By Securities and Exchange Commission of Sri Lanka
Sustainable finance refers to any form of financial service integrating Environmental, Social and Governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large. Presently, a number of securities regulators are focused on whether the sustainable finance claims are accurate and whether investors have the information they need to evaluate sustainable finance products. Retail investors, in particular, need to be able to easily understand the characteristics of such products, as well as the associated risks, to support a more informed investment decision-making process.
Recent developments pertaining to sustainable finance in the emerging markets;
- Increasing number of institutional investors are committing to incorporate ESG factors into their investment analysis and decision-making processes
- Constant development in issuance of sustainable instruments (green bonds, social bonds and sustainable bonds)
Bloomberg Intelligence (research arm of Bloomberg) has forecasted that the global ESG assets would exceed $53 trillion by the year 2025 and would represent more than a third of the $140.5 trillion in projected total assets under management. Hence, there will be emerging investment flows to the ESG assets in the future, and if enabling frameworks are put in place to facilitate different ESG related new products and initiatives, Sri Lanka would be able to lure much needed foreign inflows to the country in going forward.
Sustainable bonds constitute financial instruments aimed at supporting sustainable development by raising capital to finance or re-finance Green or Social or Sustainability-linked projects. In general, Sustainable bonds can be distinguished from regular bonds by the specific use of the funds raised. Thus, in addition to evaluating the standard financial characteristics (such as maturity, coupon, price, and credit quality of the issuer), investors also assess the specific environmental and/or social purposes of the projects that the bonds intend to support.
Types of sustainable bonds;
- Green Bonds
- Blue Bonds
- Climate Bonds
- Social Bonds
- Sustainability Bonds
What is a Green Bond?
Green bonds are innovative financial instruments where the proceeds are invested exclusively (either by specifying the use of the proceeds, direct project exposure, or securitization) in green projects that generate climate or other environmental benefits, for example in renewable energy, energy efficiency, sustainable waste management, sustainable land use (forestry and agriculture), biodiversity, clean transportation and clean water. Their structure, risk and returns are otherwise identical to those of traditional bonds.
Green bonds can mobilize resources from domestic and international Capital Markets for climate change adaptation, renewables and other environment friendly projects. They are no different from conventional bonds, their only unique characteristic being the specification that the proceeds be invested in projects that generate environmental benefits. In its simplest form, a bond issuer will raise a fixed amount of capital, repaying the capital (principal) and accrued interest (coupon) over a set period of time. The issuer will need to generate sufficient cash flows to repay the interest and capital.
Qualification Criteria for Green Bonds
The International Capital Market Association’s (ICMA) Green Bond Principles (GBP) and the Climate Bonds Initiative’s (CBI) Climate Bond Standards (CBS) help to determine whether a bond qualifies as green or not. Usually, green bonds must undergo a third party verification/certification to establish that the proceeds are funding projects that generate environmental benefits. The four Green Bonds Principles that define a green bond relate to:
- Use of proceeds: the issuer should declare the eligible green project categories it intends to support. It should also provide a clear definition of the environmental benefits connected to the project(s) financed by the proceeds.
- Process for project evaluation and selection: the issuer should outline the investment decision making process it follows to determine the eligibility of individual investments using the green bond’s proceeds.
- Management of proceeds: the proceeds should be moved to a sub portfolio or otherwise attested to by a formal internal process that should be disclosed.
- Reporting: the issuer should report at least annually on the investments made from the proceeds, detailing wherever possible the environmental benefits accrued with quantitative/qualitative indicators.
Green Bond Issuances by the Emerging and Developing Economy Segment
Cumulative Emerging Market Green Bond Issuances From 2012-2021 ($mn)
Total Return Performance of Global Green Bonds vs. Global Aggregates
Benefits of Issuing Green Bonds
Benefits for issuers can include:
- Improve investor diversification
- Enhance issuer reputation
- Provide an additional source of sustainable financing
- Increase alignment regarding the durability of instruments and the project lifecycle
- Attract strong investor demand, which can lead to high oversubscription and pricing benefits
- Can facilitate the establishment of public private partnerships that might accelerate the pace of green investment and lead to the adoption of new technologies.
Benefits for investors can include:
- Comparable financial returns with the addition of environmental and/or social benefits
- Satisfy ESG requirements for sustainable investment mandates
- Contribute to national climate adaptation, food security, public health, energy supply, amongst others
- Enable direct investment in the ‘greening’ of brown sectors and social impact activities
- Increased transparency and accountability on the use and management of proceeds, becoming an additional risk management tool
- Green bonds can help mitigate climate change-related risks in the portfolio due to changing policies such as carbon taxation which could lead to stranded assets. Instead, a green bond invests in climate-friendly assets, such as green buildings, renewable energy, that over time bear a lower credit risk.
Potential for Introducing Green Financing Initiatives in Sri Lanka
Presently, more corporate bodies are interested in moving towards green projects/initiatives in order to ensure sustainable development in their businesses while ensuring the protection of the environment and wellbeing of the society. Green Bonds will broad base investment opportunities available for investors and provide an avenue for the companies who are interested in engaging in green projects. This would offer investment opportunities to groups (both local and foreign) who are interested in investing in green projects which would benefit the overall Capital Market.
In year 2022, the Central Bank of Sri Lanka (CBSL) launched a green taxonomy in partnership with the International Finance Corporation (IFC) that defines and categorizes economic activities that are environmentally sustainable, and would aide in providing a holistic strategy to integrate sustainability into the country’s financial system.
The Colombo Stock Exchange (CSE) is already registered under the Sustainable Stock Exchanges (SSE) initiative and is currently working on ESG related initiatives under the guidance of the Securities and Exchange Commission of Sri Lanka (SEC). The SSE initiative provides a peer to peer learning platform for exploring how exchanges in collaboration with investors, regulators, and companies can encourage sustainable investment and enhance corporate transparency, and performance on ESG.
Steps Taken by the SEC for Introducing Green Bonds and Facilitating Sustainable Finance Initiatives
The introduction of Green Bonds to the Sri Lankan Capital Market would enable listed entities to raise capital for Green projects adhering to international principles applicable. This would not only expand the supply side but also open up avenue for getting much needed foreign inflows to the country from foreign funds.
Moreover, in June 2022 to enhance the awareness building initiatives in relation to ESG, a MOU was signed between the SEC, CSE and the Chartered Financial Analysts (CFA) Society. The MOU broadly intended to establish a collaborative relationship to promote awareness of ESG among Sri Lankan investors to enhance investor protection, encourage capital market practitioners to introduce ESG into their investment research and valuation process to keep abreast with challenging global trends and ensure that the professional standards and integrity are maintained in the Sri Lankan capital market.
In August 2022, to promote ESG reporting by listed companies, the SEC, CSE and the Institute of Chartered Accountants of Sri Lanka (ICASL) entered in to a Memorandum of Understanding (MOU) which broadly covered areas on building awareness on integrated reporting, corporate governance, sustainability and any other related areas for the benefit of corporates and the users of financial statements/corporate reports.
In addition the SEC developed a policy and regulatory framework governing Green Bonds in consultation with Technical Experts from the Asian Development Bank (ADB) and the CSE and in April 2023, the SEC Commission approved rules for issuing Green Bonds.
Presently, the CSE under the guidance of the SEC is completing the groundwork for launching a green index. A green index would help investors assess and integrate sustainable financing considerations in their investment process and portfolio.