Financing the Transition to Net Zero

Sembcorp Industries, an energy and urban development company based in Singapore that works in countries including Bangladesh, India, and Vietnam, has set some of the most ambitious sustainability targets among energy players in Asia. Its plans include a goal to quadruple its renewable energy capacity to 10 gigawatts by the end of 2025.

And if it fails to meet those targets, there’s a price to pay: Investors in a new, innovative type of bond the company issued in October get a higher payout—0.25 percent more than the current coupon.

“This bond completely aligns us with the notion of energy transition,” said Eugene Cheng, Group Chief Financial Officer of Sembcorp. “We are focused on aligning every single aspect of everything we do to it, even our corporate culture. A lot of players consider green financing restrictive, because it is only intended for use for renewables and green projects. With sustainability-linked financing, you have to define your sustainability performance targets. There will be certain companies that will perhaps define those targets more loosely, but for Sembcorp, they’re very clear.”

“We need to roll out green bonds much more broadly, but we also need to increase and improve the tailoring of climate capital market products to maximize the impact and fit the needs of the issuer,” added Cashion. “That’s where these new types of instruments like sustainability-linked bonds come into play.”

Since Italian utility Enel issued the world’s first sustainability-linked bond in 2019, the market has grown significantly. Over $88 billion has been issued to date, according to data from Bloomberg, $72 billion of which has been issued this year alone. Still, SLBs require a solid understanding of the issuer’s business, industry, and market. Investors need to challenge issuers on their ambitions and commitments—and hold them to them.

“Green bonds sparked the growth of the green finance ecosystem, but only financing green projects will not take us to net zero by 2050,” said Berit Lindholdt-Lauridsen, Senior Climate Finance Specialist at IFC.

“We still depend on carbon-intensive industries, such as cement, chemicals, steel, and heavy transport, which are estimated to be responsible for almost 30 percent of global emissions," she said. "Transforming these sectors would contribute substantially to a reduction in carbon emissions. With that in mind, sustainable finance is the future of finance. However, to avoid 'sustainability washing,' issuers and investors must do their homework even more thoroughly to ensure targets are material, ambitious, and robust.”

Blue Beginnings

Blue finance is another tool that will support the global journey to net zero. Although traditionally classified as a subset of green finance, the urgency of the marine plastics crisis and the need for private-sector flows to address them has led to the market looking at blue finance as a specific asset class. Since the World Bank supported the Republic of Seychelles in the 2018 launch of the world’s first sovereign blue bond, issuance has also begun in the private sector.

Last year, IFC arranged a $300 million blue loan for Thailand’s Indorama Ventures, the world’s largest producer of recycled polyethylene terephthalate (PET) for beverage bottles, which it manufactures for clients including Coca-Cola. Indorama intends to use the funding to achieve its goal of recycling 50 billion PET bottles globally a year by 2025. It plans to do this by expanding its recycling capacity in Thailand, Indonesia, Philippines, India, and Brazil, countries that are grappling with mismanaged plastic waste, thereby diverting plastic waste from landfills and oceans.

Still, this is a huge business opportunity. Earlier this year, the World Bank Group published a series of market studies examining the untapped economic opportunities to promote plastic circularity and address marine debris in Malaysia, the Philippines, Thailand, and Vietnam. The studies show that over 75 percent of the material value of the plastics is lost--the equivalent of nearly $9 billion a year in these four countries—when single-use plastics are discarded rather than recovered and recycled.

Creating Carbon Finance Tools

Other climate-smart financing opportunities are also emerging for investors, including a range of innovations in the carbon finance market. In September, HSBC Australia and London-based Earth Security launched a new project that will develop a framework for a mangrove bond that can be used to protect and restore vital natural habitats, which they hope will develop a blueprint for such instruments that could be used by issuers globally.

Mangroves cover just 0.1 percent of the Earth’s surface but store up to 10 times more carbon per hectare than terrestrial forests, making them critical in global efforts to tackle climate change. In 2016, IFC also issued the world’s first forest bond, which channeled private funds into preventing deforestation in developing countries and gave investors the option of being paid in carbon-credit coupons rather than cash, which was also a first at the time.

Carbon credits provide businesses that cannot fully reduce their emissions with tradable certificates or permits representing the right to emit one ton of carbon dioxide or the equivalent amount of another greenhouse gas. The buyer can claim an offset as a result of financing either a reduction or avoidance of carbon emissions or the removal or sequestration of carbon dioxide in the atmosphere.

Voluntary carbon credit markets, aimed at purchases made voluntarily rather than for compliance purposes, direct private financing to climate-action projects that would not otherwise get off the ground, such as those aimed at biodiversity protection, pollution prevention, and public-health improvements.

Carbon credit markets have become a hotbed for financial innovation. Dutch impact investor BIX Capital, for example, provides working capital financing to small and medium-sized manufacturers and distributors of climate-smart household appliances backed by future cash flows from carbon credits, which help to bring clean cookstoves, water purification systems, and other appliances to low-income households in sub-Saharan Africa.

While most carbon credits are still traded over the counter, exchanges are beginning to add contracts as volumes increase. The market for these instruments could be worth upwards of $50 billion by 2030, or 15 times its size today, according to estimates by the Taskforce on Scaling Voluntary Carbon Markets.

A "Top National Priority"

Other emerging markets leading the way in sustainable finance regulation include Morocco, which in 2015 announced ambitious climate targets at COP21 ahead of hosting COP22 in Marrakech the following year. In accordance with the country’s High Royal Directives, sustainable development has become a top national priority in Morocco, and COP 22 really kick-started the country’s sustainable finance journey, according to Nezha Hayat, Chairperson and Chief Executive Officer of the Moroccan Capital Market Authority (AMMC).

Since then, AMMC has published guidelines on green, sustainability, and social bonds, with support from IFC, in addition to guidelines on gender bonds, corporate social responsibility, and environmental, social and governance (ESG) reporting. It has also made annual ESG reporting mandatory for all publicly listed companies, and has built an ESG index with the Casablanca Stock Exchange.

“These initiatives have allowed the market to gain traction and provided a clear framework, enabling the successful issuance of sustainable finance instruments while reducing the risks of greenwashing, which is necessary for the development of a nascent market,” according to Hayat.

“The framework is now very comprehensive and has everything companies need to issue sustainable finance instruments," she said. "In addition, AMMC will continue its capacity building and framework development efforts for fostering the growth of a local ecosystem that is able to support the development of the market, with a particular focus on investors. The sustainable finance journey is a never-ending one. There is no finish line, and as a regulator we should always continue working to create the right enabling environment.”