of this year and lower volumes expected in the fourth quarter.
Sustainable finance is going through a metamorphosis, as companies are increasingly penalised for failing to meet emissions criteria, with tighter European regulation expected by the end of the year.
Green bonds and sustainable finance as an aggregate group was flat on the prior quarter in the three months to the end of September, and both quarters demonstrated lower volumes than the close to $400bn generated in Q2 2023, ING said.
Rahill told Energy Voice that although the premia that is priced into environmental, social and governance (ESG)-linked debt has been limited so far this year, the bank is “bearish” about how the market will play out next year.
“For 2025, we think differentiations will grow as we are ever so slightly bearish on the market as a whole, thus more outperformance of ESG is likely going to be seen, and more greenium should be priced in,” Rahill said.
The bank is “optimistic” about the prospects for sustainable finance in the new year, anticipating that stricter enforcement and regulation of the criteria that govern sustainable bonds and loans will make these instruments more credible as investments.
Greenium
Credit strategist Rahill explained that there is usually some ‘greenium’ present in the primary bond market, as ESG bonds “come with higher subscription levels on the book” and a marginally lower spread.
However, he said there has been “overall compression” across all segments of the bond market this year, not least sustainable finance.
ING warns in its latest Sustainable Finance Pulse that the theme of slightly “lower supply looks set to continue in Q4”. In October alone, just $117bn of sustainable finance was issued, according to its analysis. Meanwhile, in November, the US election meant “more than normal limitations on issuance windows”.
December is usually a quiet month for green bonds, and this year will be no exception, as ING predicts a “very quiet” final month of the year. Sustainable finance “will really struggle to match” the levels demonstrated in the fourth quarters of the two years prior of about $340-380bn, the bank said.
Arash Mojabi, UK head of sustainable finance at ING, explained that greater guardrails on the provision of finance to the energy sector has contributed to smaller volumes of sustainable finance year on year.
Sustainable and green bonds could be in for a resurgence, however, despite recent crackdowns on companies like Italian energy company Enel over emissions and moves towards greater stringency in how green bonds are regulated, as well as a wider retrenchment of the banks from financing fossil fuels.
“The drop between the years is, I think, naturally a tightening of the guardrails and the guidelines and the scrutiny imposed,” Mojabi told Energy Voice. “So under that new normal it clearly is going to, all things being equal, lead to lower volumes.”
The last couple of years have undergone a shock in the market for sustainable and green bonds, amid a clampdown on performance management and the monitoring and enforcement of sustainable practices.
Enel Group missed its 2023 greenhouse gas emissions targets on its green bonds, and consequently had to raise its coupon, increasing the amount the issuer must pay back on the debt.
Mojabi explained that stricter key performance indicators (KPIs), the way lenders monitor and enforce how sustainable bonds are in practice, driven by greater regulatory measures, will ultimately make these green investments and debt instruments more credible with time.
ING said most of the emphasis on KPIs related to climate change concerns the energy, transport and logistics sectors. Yet only 8% of the sustainability linked loans that it issued in 2024 for the year to date were in the energy sector.
The City of London Corporation is working on measures, as outlined in the Transition Finance Market Review, to support a recategorisation of lending specifically for energy transition purposes.
The outcomes of this report could lead to greater accessibility of sustainable loans and finance as the guardrails are recalibrated to allow companies that can demonstrate commitment to cleaner energy greater leeway and access to finance.
“We’ve now reached normality from which here, the market will grow; but I certainly think that transition finance will also be incremental to volume,” said Mojabi. “So I think we should see some growth in that space as well.”
The European Union is rolling out new legislation in the form of corporate sustainability reporting rules, adopted in January 2023, which it said “strengthens the rules concerning the social and environmental information that companies have to report”.
“The first companies will have to apply the new rules for the first time in the 2024 financial year, for reports published in 2025,” according to the European Commission.
More plentiful
ING is optimistic for growth in sustainable finance next year.
“We expect sustainable finance will be more plentiful next year in 2025, matching the rise of supply overall,” the bank said in its latest report.
The bank said it expects a recovery in 2025 as issuers turn to ESG “to increase demand” and get “lower cost” on their new issues.
Effectively, it is becoming cheaper to seek sustainable finance than not.
“The bond markets will certainly remain open for Energy corporates, particularly for ESG debt for transition finance,” said Rahill.
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