The opportunity for sustainable finance in Emerging Markets

2018 0402 East 03

east-logo-whiteAs of March 2018, Fiji and Nigeria are the only two emerging markets to have issued sovereign green bonds. They are two of just four countries globally indicating a commitment to independent sustainability policies and carbon emission reduction under the Paris Agreement. Outside of these two sovereign bonds, the big corporate issuers in emerging economies are China and Mexico with a combined green bond deal value in 2017 of US$28.8bn. China, the world’s top carbon-emitter, has faced criticism about where and how the money raised is being spent. This highlights a challenging issue for the proliferation of sustainable finance in emerging markets – what specifically is classified as ‘sustainable’ and what official measurements are there of the outcomes?

Sustainable development is hugely expensive. The UN estimates that up to US$7tn in investment is needed each year to achieve the Sustainable Development Goals however it is certain that it will be even more expensive in the long run if we turn a blind eye. As the driving force of the worlds’ economy, sustainable development across emerging markets is both critically important and likely even more expensive than in their developed market peers. In general, emerging markets lag behind developed economies in environmental stewardship as well as social and governance areas, highlighting the need for emerging markets to take an active role in the move to a more sustainable future.

What is sustainable?

There is often controversy around what is classified as sustainable or ‘green’. While initiatives such as the Task Force on Climate-Related Financial Disclosures and the Sustainable Banking Network are seeking to create internationally recognised guidelines, these blueprints are ultimately still voluntary. Issues around corporate disclosure are an enormous barrier to gaining investment from institutional investors.

If the problem exists at the level in which companies are sophisticated enough to try and attract investor funds, the problem is on an unimaginable scale at the small end of the market. Small businesses applying for green loans from their bank face an uphill battle when it comes to securing the debt, assuming the bank even has a specialised product that businesses can apply for. Small businesses across all markets but particularly those in emerging markets need knowledge and guidance that green financing is available and attainable for them. Emerging economies have undergone rapid urbanisation and industrialisation over the past few decades at a time when developed markets have already reached their limit, leading many to place the blame for todays sustainability woes at the feet of emerging markets. Perhaps because of this, as well as a lack of legacy issues and resources leading to the need to improvise, emerging markets are taking a lead role in sustainability initiatives.

2018 0402 East 01A network is launched

The Sustainable Banking Network, launched in 2012, is a community of financial sector regulatory agencies and banking associations from emerging markets committed to advancing sustainable finance in line with international best practice. Members including Argentina, the Philippines, Bangladesh, China, Mexico and Nigeria facilitate a global knowledge network on sustainable banking to develop regulatory guidance and national policies to support their local businesses and financial institutions.

Regulators are only one part of the solution for actionable outcomes that result in suitable capital allocation to sustainable practices in the real economy. Banks need to be more involved on a local level. JP Morgan Chase has committed US$200bn to combat climate change through sustainable policies. HSBC and BBVA have both pledged US$100bn with HSBC also reducing its funding of coal projects, Deutsche Bank and Credit Agricole have also exited coal lending however how much of this money is simply going to proven technology and large institutions in established markets rather than innovating businesses in emerging markets?

Emerging economies are a hot topic at the moment, bandied about by investors and banks as the next big growth area. Notably risk always accompanies rapid growth opportunities. As the market for sustainable finance and Environmental, Social and Governance criteria (ESG) is still developing, financial returns are still far from guaranteed. Combining the two areas, one with as yet unproven returns and the other with both known and unknown risks, it’s not hard to see why most banks are hesitant at putting their PR, and funds, into practice.

At this early stage it appears a ‘trickle down’ approach to the adoption of sustainable investment principles will occur among small business borrowers as more pressing concerns keep them awake at night such as cash flow constraints, staffing and cybersecurity. If banks were to offer green loans at better interest rates or more favourable terms than standard debt perhaps uptake would be better, without such loan products however SMEs can only wait for solutions that have been implemented at the top end of town to filter down.

2018 0402 East 02The next frontier of finance

Emerging economies continue to be the next frontier for the finance industry. Initiatives such as the Sustainable Banking Network as well as sovereign and corporate green bonds issued from emerging markets indicate their appetite and interest in the area however middle market and SME businesses are yet to engage fully. It could be a ‘chicken and egg’ conundrum in which no one is sure what comes first – the demand from businesses or the supply of appropriate solutions from providers. It is likely that supply will drive demand in this case, if finance is available for ESG complaint initiatives then businesses will seek it out and alter products and practices to secure the funding.

Most commercial banks have now put in place defined policy regarding their attitude and stated actions towards furthering the sustainability agenda in both developed and emerging economies. It remains to be seen who will actively work to fund real businesses and which banks are only offering platitudes for good PR.

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