The boom in so-called ESG investing has been accompanied by a sharp rise in complaints about greenwashing -- exaggerations or misleading statements about environmental claims. It’s a rise driven by the so-called “greenium” -- the money companies can save by convincing lenders to offer better terms when borrowing is tied to an ESG (environmental, social or governance) goal. Figuring out what’s real and what isn’t has grown even more complicated in debt markets, where a host of new lending formats have been introduced, including some that link payment terms to progress on specific ESG goals. Here are some factors to keep in mind to help you figure out if your money is really doing what was promised.
1. Is the goal a real goal?
Bloomberg News analyzed more than 100 bonds tied to issuers’ ESG credentials worth almost $68 billion that were sold by global companies to investors in Europe and found that the majority were tied to climate targets that are weak, irrelevant or even already achieved. Some companies promised to do no more than maintain their existing ESG ratings.
2. Are emission targets incomplete?
Environmentalists have developed “scope” as a concept for breaking down and tallying a company’s impact on climate change -- and sometimes companies only fess up to part of the story. Under international standards, Scope 1 emissions just reflect the emissions caused directly by a company’s own operations. Scope 2 represents the carbon emissions that come from producing things purchased in the course of a company’s business, like the electricity or cement it uses. The biggest number often comes in Scope 3 emissions -- those produced by companies in its supply chain, or by the customers using its product, like the carbon released when truckers burn diesel fuel. For an oil company, Scope 3 could include 90% of its total emissions. But in a lot of cases, borrowers aren’t including Scope 3 emissions among the goals tied to borrowing costs. Tesco Plc, for example, sold a bond tied to its ESG efforts in 2021 which excluded Scope 3 emissions and included its Scope 1 and 2 emissions.
3. Are S and G goals forgotten or fuzzy?
Social and governance aspects have grown to be just as crucial as companies’ environmental efforts, especially since the #MeToo and Black Lives Matter movements began making an impact on consumers’ spending. Many corporations are using their annual sustainability reports to showcase how fair they are in equality employment or what they did to improve employee wellbeing. Given some of these goals are hard to measure in areas where little data is available, there’s a risk in overstating the results. BlackRock Inc., for example, settled a discrimination lawsuit in July 2021. Ironically, the U.S. firm had months earlier tied its borrowing costs to targets that included the number of women in leadership roles, and the number of Black, African American, Hispanic and Latino staff it employs.
4. It sounds like ESG, but is it?
New debt structures have emerged continuously as the money flowing into sustainable investing has grown. But in some of these formats, the link between the ESG label and ESG goals have grown tenuous. Bank of China Ltd.’s so-called re-linked bond sold in 2021 is tied to the performance of a pool of sustainability-linked loans made to its clients -- that is, not to anything BOC is or isn’t doing in ESG terms, but to the ESG performance of the clients who have taken out those loans. Nordea Bank Abp priced a bond in September 2022 with proceeds committed to its sustainability-linked loan business, claiming it’s “the first of its kind”. Many banks raise funds from the bond market and sometimes, proceeds are used to support lending businesses. So, does Nordea’s deal count as a ESG debt? Not according to definitions by finance bodies International Capital Market Association and global loan market associations.
5. How flexible is too flexible?
Sustainability-linked bonds and sustainability-linked loans are signed with commitments from borrowers to achieve certain environmental or social targets, but those goals can be changed. The more flexible agreements allow issuers to adjust those targets under certain conditions, without incurring a penalty. Issuers argue that they have to look for ways to cope with increasingly volatile markets in which key ESG parameters such as energy prices become harder to predict. Then there’s the ‘sleeping’ sustainability-linked debt where financing has an ESG label but with no immediate sustainability targets.
6. Who’s checking up?
There are tens of ESG rating and data providers globally which can provide some assurance that companies are doing their part in sustainability and if the ESG debt are what they say they are. All of this greenwashing detective work would be easier if investors and the public had a standardized approach and robust set of data to compare. Private ratings systems can be unreliable and corporate reporting is spotty and hard to compare. The European Union has proposed a European Green Bond Standard, which could be applied to other type of ethical debt such as sustainability-linked issues or social financing, laying out a clear methodology and disclosure requirements for ESG analysis or rating providers. The guideline, though voluntary, could encourage consistency in disclosures of ESG metrics. Financial bodies also regularly update ESG debt principles to keep up with market changes to avoid risk of greenwashing. Global loan associations, for example, amended their sustainability-linked loan principles in 2021 to make it compulsory for ESG targets to be verified by an independent arbiter. Even with market guidelines and third-party reviewers, many are still questioning whether companies are disclosing enough information to justify the ESG rating or claims they make.
7. Are the targets truly relevant?
Companies have been setting ESG targets which they proudly announce or raising debt tied to selected ESG achievement. For example, some social housing providers promising to build more affordable developments or education services providers committing to extend training internationally - even though that’s their primary business operations. Some claimed they aligned their objectives with the United Nations’ sustainable development goals and some said they followed a guided registry of material performance indicators recommended by the ICMA. Yet, it’s hard to judge individual target’s impact on company’s overall sustainability performance.
8. Are the goals a secret?
While many issuers are bound by public debt market requirements to disclose their ESG targets if they want to link their financing to such objectives, the private nature of the loan market allows borrowers to hide their set goals from public eye. And it is not mandatory for borrowers to reveal the loan terms so there is no way of knowing the effect of their ESG efforts on the planet or how aggressive their targets were in the first place.
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