It is a pivotal year for sustainable finance, with green bonds potentially on track to set a global record amid a wave of elections that could shift ESG policies in multiple countries, says Fanny Doucet, Scotiabank’s Managing Director & Head of Sustainable Finance.
In May alone, there was US$70 billion worth of green bond issuance globally, the busiest May ever, said Doucet at a recent Toronto conference.
Meanwhile, over 60 countries are holding national elections in 2024, with environment, social and governance issues (ESG) front and centre in the political debate, Doucet noted.
“ESG is certainly part of the conversation,” she said. “There’s a lot of policy that’s potentially at play.”
Doucet was speaking during the Scotiabank ESG Conference and Sustainability Summit, held over two days in June. The event brought together leaders from various sectors of the global economy, including executives from Brookfield Asset Management, Cameco, the Canadian Sustainability Standards Board (CSSB), CEMEX, Fibra UNO, Hydro One, Microsoft and Teck Resources. Various presentations and panel discussions covered topics including energy transition, nuclear energy as a future pathway, sustainable finance, and carbon market infrastructure during the conference, now in its sixth edition.
In her presentation, Doucet gave an overview of the sustainable finance landscape and highlighted key and emerging ESG trends.
1. Elections could prompt ESG policy change
Doucet noted that at least 64 countries are holding elections this year, including in the European Union and the United States, that could result in major political shifts around ESG policy.
For example, in the recent EU Parliament election, the Green party lost some of its seats, raising questions about what that means for the European Green Deal and future sustainability policies.
As well, the results of the upcoming U.S. election may have ramifications for the Inflation Reduction Act, President Joe Biden’s signature climate legislation, which has faced much pushback from Republicans.
“With this year being a huge year for elections, there have been widespread political movements with respect to ESG,” she said.
Doucet noted that while 18 U.S. states have passed anti-ESG legislation since the beginning of 2020, six states have passed pro-ESG legislation, including California.
“Certainly a big divide, and I think this is going to continue,” she said.
2. Governments paving the way on ESG and sustainable finance
Across global jurisdictions, sustainability-related disclosures — providing information to the market about the environmental and social characteristics of a particular entity or financial product — are becoming increasingly adopted, with many countries taking steps to mandate disclosures aligned with the International Sustainability Standards Board’s (ISSB) standards. These reporting requirements can help guide companies along their own sustainable finance journeys, building greater internal strategic ESG alignment.
Meanwhile, sovereigns and government agencies are increasingly looking to sustainable financing. The continued development of national taxonomies, which define environmentally and socially impactful activities, helps set the stage for these issuers to effectively promote their sustainable development in the capital markets.
For example, already in 2024, Canada priced its second green bond deal, Australia priced its inaugural green bond transaction, and Japan priced its inaugural climate transition-labeled bond, said Doucet.
“Governments are really leading the way and saying sustainable finance is a helpful tool for them and leading by example for corporate and financial issuers within their countries,” said Doucet.
3. Regional disparity in sustainable finance appetite
The popularity of ESG-labeled bonds varies widely across different regions.
Europe is a leader in this space in terms of overall volume, with roughly 15% to 20% of corporate and financial bond issuance having an ESG label, whether that’s green, social, sustainability or sustainability-linked, noted Doucet. Canada is in the “high single digits” on this front, but the U.S. has seen ESG bond issuance decline, she added. It used to be about 7% during the sustainable finance market’s recent peak in 2021, but has been closer to 3% in the past two years.
“That makes a lot of sense when we think about the political environment in the U.S.,” she said.
Mexico is a bright spot. For example, almost one-fifth of the bond issuance in Mexico’s local market has an ESG label, again looking at corporate and financials specifically. Factoring in Sovereign, Supranational and Agency Debt (SSA) bonds and development banks as well, ESG-labeled bonds represent roughly 40% of issuance in Mexico, she added.
“LATAM has really been leading the charge, and we see Latin America as a hub for sustainable finance product innovation,” said Doucet.
Investors are getting more sophisticated and asking for more from companies.”
Chile in March 2022 placed its debut sustainability-linked bond (SLB), a fixed-income instrument where the financial or structural characteristics, such as interest rate, are tied to predefined sustainability objectives. It became the first country in the world to issue sovereign debt of this type, and also became in June 2023 the first sovereign SLB issuer to include a social KPI.
Additionally, the first green and sustainability-linked bond in the Americas was issued from LATAM-based Inversiones CMPC, a provider of paper products, in June 2023. These instruments combine use of proceeds and sustainability-linked features, whereby proceeds are used for specifically earmarked environmental projects and the interest rate is also tied to predefined sustainability objectives.
4. ESG factors, metrics and reporting are maturing
Investors themselves are becoming more sophisticated as well.
Initially, Doucet said, the market was very focused on factors such as diversity and inclusion, and Scope 1 and 2 emissions, which refer to an organization’s direct greenhouse gas (GHG) emissions associated with its operations.
“Those are really being seen as a baseline for large corporate companies to have as of now.”
Reporting is now including more in-depth factors, such as the circular economy, Scope 3 emissions, which refer to GHG emissions that result from activities not owned or controlled by the organization but in its overall value chain, nature and biodiversity.
“Investors are getting more sophisticated and asking for more from companies,” she said, highlighting that investors are now looking more broadly at company ESG profiles and sustainability strategies, not just sustainable finance labels, when it comes to assessing ESG-labeled bonds.
5. Growing demand, particularly for green bonds
There has been some discussion about how global sustainable fund flows have peaked, but a closer look at the data shows a more nuanced picture.
The U.S. equity market for assets such as clean tech or renewables has been impacted by macroeconomic factors including higher interest rates and supply chain pressures, but fixed income funds have been “very resilient,” Doucet said.
According to data obtained by Morningstar and EPFR, as of Q1 2024, U.S. equity funds with sustainable or ESG characteristics have experienced net inflows in just one of the previous eight quarters, whereas U.S. fixed income funds with sustainable or ESG characteristics have experienced net inflows in five of the previous eight quarters.
“There's been a lot of money continuing to flow into ESG fixed income funds, and this is not just in Europe, but across every region, including the U.S.”
Demand for ESG-labeled bonds is growing as well. A recent Scotiabank ESG fixed income survey showed that 60% of respondents said they were planning to increase their allocation to ESG instruments.
“There’s a positive picture on the investment side,” Doucet said. “Investors are putting more money into this.”
Yet, on the supply side, issuance has been flat, she noted.
“There's a bit of an imbalance in terms of supply and demand,” Doucet said. “The increase in supply has not been matching the increase in demand for these types of products.”