Abstract
This chapter aims at giving an overview of the key characteristics of the green finance market as it stands today. To this extent, the chapter first recalls the main roots of the role of ethics in finance. Hence, it deals with the political process culminating with the Paris Agreement and the adoption of the Sustainable Development Goals as well as highlights the role of green finance in such a process. Hence, it provides a detailed picture of the market by describing the types of existing green securities and financial products and showing the recent investment trends. Finally, the chapter summarises the key challenges still ahead for green finance in order to be considered a stable component of the modern financial landscape.
The contents included in this chapter do not necessarily reflect the official opinion of the European Commission. Responsibility for the information and views expressed lies entirely with the authors.
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Notes
- 1.
As of today, a unique and well-established definition of green finance does not exist. Several definitions have been proposed by the industry and by international organisations for specific green securities and products as well as for the different components of the sustainable finance industry. A more detailed dissertation about the definitions used in the field of green finance is given in Chap. 2.
- 2.
An example is given by cooperative and savings financial institutions, which formally adopted since the nineteenth century in Europe a dual bottom-line approach for which financial performance needed to coexist with social goals (such as mutuality, financial and social inclusion, support to the local communities). For more details, see for example Ayadi et al. (2010) or Migliorelli (2018).
- 3.
For a thorough dissertation of the detrimental consequences of an increase in the global temperatures, see again IPCC (2018).
- 4.
Even today, many Muslims, on the basis of the precepts of Sharia, avoid practices of lending that result in any kind of riba (interest) and investing in industries such as tobacco, alcohol or gambling. These are some of the elements that feature in the modern Islamic finance. For a more accurate analysis, see for example Ayub (2013) or Warde (2000).
- 5.
For example, in England, a law called The Act Against Usury, which prohibited excessive interests on loans was in effect from 1571 to 1624 (Glaeser and Scheinkman 1998; Lewison 1999). In the mid-1750s, Quakers banned their followers from participating in the slave trade, and believers in the Methodist Church were asked to avoid investments in weapons, tobacco, alcohol or gambling, or any trade that could be harmful to life and health (Renneboog et al. 2008).
- 6.
Sustainable finance can be broadly defined as the stocks and flows of financial resources and assets (across banking, investment and insurance industries) which is aligned with a large range of environmental, social and economic objectives and more generally with the delivery of the Sustainable Development Goals (SDGs) as developed in the context of the United Nation Development Program (UNDP). In this respect, green finance should be considered a fundamental component of sustainable finance. For more details, see also UNEP (2016).
- 7.
The original Sullivan principles were developed by the African-American preacher Rev. Leon Sullivan, promoting corporate social responsibility and to apply economic pressure on South Africa in protest of its system of apartheid. The principles eventually gained wide adoption among US-based corporations. As investors realised that some American firms did not make any particular efforts to end discrimination in South Africa, these firms were eventually hit by a massive wave of divestment. The success of this initiative led in 1999 to a new global version of the Sullivan principles. Jointly unveiled by Rev. Sullivan and United Nations Secretary General Kofi Annan, the new and expanded code of conduct, as opposed to the originals’ specific focus on South African apartheid, was designed to increase the active participation of corporations in the advancement of human rights and social justice at the international level.
- 8.
Defining precisely what constitutes the SRI industry may be a challenge. One possible current definition is given by Eurosif, a leading European association for the promotion and advancement of the SRI industry in Europe. Based on this definition, “Sustainable and responsible investment (SRI) is a long-term oriented investment approach which integrates environmental, societal and governance (ESG) factors in the research, analysis and selection process of securities within an investment portfolio. It combines fundamental analysis and engagement with an evaluation of ESG factors in order to better capture long term returns for investors, and to benefit society by influencing the behaviour of companies”.
- 9.
See UNEP (2005).
- 10.
The CERES is a non-profit organisation based in the United States which comprises investors and environmental, religious and public interest groups. The organisation’s purpose is to promote investment policies that are environmentally, socially and financially sound. There are currently more than 70 members, including large financial organisations.
- 11.
The primary mission of UN, after peacekeeping, security and human rights, is economic development and humanitarian assistance. These objectives led to the creation of well-known international organisations that focused on some of its specific underlying missions. This included global international development (United Nations Development Program, UNDP), agricultural development and food security (The Food andAgricultureOrganization, FAO), aid for children around the world (United Nations Children’s Fund, UNICEF), funding of international development and global access to finance (World BankGroup) and global economic cooperation (International Monetary Fund, IMF) amongst others.
- 12.
The targets for the first commitment period of the Kyoto Protocol covered emissions of the six main greenhouse gases, namely, carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF6). The maximum amount of emissions (measured as the equivalent in carbon dioxide) that a Party to the Protocol may emit over a commitment period in order to comply with its emissions target is known as a Party’s assigned amount. The individual targets for the Parties are listed in the Kyoto Protocol’s Annex B.
- 13.
The most publicised event on the subject after that was the 2009 conference in Copenhagen (COP 15), when the US President, Barack Obama, a climate action supporter, had just entered office. The event can be considered largely a failure, as results were far below expectations.
- 14.
Encyclical letter Laudato sí of the Holy Father Francis on Care for Your Common Home.
- 15.
The MDG were: to eradicate extreme poverty and hunger, to achieve universal primary education, to promote gender equality and empower women, to reduce child mortality, to improve maternal health, to combat HIV/AIDS, malaria and other diseases, to ensure environmental sustainability, to develop a global partnership for development.
- 16.
For more details, see UN (2015a).
- 17.
For more details, see UN (2015b).
- 18.
Climate change mitigation usually refers to efforts to reduce or prevent emission of greenhouse gases (GHG). Climate change adaptation normally concerns the adjustments in ecological, social or economic systems in response to actual or expected climatic modifications and their effects or impacts.
- 19.
This bond was labelled Climate Awareness Bond.
- 20.
Icons like Larry Fink, the chief executive officer of the USD 6.3 trillion asset management firm Blackrock, warned chief executive officers of public companies that “society is demanding that companies, both public and private, serve a social purpose” and expressed his expectation that they start accounting for their impact on society. Robert Litterman, Goldman Sachs’ former head of risk, affirmed in an interview that “climate risk is not being priced right by society” and is now a renowned promoter of climate-oriented market solutions.
- 21.
In this respect, in 2005 hurricane Katrina, which had devastating consequences on the population and had an unprecedented echo in the media, resulted as an event able to trigger major developments for the SRI and ESG industry, as many institutional investors started to invest in ESG research and analytics.
- 22.
It can be also argued that the development of the SRI and ESG investing industries was linked to the subprime mortgage crisis and the exposure of the great systemic ethical failures of financial markets. Even though the impact of the subprime crisis mostly resulted in social and governance changes rather than environmental, it further raised the question of the extra-financial impact of corporations and financial actors globally.
- 23.
Source: Climate Bond Initiative (2018).
- 24.
Based on ICMA (2018), there are currently four types of green bonds in the market: standard green use of proceeds bonds (standard recourse-to-the-issuer debt obligations aligned with the GBP), green revenue bonds (non-recourse-to-the issuer debt obligations aligned with the GBP in which the credit exposure in the bond is to the pledged cash flows of the revenue streams, fees, taxes, etc. and whose use of proceeds go to related or unrelated green projects), green project bonds (project bonds for a single or multiple green projects for which the investor has direct exposure to the risk of the projects with or without potential recourse to the issuer, and that is aligned with the GBP) and green securitised bonds (bonds collateralised by one or more specific green projects, including but not limited to covered bonds, asset-backed securities, mortgage-backed securities and other structures and aligned with the GBP and for which the first source of repayment is generally the cash flows of the assets).
- 25.
See ICMA (2018).
- 26.
For a more detailed analysis of the GBP, see Chap. 2.
- 27.
Examples of organisations offering these services are CICERO, Vigeo, Oekom, Sustainalytics, but also Deloitte, EY and KPMG.
- 28.
Use of proceeds, process for project evaluation and selection, management of proceeds, reporting.
- 29.
The property assessed clean energy (PACE) model is a mechanism for financing energy efficiency and renewable energy improvements on private property used in the United States. PACE programmes exist for both residential properties (commonly referred to as Residential PACE or R-PACE) and commercial properties (commonly referred to as Commercial PACE or C-PACE).
- 30.
Source: Moody’s, data concerning the first three quarters of 2018.
- 31.
A green loan is defined as “any type of loan instrument made available exclusively to finance or refinance, in whole or in part, new and/or existing eligible green projects”. See also LMA (2018).
- 32.
A similar array of providers of second-opinions acting in the green bonds market are also present in the green loans sector, in particular CICERO, Vigeo, Oekom and Sustainalytics.
- 33.
Within the broad category of green loans several types of products or schemes can indeed be listed. For example, green commercial building loans have started to emerge to finance new buildings in line with strict environmental standards or to retrofit existing constructions to improve energy consumption or waste and pollution management. An interesting case study of this type of product is linked to the construction of the Duo Towers in Paris. The construction of the two skyscrapers (due for completion in 2020) is funded through the first green-labelled commercial real estate loan in Europe. The EUR 480 million construction is to meet the most rigorous environmental standards, and the buildings’ performance in terms of energy consumption and carbon emissions, which will be monitored and reported regularly. Other examples are given by green mortgages schemes, which provide clients that wish to purchase energy efficient homes or transform their homes with lower interest rates than plain loans or by the Energy Efficient Mortgage Action Plan (EeMAP) initiative launched in June 2018 by the World Green Building Council in partnership with major European banks such as BNP Paribas, Société Générale, Nordea Bank and ING Bank. Smaller-scale financial products can in principle also be designed, in particular for smaller, more widespread funding needs. Green car loans are already conceptualised and may offer preferential rates for less polluting vehicles.
- 34.
In case of green loans dedicated to large companies, at least three technical possibilities may be foreseen: green bilateral loans (a contract formalised by a bank and a company), syndicated loans (in which a group of banks finance a company for a specific project) or a green revolving credit line (in which a bank gives to a company the availability of funds for future projects and activities which are in line with the GLP but are not defined ex-ante).
- 35.
- 36.
In recent years, several multinational development banks, including the World Bank and EIB announced their commitment to increasing capital flows directed to support the transition to a low-carbon economy. In doing that, they can also establish specific funds. For instance, the IFC (International Financial Corporation, member of the World Bank Group) initiated in 2017 the work on Amundi’s new USD 2bn Cornerstone Green Bond Fund, which will invest in bonds issued by banks in emerging markets. The IFC has committed up to USD 325 ml and the EBRD intends to invest up to USD 100 ml.
- 37.
Labelling services for investment fund are also emerging. An example of providers of these services is Luxflag.
- 38.
The Equator Principles are an example. Formulated by the Equator Principles Association (EPA), they represent a risk management framework, aimed at financial institutions, for determining, assessing and managing environmental and social risks in projects. Such a framework is primarily intended to provide a minimum standard for due diligence and monitoring to support risk decision-making. The Equator Principles apply to project finance (including advisory services), project-related corporate loans and bridge loans.
- 39.
A few examples of green indices are the S&P Green Bond Index (focused on green bonds), the S&P Green Project Bond Index (designed to capture bonds which produce environmental benefits but don’t necessarily carry green labels) or the S&P 500 Environmental & Socially Responsible Index (which measures the performance of securities from the S&P 500 that meet specific social and environmental criteria).
- 40.
As an example, investments of around EUR 520–575 bn annually have been estimated to be necessary in the EU only in order to achieve a net-zero greenhouse gas economy in the 2050 horizon. Source: EC (2018b).
- 41.
In May 2018, the European Commission adopted a proposal for a regulation on the establishment of a framework to facilitate sustainable investment. This regulation establishes the conditions and the framework to gradually create a unified classification system (“taxonomy”) on what can be considered an environmentally sustainable economic activity. Following this proposal for a regulation, in June 2019 the Technical Expert Group (TEG) established by the European Commission to support (inter alia) in the definition of the taxonomy, released its technical report (see TEG 2019). This report will be a key element in the establishment of the first version of the taxonomy. For a more detailed dissertation, see Chap. 6.
- 42.
Abundant evidence exists showing a generally positive relationship at least in the last 20 years between corporate finance performances and environmental, social and governance (ESG) performance. See for example Friede et al. (2015).
- 43.
See EC (2018a).
- 44.
In particular, following the Action Plan for a greener and cleaner economy, in May 2018 the European Commission adopted a package of implementing measures including: a proposal for a regulation on the establishment of a framework to facilitate sustainable investment (this regulation establishes the conditions and the framework to gradually create a unified classification system—or taxonomy—on what can be considered an environmentally sustainable economic activity); a proposal for a regulation on disclosures relating to sustainable investments and sustainability risks and amending Directive (EU)2016/2341 (this regulation aims at introducing disclosure obligations on how institutional investors and asset managers integrate environmental, social and governance factors in their risk processes); a proposal for a regulation amending the benchmark regulation (to create a new category of benchmarks comprising low-carbon and positive carbon impact benchmarks, which should provide investors with better information on the carbon footprint of their investments). See also Chap. 6.
- 45.
EC (2018b).
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Berrou, R., Dessertine, P., Migliorelli, M. (2019). An Overview of Green Finance. In: Migliorelli, M., Dessertine, P. (eds) The Rise of Green Finance in Europe. Palgrave Studies in Impact Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-22510-0_1
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