Rewiring capital markets for the green transition and a new generation of responsible investors

In Sibos 2022’s sustainability stream, leading finance professionals look to dissect the nuts and bolts of how to successfully achieve sustainability commitments in the fast-changing space.

With 2022 marked by unprecedented European heatwaves and devastating floods in Pakistan, sustainability has skyrocketed in importance for investors and lenders looking to leverage finance to tackle climate change and social issues. Driven by impending climate deadlines, the sustainable development imperative and rapidly emerging regulation, investor appetite for assets taking environmental, social and governance (ESG) factors into account has grown by 15% in the last two years alone, according to the Global Sustainable Investment Alliance (GSIA).

With Accenture reporting that younger generations in the US alone are set to inherit $30 trillion from baby boomers over the three decades, the demand for sustainable assets and investment opportunities will only accelerate. In what should be one of the most anticipated events of the week, BMO and Deutsche Bank will join others to discuss the issue in the panel ‘Green, clean, and ESG: Rewiring capital markets for a new generation of responsible investors’.

According to BMO’s Jonathan Hackett, who co-leads the Canadian bank’s Energy Transition Group alongside his role heading up the Sustainable Finance team, the next generation of investors will likely be aiming to create positive impact with their investments. “My suspicion is that these investors won’t just want companies who are ESG leaders in certain industries – they’ll really want to invest in creating the solutions that are going to drive the energy transition or create positive social outcomes.”

Lavinia Bauerochse, global head of ESG Corporate Bank and member of the corporate bank executive committee at Deutsche Bank, agrees. “If you look at how ESG and sustainable finance developed, it was driven by investors looking to exclude certain companies or industries. Now it has broadened – they’re looking for positive impact,” she says.

However, the market is grappling with how exactly to measure and demonstrate impact in the absence of universally agreed standards and metrics. Despite finance players making use of the UN Sustainable Development Goals and the European taxonomy as guiding frameworks for demonstrating impact, much more work needs to be done.

For Hackett, BMO’s $350m impact investment fund demonstrates some of the complexities in measuring impact. “The fund operates under the thesis of helping clients solve their sustainability challenges. That's a diverse set of outcomes, so we measure impact at an investment level, usually by finding an impact metric that's also correlated to revenue growth,” Hackett says. “However, it's not aggregatable in a clean way that leads to a single metric at the portfolio level.”

“Measuring an asset’s clear intent and contribution to a positive impact is still at an infant stage,” Bauerochse says. “We need a definition of shared standards for impact so that we can identify the pioneers in the market – those companies that are on the credible transition path. That’s a prerequisite for further development of the market.”

We need a definition of shared standards for impact so that we can identify the pioneers in the market – those companies that are on the credible transition path."

Lavinia Bauerochse, global head of ESG Corporate Bank and member of the corporate bank executive committee at Deutsche Bank

Data challenges

As financial institutions have a critical role to play in catalysing innovation and financing transition plans, understanding the transition plans of customers will be an area of focus over the coming years, according to Bauerochse. “There's continuous dialogue on what constitutes a credible transition path for different industries – what are credible technological advances, and in which timelines? Standards are required so those that are on the transition journey understand what the criteria are, and which areas they should focus on.”

Data is at the heart of ESG, but practitioners have long been plagued by how best to collect and use sustainability data amid a proliferation of disclosure frameworks, a patchy regulation landscape, and – increasingly – corporates and finance players being accused of greenwashing when they can’t back up their sustainability claims. This will be discussed on Wednesday’s panel, ‘Harnessing big data towards ESG compliance’.

Natasha Condon, global head of core trade at J.P. Morgan, who will be speaking on the panel, says: “There's a lot of noise in the market about products that label themselves as ESG and can't prove it when it comes to the crunch.”

There's a lot of noise in the market about products that label themselves as ESG and can't prove it when it comes to the crunch."

Natasha Condon, global head of core trade at J.P. Morgan

Financial regulators have been fervent in their efforts to curtail fund managers and other financial service providers looking to exploit ESG demand by overstating their products’ sustainability credentials. The US Securities and Exchange Commission has cracked down on greenwashing among fund managers, while the European Securities and Markets Authority, too, has urged European regulators to step up scrutiny of ESG claims.

The problem is, ESG rules and green definitions are still evolving and there are differences across jurisdictions, with many outstanding points of contention.

Professor Yao Wang, director general of International Institute of Green Finance (IIGF), for example, says ESG evaluation systems and definitions of green and transition need to further consider national market and industry characteristics so non-Western companies aren’t left behind.

Regulatory clarity

This led the IIGF to develop an ESG indicator system localised for the Chinese context. To illustrate, Wang gives the example of Chinese state-owned enterprises: “These may not perform as well under the “G” element of Western ESG ratings because of differences in governance structure, despite the fact that they may be more stable than private enterprises,” she says. “Therefore, from the investor side, a localised ESG rating system can help them understand the value of Chinese businesses to aid in making investment decisions for the long-term.”

Transition definitions, too, must consider national particularities, Wang maintains. “Different countries are in different stages of development, and have different energy mixes and industry structures, so transition frameworks must account for that.”

Different countries are in different stages of development, and have different energy mixes and industry structures, so transition frameworks must account for that."

Professor Yao Wang, director general of International Institute of Green Finance (IIGF)

For Condon, more clarity is needed from regulators on the viability and materiality of ESG data. “It would be helpful to the whole trade industry at this point if there was a common set of standards for all parties, saying: this is what data you collect, and this is how you evidence that a transaction meets those standards.”

In the meantime, Condon says, J.P. Morgan has developed a “rigorous” internal ESG standard which a specialist team uses to assess anything labelled ESG. In the trade finance context, J.P. Morgan runs an ESG-linked supply chain programme for tyre company Bridgestone that advances funds earlier to suppliers. Incentive pricing is available to suppliers that sign up to sustainability standards and consent to being audited by a third-party environmental auditor – a structure Condon expects to become popular as a standard option for clients.

“Once you know what data you’re collecting, it’s about what you do with it, and how you incentivise change with this information,” Condon says. “Our products need to prove with hard numbers the ESG benefit that each of those financings have provided, because my clients are not waiting – they want to implement ESG trade structures today.”