Naomi Gaston: How finance is embracing green values
Australian online lender UBank recently announced the launch of a direct customer 'green term deposit'. This product is focused on more environmentally aware younger customers and is marketed as allowing depositors the chance to make a positive impact on the environment.
UBank's green term deposit will be invested in projects such as solar power, wind projects and low carbon transport. It has yet to be seen if the appetite among consumers for more climate aware investments will prompt further developments in this type of sustainable lending.
Environmental, social and governance (ESG) issues are gaining greater influence in funding decisions - and not just in renewable project finance. ESG may already form part of the credit approval process for more mainstream corporate loans as more lenders consider ESG in investment decisions.
More responsible and environmentally switched-on investors are interested in the environmental impact of specific investments and this is making lenders pay more attention. Financial markets respond to consumer and investor demand and there is a growing body of evidence that ESG factors related to climate change can have significant financial relevance.
Historically there have been performance concerns and perceived lower return on ESG-focused investments even though customer survey data has shown investors tend to be supportive of ESG-orientated investment. Consumer demand for sustainable chocolate, coffee, tea and toiletries has shown ESG-focused investment can be a powerful marketing tool. But finance markets have been slower to focus on and reward greener businesses.
Traditionally, ESG as part of an overall financing focused on negative screening by excluding companies that did not meet an ethical standard or minimising liability for environmental contamination. This was motivated by the desire to reduce risk resulting in financial exposure.
Environmental risk was viewed almost exclusively in relation to operational mismanagement. For example, contamination or pollution could result in an impairment of a borrower's ability to repay its loan, reducing the value of any security or assets offered as collateral. In more extreme examples, a lender could incur liability for environmental risk and suffer damage to its own reputation.
As environmental awareness has developed, lenders are becoming increasingly aware of wider environmental and social benefits from 'greener' investments such as energy efficiency, climate change and the cost of carbon. In addition, there is evidence that links incorporation of sustainability into key strategies to higher profitability.
This is leading to a greater acceptance that successful businesses can secure higher return on investment and support environmentally sustainable economic activity. Some lenders are offering ESG-linked loans which offer a lower cost for lending based on a company's green credentials.
These ESG-linked loans may be used for general working capital and do not necessarily need to be connected to green projects or technologies. ESG-linked loans offer borrowers focused on sustainability certain financial flexibility and potentially more favourable financing terms.
If existing credit approval processes do not already include consideration of ESG, lenders may be in the process of revising their processes. There is no single universal market standard guidelines for lending to improve environmental or social impact, which can make it difficult to determine a borrower's relative ESG performance, commitment and effectiveness.
Lenders may adopt a range of guidelines to help evaluate ESG. These include:
(i) Equator Principles, a set of guidelines to assist in identifying, assessing and managing environmental and social risks of project finance and certain corporate loan transactions;
(ii) UN Principles for Responsible Investment, which help incorporate consideration of the environmental risk into investment decision making processes; or
(iii) Green Loan Principles which adapted the Green Bond Principles to encourage sustainable finance and green lending.
ESG is increasingly becoming more mainstream. As ESG develops it will promote more sustainable business practices and hopefully improve the world we all share.