Sustainable finance instruments offer businesses several ways to finance their sustainable business activities. There are two types of instrument (bonds and loans), four classes (green, social, sustainability and sustainability-linked) and two purposes (use of proceeds purposes for specific projects and general corporate purposes for businesses that are transitioning to more sustainable ways of doing business).

  • This article describes the different categories of sustainable finance
  • 11 min read
  • Last updated 1 November 2020

Sustainable Bonds

Just over one third of sustainable investment funding is invested in bonds.

What are bonds?

A bond is an instrument issued by a company representing a loan to the business for its operations or a project. The company pays a fixed rate of interest and returns the borrowed amount when the bond reaches its maturity date.

What are sustainable bonds?

Sustainable bonds are an area of fast-growth innovation in the finance market. The first green bonds were issued in 2014 and by 2020 global issuance had reached US$1 trillion cumulative. Issuers of bonds can be private companies, banks and public entities at city, regional and national level. The first sovereign green bond was issued by Poland in 2016, the first sovereign blue bond (for marine protection) was issued by the Republic of Seychelles in 2018, and the first bond linked to the UN SDGs was issued by Mexico in 2020.

There are two classes of sustainable bond: those funding specific activities (use of proceeds) and those funding the business generally (general corporate purpose). Within these classes, there are several products.

Use of proceedsGeneral corporate purposes
Green bonds
Social bonds
Sustainability bonds
Sustainability-linked bonds

Use of proceeds sustainable bonds include green bonds, social bonds and sustainability bonds (green+social). These were first issued in 2014, and by 2020 had reached US$1 trillion cumulative global issuance. General corporate purpose sustainable bonds, also known as sustainability-linked bonds, help fund a business’s transition toward sustainability. These are much newer – the first one was issued in 2019.

Green Bonds

What are they?

Green bonds are environment-themed assets and must be used for specific activities with positive environmental or climate benefits. In New Zealand, Contact Energy certified all its debt as green in one go (through the Climate Bonds Initiative) against its renewable power generating assets (Juno, 2019).

What standards are applied?

There is no commonly agreed international standard for green bonds; however, there are several options:

  • the Green Bond Principles, developed by the ICMA, are voluntary process guidelines clarifying the approach for issuance of a green bond, with a particular emphasis on ‘use of proceeds’
  • the Climate Bonds Initiative provides the Climate Bonds Standard, based on the Green Bond Principles, and an assurance and certification scheme delivered through independent verifiers, using the Climate Bonds Taxonomy (of low carbon projects) and ensuring bonded projects are consistent with the 2C global warming limit in the Paris Agreement
  • the proposed EU Green Bond Standard (planned for launch in 2021) builds on the Green Bond Principles, providing a voluntary standard for issuers who wish to align with the EU Taxonomy of environmental objectives, including a framework, allocation and impact reporting and external verification requirements
What are the criticisms?

The main criticism of green bonds is that the issuer is not held to account for defaulting (ie using proceeds outside the nominated project) or for their performance (ie delivery against the planned benefits of the nominated project) (Chapman Tripp, 2019).

What about assurance?

Issuers may wish to provide investors with a level of assurance about their green bond’s credentials and their impact (Climate Bonds Initiative). Assurance can be pre issuance (one off) or post issuance (annual) with a variety of assurance options possible. Pre issuance second party opinions (ie organised by the issuer to support the marketing of the green bond) and post-issuance impact reporting are standard in some bond markets, such as Japan.

Pre issuance (one-off)

  • third party assurance that the issuance is in alignment with an international framework of principles
  • second party opinion that the project is eligible under the taxonomy
  • green bond rating, assessing the bond’s alignment with principles
  • pre-issuance verification of Climate Bonds Standard certification

Post issuance (annual, for outstanding items)

  • second or third party assurance that proceeds were allocated to the eligible project
  • impact report quantifying the climate or environmental impact of the project
  • post-issuance verification of Climate Bonds Standard certification

Example: Visa

Visa has issued a seven-year US$500 million green bond, the first by a consumer finance company, and at a record low yield of 0.75% (Bloomberg Green, 2020). The company obtained a second party opinion on the bond’s eligibility from sustainability rating agency Sustainalytics. Proceeds will be used to finance projects to reduce Visa’s greenhouse gas (GHG) emissions, including building upgrades, energy efficiency schemes and renewable energy, in alignment with Green Bond Principles.

Social Bonds

What are they?

Social bonds are social-themed assets that finance projects with an identified social objective. The social bonds market commenced in 2013 and is still relatively small (US$16.5 billion by 2018) compared to green bonds, and only 6% of social bonds have been issued by companies. Danone was the first corporate to issue a social bond following the Social Bond Principles (ICMA, 2018 (pdf)). Housing New Zealand issued a NZ$500 million social bond and a NZ$600 million wellbeing bond aligned with the New Zealand Government’s Living Standards Framework (ANZ, 2019).

What standards are applied?

There is no common international standard for green bonds; however the Social Bond Principles, developed by the ICMA, promote integrity in the Social Bond market through guidelines that recommend transparency, disclosure and reporting. According to Social Bond Principles 2020, there are two elements to social impact: what type of project and who is it for. Allocation of proceeds must address one or more social issues and benefit a target population.

The most common types of project supported by social bonds are:

  • Affordable basic infrastructure – clean drinking water; sewers; sanitation; transport; energy
  • Access to essential services – health; education and vocational training; healthcare; financing and financial services
  • Affordable housing
  • Employment – employment generation; programs designed to prevent and/or alleviate unemployment stemming from socioeconomic crises, including through the potential effect of SME financing and microfinance
  • Food security and sustainable food systems – physical, social and economic access to safe, nutritious, and sufficient food that meets dietary needs and requirements; resilient agricultural practices; reduction of food loss and waste; improved productivity of small-scale producers
  • Socioeconomic advancement and empowerment – equitable access to and control over assets, services, resources, and opportunities; equitable participation and integration into the market and society, including reduction of income inequality

Specific target groups include:

  • those living below the poverty line
  • excluded and/or marginalised populations and /or communities
  • people with disabilities
  • migrants and /or displaced persons
  • under-educated people
  • under-served people, owing to a lack of quality access to essential goods and services
  • unemployed
  • women and/or sexual and gender minorities
  • aging populations and vulnerable youth
  • other vulnerable groups, including as a result of natural disasters

Example: Danone

Danone issued its seven-year €300 million social bond in 2018, obtaining a second opinion on the sustainability credentials and management of the bond from Vigeo Eiris, an ESG rating agency. Proceeds are allocated to projects promoting positive social impact on Danone’s stakeholders, spanning quite a wide range of projects, including: research and innovation for advanced medical nutrition, social inclusiveness, responsible farming and agriculture, entrepreneurship financing and quality healthcare and parental support.

Sustainability Bonds

What are they?

Sustainability bonds are bonds where the proceeds will be exclusively applied to finance or re-finance a combination of both green and social projects.

What standards are applied?

As with green and social bonds, there is no common international standard for sustainability bonds; however Sustainability Bond Guidelines have been developed by the ICMA.

Example: Obayashi

Japanese construction company Obayashi issued a five-year JPY 10,000 million sustainability bond in 2019, in accordance with the ICMA’s Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines, and /or the Green Bond Guidelines of the Ministry of the Environment, Japan. The company obtained a second party opinion regarding the bond’s eligibility.

Proceeds are allocated to the following projects:

  • Construction of a new environmentally friendly “Wellness Building”
  • Securing skilled workers in the construction industry
  • Renewable energy, includind R&D for a hydrogen production plant, a biomass power plant and an onshore wind power plan

A list of all green, social and sustainability bonds issued since 2016 can be found on the International Capital Market Association (ICMA) website. A mapping of the ICMA’s green and social bond principles to the SDGs provides a broad frame of reference by which issuers, investors and bond market participants can evaluate the financing objectives of a bond programme against the SDGs.

Sustainability-linked Bonds

What are they?

Sustainability-linked (target-linked, KPI-linked or transition) bonds are used for general corporate purposes. They are very new; the first one was issued in 2019. While green, social and sustainability bonds have led the way in sustainable finance, they fall short for businesses that are pivoting their entire business model toward sustainability performance or that cannot identify eligible green or social projects. They particularly suit industries that are ‘brown’ today but are transforming to be ‘green’ tomorrow, such as heavy industry, manufacturing and textiles. Transformation funding for businesses that are not yet low carbon is critical to achieving the Paris goals and the SDGs.

What standards are applied?

There are no standards, however Axa Investment Managers have drafted guidelines for transition bonds.

What are the criticisms?

Observers aren’t sure these don’t simply add a veneer of responsibility to businesses that simply aren’t sustainable. Companies should be required to meet targets on sustainability issues that are material to their business or show improvement in their overall sustainability performance as independently assessed by a third party rater (Environmental Finance, 2020 (pdf)). Financing costs should be increased in the event of failure to achieve a sustainable performance objective.

Example: Enel

Enel, an electricity company based in Italy, launched an SDG-linked bond worth US$1.5 billion in 2019.

Enel will use the funds to support four SDGs through specific commitments:

  • SDG 7 Affordable and clean energy (target 7.2 to increase substantially the share of renewable energy in the global energy mix by 2030)
    • Business target – 11.6 GW of additional capacity
  • SDG 9 Industry, innovation and infrastructure
    • Business target – 46.9 million smart metres installed and 5.4 billion euros of investment in innovation and digitalisation
  • SDG 11 Sustainable cities and communities
    • Business target – retail investment and new electrification-oriented energy services to achieve 9.9 GW of demand response capacity and 455,000 charging points for electric mobility
  • SDG 13 Climate action
    • Business target – carbon dioxide emissions reduced to below 0.350 kg/kWheq in 2020 and full decarbonisation by 2050

One critic of this kind of bond labelled this as greenwashing, describing it as “an option on Enel failing to meet its renewables targets”. It was oversubscribed by three times its value. (Environmental Finance, 2020 (pdf)).

The issuance was supported by the UN Global Compact and a syndicate of bookrunners, including Bank of America, BNP Paribas, Citigroup, Goldman Sachs, J.P. Morgan, Morgan Stanley and Société Générale (Responsible Investors, 2020). Dutch pensions funds ABP, PFZW and PMT have invested (IPE, 2020). Enel’s coupon will rise by 25 basis points if the company fails to hit a target of generating 55% of its capacity from renewables by the end of December 2021.

Sustainable Loans

About one half of sustainable investment funding is invested in loans.

What are loans?

A loan is a financial instrument prescribing a specific purpose for which the funds may be used; it is for a specific term, at the end of which funds must be repaid; and, the financial cost to the borrower is incurred through interest that can be fixed, variable, or a combination of the two.

What are sustainable loans?

As with sustainable bonds, sustainable loans are an area of innovation in finance, with both use of proceeds and general corporate purpose products issued in recent years.

Use of proceedsGeneral corporate purposes
Green loansSustainability-linked loans

The first use of proceeds green loans in Aus/NZ were issued in 2018. General corporate purpose sustainability-linked loans were first issued in Australia was in 2018 and in NZ in 2019 (Green Loans Australia & New Zealand, Climate Bonds Initiative, 2020).

Principles of Responsible Banking

Sustainable loans are usually issued by a bank. The UN Principles of Responsible Banking is a framework for ensuring that signatory banks’ strategies and practices align with the SDGs and the Paris Agreement.

There are, as of September 2020, 185 signatories, representing more than a third of the global banking industry. Eighteen months after signing, signatory banks must report on their impact, how they are implementing the Principles, the targets they have set and the progress they have made. Within four years, signatory banks must have met all these requirements.

French bank BNP Paribas, for instance, has introduced policies that exclude a number of unsustainable activities, including ceasing lending to new coal-fired power plants in 2017 and excluding utilities with coal-fired generation in the EU by 2030 and globally by 2040. It has also reallocated resources to assets and projects that contribute to the SDGs (Environmental Finance, 2020 (pdf)).

The UN PRB principles are:

  1. Alignment – We will align our business strategy to be consistent with and contribute to individuals’ needs and society’s goals, as expressed in the Sustainable Development Goals, the Paris Climate Agreement and relevant national and regional frameworks
  2. Impact and target setting – We will continuously increase our positive impacts while reducing the negative impacts on, and managing the risks to, people and environment resulting from our activities, products and services. To this end, we will set and publish targets where we can have the most significant impacts
  3. Clients and customers – We will work responsibly with our clients and our customers to encourage sustainable practices and enable economic activities that create shared prosperity for current and future generations
  4. Stakeholders – We will proactively and responsibly consult, engage and partner with relevant stakeholders to achieve society’s goals
  5. Governance and culture – We will implement our commitment to these Principles through effective governance and a culture of responsible banking.
  6. Transparency and accountability – We will periodically review our individual and collective implementation of these Principles and be transparent about and accountable for our positive and negative impacts and our contribution to society’s goals

Green Loans

What are they?

A green loan is made available by a bank to a business exclusively to finance projects that deliver environmental impacts. Eligible projects can include those that seek to address climate change, the depletion of natural resources, the loss of biodiversity and pollution, but can also include projects that significantly improve the efficiency of utilisation of fossils fuels. Lenders tend to charge lower interest rates to finance green projects to incentivise borrowers, on the basis that businesses that are more sustainable have better risk management and governance in place.

What standards are applied?

Green Loan Principles have been developed by the Loan Markets Association.

What are the criticisms?

Critics mention the halo effect associated with green loans that benefits both lender and borrower.

Example: Cleantech Solar

Cleantech Solar is a pan-Asia developer and supplier of commercial and industrial focused solar PV. Headquartered in Singapore, Cleantech has installations in India, Cambodia, Malaysia, Thailand, the Philippines, Vietnam and Singapore and includes numerous RE100 initiative members in its customer base. According to the International Energy Authority, the demand for electricity in Southeast Asia is expected to grow 6% annually with renewable energy currently meeting just around 15% of demand (Cleantech Solar, 2020). Cleantech Solar is 49% owned by Shell (Reuters, 2018).

A US$75 million green loan under Green Loan Principles is supporting the company’s expansion strategy of building over 500MW of solar power projects for multinational corporates across Southeast Asia. The loan is provided by ING, which is ranked third in terms of the number of green loans or sustainability-linked loans issued, with a total value of US$7.3 billion, according to data from Bloomberg (ING, 2020).

Sustainability-linked Loans

What are they?

Sustainability-linked loans are general corporate purpose loans to support and incentivise sustainability transformation and the alignment of financing and sustainability objectives. Interest is linked to selected sustainability KPIs, eg carbon emissions or an independent sustainability rating. Companies that achieve their targets benefit from favourable interest rates, while a failure to do so will lead to higher rates.

Any target that is meaningful to the borrower can be worked into a sustainability-linked loan. This demands collaboration between the company’s finance and sustainability teams to choose a KPI, creating financial incentives aligned to long term goals.

The first SLL was issued for €1 billion to Phillips in 2017. Interest was linked to an ESG rating from rating agency Sustainalytics (BNP Paribas, 2019).

What standards are applied?

Sustainability-Linked Loan Principles have been developed by the Loan Markets Association.

Example: UPM

Finnish forest-based bio-industry company UPM is one of the first companies to link the pricing mechanism of a revolving credit facility to biodiversity and climate-related targets.

The margin of its €750 million loan is tied to two KPIs:

  • a net positive impact on biodiversity in the company’s forests in Finland
  • a 65% reduction in CO2 emissions from fuels and purchased electricity between 2015 and 2030, in line with UPM’s commitment to the United Nations’ Business Ambition for 1.5°C.

The five-year facility has two one-year-extension options, was coordinated by BNP Paribas.