Transitioning to a more sustainable economy requires huge amounts of investment. According to recent research by Moody’s, the global issuance of sustainable bonds hit record volumes in 2020 with US$491 billion issued. Continued momentum is expected with a forecasted new high of US$650 billion in 2021 – comprising approximately US$375 billion of green bonds, US$150 billion of social bonds, and US$125 billion of sustainability bonds.
So how do we define these bonds? Green and social bonds are bonds where the proceeds will be exclusively applied to finance or refinance environmental projects and social projects, while sustainability bonds refer to bonds which finance or refinance a combination of environmental and social projects.
As companies and governments map out their net-zero commitments, transition bonds, which are typically used to fund a firm’s transition to a lower environmental impact, are also emerging as a popular solution to finance carbon-reduction projects.
Raising capital from the debt market for sustainable or transition projects will require companies to gauge the confidence of financiers by communicating their ESG propositions effectively.
Here are some insights on how ESG disclosures steer a company’s cost of capital:
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There is a lack of hard evidence about the causal link between the level of ESG disclosures and a company’s cost of capital.
This may be because of the highly variable factors involved, including the social responsibility values, economic system, financial transparency, and sustainability of the jurisdictions in which investors and businesses operate. Prevailing company and industry resources, and potential data lags in many ESG data sets may also make them difficult to quantify using traditional investment criteria.
However, numerous studies do show a positive correlation between a company’s ESG performance and its financial performance. They suggest companies that fall behind in integrating ESG considerations into their business strategy put their long-term competitiveness at risk, while companies that fail to communicate their ESG propositions and performance risk losing opportunities to attract long-term investors.
Moving into a larger pool of investment funds can drive greater buying pressure and higher valuation metrics. Financial institutions are increasingly defining the universe of stocks for investment by banking on negative and best-in-class screening techniques to identify leaders, improvers, and laggards in ESG strategy.
As quality of disclosures may have growing implications for a company’s ability to capture a lower cost of capital and larger fund allocations with reduced demanded rates of return, demand for transparency and comparability is also rising to understand potential risks and uncertainties associated with future investment flows.