Rising demand for sustainable investments sparks innovation in credit markets
The effects of climate change are becoming the new normal in Vietnam, including increased sea level rise, increased number of heatwaves and increased frequency of hot days and hot nights. At the same time, Vietnam’s greenhouse gas emissions are increasing dramatically. Between 2010 and 2030, its overall emissions will increase fivefold, per capita emissions fourfold, and the carbon intensity of GDP by 20 percent. Huge investments are needed to address these challenges.
Globally we are seeing a remarkable interest in the private sector to scale up investments dedicated to mitigate (and adapt to) climate change driven by growing concern about these issues and the enormity of the economic costs and financial losses facing the financial sector.
The most obvious reflection of this interest is the rapid growth of the Green Bond market. New issuances surged to more than US$250 billion in 2019. The Green Bond is a fixed-income instrument that finances environment-friendly projects and appeals in particular to an expanding pool of investors who are interested in making measurable, beneficial social and environmental impact, while earning commercially appealing returns.
However, these markets remain relatively under-developed in many developing countries. Banks and financial institutions in these countries can play an important role in lowering the carbon footprint of rapid growth by redirecting capital flows to environmentally responsible projects and innovative technologies.
Mobilizing innovative financial products and services
Emerging market regulators are using a combination of regulations, guidelines, taxation, fiscal and non-fiscal incentives and award schemes with very positive results in some instances.
Green credits such as loans to projects offering energy savings or emission reductions now make up approximately 10 percent of the portfolios of China’s top 21 banks thanks to mandatory Green Credit Guidelines issued by the China Banking Regulatory Commission and the People’s Bank of China.
The Government of Malaysia’s Green Technology Financing Scheme (GTFS) has resulted in the participation of 28 banks and financial institutions in 319 projects (approximately US$875million in loans) as of July 2018. The Scheme offers borrowers a two percent rebate on the total interest charged by banks for eligible green projects as well as a guarantee of 60 percent of the total approved loan.
Green loan portfolios of Bangladeshi banks increased from BDT24.2 billion in to BDT94.1 billion in 2018 after the central bank set a minimum annual target for banks and other financial institutions to dedicate 5 percent of total loan disbursements and investments to green financing.
Rise of the labeled Green Loan
Using loan finance to fund green projects is not new, but in December 2018, the Loan Market Association, in conjunction with leading financial institutions, developed a standardized industry framework to finance projects that provide clear environmental benefits. The Green Loan Principles (GLPs) are closely modelled on the widely recognized Green Bond Principles (GBPs) and promote the same type of transparency in project selection, fund allocation and reporting.
Applying a globally consistent methodology to identify a loan as “green” can help banks and financial institutions track the green share of their lending portfolio vis-à-vis their sustainability goals, redirect capital flows to meet targets, and even consider divesting in assets seen as vulnerable to climate events. GLP-aligned loans also help regulators apply universally accepted eligibility criteria for incentives such as grants or tax rebates, allowing small-sized projects that require smaller investments to access cheaper financing. Banks and financial institutions can also package such loans into Covered Green Bonds.
While still early days, labeled Green Loan issuance amounted to about US$60 billion in 2018. In the ASEAN region, ING issued the first GLP- compliant Green Loan to finance a portfolio of rooftop solar projects developed and owned by Sunseap Commercial Assets Pte. Ltd., a subsidiary of Sunseap Group, the largest clean energy solutions provider in Singapore.
Loans with sustainability-linked pricing
Another type of loan that is gaining traction is the Sustainability-Linked Loan. Also known as ESG-Linked Loan or Positive Incentive Loan, the proceeds of the loan are used for general corporate purposes, rather than “green” projects. But the pricing of the loan is based on the borrower’s environmental, social and governance (ESG) score or overall sustainability achievements such as emission reductions. If the borrower achieves its sustainability target, it benefits from favorable interest rates on the loan. If it fails, it pays a higher rate. These loans are also governed by standards developed by the Loan Market Association.
Global agricultural firm Louis Dreyfus (LDC), headquartered in the Netherlands, has two loans with sustainability-linked pricing mechanisms—a US$750 million revolving credit facility (RCF) in North America and a US$650 million RCF in Asia. LDC will benefit from a reduction in the interest rate on the RCFs each year it makes improvements in its sustainability performance. An independent auditor will provide validation. Other companies like Nokia (Eur1.5 billion) and US company CMS Energy (US$1.4 billion) have also signed Sustainability-Linked Loans.
As global demand for sustainable finance continues to surge, the supply of these types of loans is expected to increase, especially from companies committed to reducing their carbon footprint and achieving positive impact.
Tremendous potential in Vietnam
Banks and companies in Vietnam can also grasp these business opportunities while contributing to reducing the impact of climate change. In the Mekong Delta alone, there is huge untapped potential for investments in climate-smart agriculture and renewable energy, especially wind and solar.
This article was originally published in the Vietnam Investment Review.