Sustainable finance will emerge stronger from Covid-19 rebalancing

August 31, 2021

Crises often force change. Sources say that aspects of the environmental, social and governance movement will gain even more traction as a result

All aspects of the environmental, social, and governance (ESG) movement will emerge stronger from the Covid-19 pandemic, which has prompted a welcome rebalancing.

Shifts in the way the financial markets view social and environmental requirements, and corporate attitudes more generally, will pave the way for a more collaborative approach going forward.

As previously documented in IFLR, there has been a significant rise in the number of social bonds targeted at those countries most impacted by the virus. The social aspect, however, has not been the only beneficiary.

"The Covid-19 pandemic certainly has shone light on some of the matters that sustainable bonds have been raising awareness of in the investment community. In particular social and sustainability bonds, in terms of the use of proceeds," said Denise Odaro, head of investor relations at the International Finance Corporation (IFC).

"The socioeconomic crisis brought on by the pandemic has provided some clarity as to what a social issue could be. This was previously a moot point for some and now, similar to climate change, other socioeconomic issues categories are now under the spotlight."

Unprecedented issues have been an unintentional but welcome education to the market participant on the use of proceeds of these bonds, she added. "Investor reaction to recent social bond transactions have shown the appeal and I believe that the appetite to support sustainability through investments will continue to grow".

Interest in green and climate-linked bonds will also continue to grow, and while there was a lapse earlier on in the year as priorities shifted to immediate response to the public health issue, the need for low carbon and climate-resilient infrastructure remains. As sovereigns reopen their economies, the opportunities to rebuild more sustainably is there, and a number of governments have shown that green is the path they intend to take.

"This can translate into growth in green bonds," added Odaro. The governments of both Germany and Sweden have both recently announced intentions to issue green bonds. Odaro foresees a greater role in the sovereign issuer space across the board with sustainability bonds: "When you look at the financial gaps needed to merely mitigate the crisis we find ourselves in this year – it lends itself quite naturally to these products."

Michael Jantzi, CEO of Sustainalytics, agreed that the pandemic has in fact strengthened the cause. "ESG is going to emerge stronger at the other end," he said.

"History doesn't always provide us with a great guide into the future, but it's not the first time ESG has emerged stronger out of crisis," he said. "There were a lot of critics calling for the demise of it during the global financial crisis. In fact, just the opposite happened, and that's what we seem to be experiencing here too."

This can be measured by any number of factors, he continued, for example the strong performance of green bonds despite market volatility. There have been strong flows into funds that characterise or define themselves as ESG, and these are starting to see very rapid returns.

"The pandemic has illustrated the systemic risks that ESG has been trying to address. In conversations with chief investment officers or those in corporate finance about systemic risks like climate change or the income gap, the pandemic has been an example of what it all actually means."

"Covid-19 is a living, breathing example of how risks that may not seemingly be attached to an investment outcome, market volatility or the economy more broadly, can quickly turn into that," he added. "We've also seen how inaction can lead to negative outcomes very quickly."

A turning point

Things were clearly on the up in the sustainable finance world before the pandemic took its grip on the world.

"We clearly were at a turning point already. At the end of last year, I wanted to write a sustainable finance article on how December 2020 will look like nothing when compared to January 2020 – and I never got to do it," said Herve Duteil, chief sustainability officer, Americas, at BNP Paribas.

"Of course, I didn't know that Covid-19 would happen in the middle of that. We were at an acceleration point for sustainable finance in the corporate world back at the beginning of this year. What the crisis has done is hammered that down even faster. Everyone is talking about sustainability in every corner of the corporate space, the investor space, the rating space, or the regulator space."

For Duteil the risk is that things move so fast that appropriate care is not taken, and that the concerns of ESG are unlikely to be solved overnight, or in six months' time. "Covid-19 has highlighted the fact that crises can be real, that our wellbeing is connected to our economic wellbeing, and that it is costly to be unprepared," he said.

Several sources suggested that it important for those involved in sustainable finance to pay close attention and be mindful about the impact and the change that the Covid-19 situation has thrust upon the global economy and the financial markets.

"But, it's also important to not take anything away from what has really transpired in the last nine to 18 months. It was already a point of fundamental change in the financial markets," said Jacob Michaelsen, head of sustainable finance advisory at Nordea Markets.

According to Michaelsen, calling ESG a mega-trend does not do it justice, because this puts it in the same boat as various other trends that have come and gone over the last years and decades. ESG itself is not really a trend rather than a fundamental shift in the financial markets.

"More than anything, Covid-19 has forced us to recognise that the social component of ESG are something to be taken seriously in the financial markets because there is such potential for risk mitigation. As a result, the finance industry is now really starting to pay more tribute to the overall development within ESG," said Michaelsen.

The market is now beginning to accept this new paradigm that share prices are no longer valued-based on the simple fundamentals of financials.

Pension funds and insurance companies have previously been able to commit to divesting from oil, natural gas or fossil fuels in x amount of years without much obligation, largely it was a statement that could be made without really upsetting anyone. Now, it is at the point where a long term investor is unable to see any form of sustainable value creation.

The cost of being unprepared has become very clear during the pandemic, and issues like climate change and the need for a more resilient world are more deeply engrained in people's minds than ever. "From borrowers to investors to regulators, the understanding is stronger and we are on a stronger foothold," said Duteil.