Mobilising the net zero transition in the global capital markets
Finance has a critical role to play in supporting the transition to net zero. The scale of investment required, USD120 trillion* over the next three decades, is massive. Estimates suggest over 70% of this capital needs to come from the private sector, including the financial system. Some of this investment will be for dedicated green activities, like renewables, electric transport or clean hydrogen. But there is a need for other forms of sustainable and transition finance too, to decarbonise high-emitting industries like steel, cement, chemicals, aviation and energy. It is the transformation of these sectors that will determine the world’s ability to reach net zero, and where the need to tie financing to credible transition plans and progress is acute.
Add to this the complexity of emerging and developing markets, where the principle of a “Just” transition – which considers the social and economic impact of the transition on communities – is paramount. Financing the transition at scale will be critical in these markets that drive the bulk of future emissions growth, and must recognise the differing starting points and transition pathways of industry there. It must also recognise the need for an affordable transition.
One nascent financing tool for companies keen to publicly share ESG strategies like transition plans, and to finance and incentivise goals including decarbonisation, is the sustainability-linked bond (SLB). SLBs do not typically earmark proceeds for specific environmental projects, as green finance does. Instead companies publish specific targets, for example to reduce emissions by a certain amount, or to draw more energy from renewable sources by a certain date. The interest cost on their borrowing then changes based on whether those targets are hit.
This is also a disclosure mechanism. Companies’ targets – which otherwise may not get public attention – are put in the public domain for the market to pass judgement, and success or failure is directly linked to financing costs. In practice, market discipline is critical. Investors will assess SLBs against their own ESG commitments, and if the issuers come up short, their access to capital will be impacted and the market will struggle to grow.
Delivering sustainable finance solutions must be a key feature of how banks support their clients to transition
Banks have worked and continue to work together through industry bodies such as the International Capital Markets Association (ICMA), with civic society and investor groups, to build a robust set of standards and frameworks that govern SLBs and ensure their integrity. SLB targets are reviewed by banks with an expectation that they are both ambitious and core to the issuer’s ESG strategy. Independent second-party institutions then review and validate the targets, and the progress made against them is also validated in line with industry frameworks.
As with any nascent market, it is natural for these standards to continue to develop. For example, more sectors are developing third party, science-based sectoral transition pathways, which set out industry-wide carbon reduction approaches, and to which transition-focused SLB targets can be tied. Banks, industry bodies and others are working hard on this, as the need to finance the transition accelerates, and as businesses come under increasing pressure to roll out credible, actionable transition plans from stakeholders like regulators and shareholders.
SLBs are not the sole answer to the climate crisis. They are a new, evolving, and transparent instrument that can help unlock capital for the transition, as part of an arsenal of sustainable financing support that is still being built, and by necessity developing at an urgent pace. It is right that companies are incentivised to do the right thing today and, as part of a broader strategy, delivering sustainable finance solutions must be a key feature of how banks support their clients to transition.
For HSBC that broader strategy includes implementing our own financing and investment guardrails to operationalise our commitment to net zero. We have committed to a science-based phase down of our fossil fuel financing and are updating our sector policies including energy and deforestation to align with latest scientific guidance. We are setting science-based 2030 financed emissions sectoral targets. We are assessing our clients’ climate transition plans starting with the highest emitting sectors and we are integrating climate risk into the bank’s risk management processes. We are also working at pace with industry bodies, regulators and central banks, governments and wider financial sector stakeholders on sustainable finance markets, guidelines and standards.
Alongside those measures we are collaborating with industry peers and governments to support research, financing, and investment in critical climate technologies like clean hydrogen, sustainable aviation fuel, next generation energy storage, and carbon removal technologies – all of which will need to be developed and deployed at scale to help reach net zero emissions in the hardest to decarbonise sectors.
Industries which are carbon intensive today face the greatest challenge. We believe we will have the biggest impact on climate action by actively engaging with these industries on their transition, being clear on what we will and will not finance, and supporting transparency and accountability on performance. We also recognise the need to scale finance quickly for the transition, and with this comes innovation, but also learning and a need to continually evolve to drive the accelerated progress on net zero the world so critically needs.
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