Sustainable financing is a term used for financing that takes into consideration the environmental impacts of the business that it is financing, also it is a tool used to promote sustainable businesses that have a positive impact on climate change and which reduce greenhouse emissions and carbon footprint. Sustainable financing may mandate the use of green methods of doing businesses or link the Interest payments to the achievement of sustainability outcomes.
Environmentally sustainable goals include the production of energy from renewable sources like solar, wind, bio-gas, etc; use of cleaner transportation that involves lower greenhouse gas emission; waste management that includes recycling, efficient disposal and conversion to energy.
ESG(Environmental,Social and Corporate Governance) metrics have appeared over the years as an important factor of consideration in financing businesses, with increased scrutiny over how much a company's goals are in line with sustainability efforts and how resilient they are against climate risks. Banks offer green loans that put mandates in place to reduce the borrower’s Environmental footprint. The issuance of ESG based green loans in the last 3 years have increased threefold from 300 billion to about one trillion dollar.Global green, Social and Sustainability loans(GSS) issuances in 2018 set a world record in the Australian market by issuing about 14 billion dollars in a year.
Green Loan Principles
Loan Market Association has put in place GLP or Green Loan Principles which have 4 basic tenets
1.Use of proceeds
The fundamental determinant of a green loan is the utilization of the loan proceeds for Green Projects. All designated Green Projects should provide clear environmental benefits, which will be assessed, and where feasible, quantified, measured and reported by the borrower.
2. Project Evaluation
The borrower of a green loan should clearly communicate to its lenders, its environmental sustainability objectives; the process by which the borrower determines how its projects fit within the eligible related eligibility criteria.
3. Management of Proceeds
Borrowers are encouraged to establish an internal governance process through which they can track the allocation of funds towards Green Projects
The borrower should report the use of proceeds And the progress of the project on an annual basis.
Banks are also issuing Sustainability Linked Loans or SSLs,These incentivise borrowers to improve their sustainability profile and reduce their environmental footprint. Sustainability Performance Targets(SPT) is a key metric that is used to gauge the performance of borrowers. These involve the use of green sources of energy, reduction of overall carbon footprint, increased recycling of the raw materials used, reduction in the emissions of greenhouse gasses in production, transportation or in relation to the products sold by the borrower.Proper alignment of borrowers with SPTs and favorable performance over the life of loan could result in reduction of Loan margin and Under performance could lead to an increase in loan margin.
Transition Financial Instruments.
Transition financial instruments is a term coined by the investment managers of AXA in France. These are tools to finance businesses that are working in high carbon emission or high environmental impact areas like oil drilling,electricity generation by fossil fuel or mineral mining. These fields typically don't qualify for sustainable finance, thus the borrowers are referred to as “brown borrowers' ', which include oil and gas mining companies, companies involved in heavy Industries like cement, fertilizer, steel and also companies involved in transportation.
These loans offered to “brown borrowers” are aimed at reducing the impact that they have on the environment like deforestation, air pollution, and biodiversity damage that mining and oil drilling can result in;these transition financial instruments promote the sustainable efforts of these companies.
Sustainable Finance in India.
CCE or Circular Carbon Economy has been the center of attention for many years in developing and developed nations and there are many organizations that raise awareness and encourage financial and non financial firms to consider sustainable energy efforts in their financing. Programs like Principles for Responsible Investment (PRI), Equator Principles (EP) for financial institutions, United Nations Environment Programs (UNEP) and Statement of Commitment by financial institutions on sustainable development suggest ways for implementing green finance among the signatories. Several entities from India is a signatory to these programs.
Reserve Bank issued a notification on “Corporate Social Responsibility, Sustainable Development and Non- financial Reporting – Role of Banks in 2007. In 2008,The National Action Plan on Climate Change (NAPCC) was put in place, but a major move was made in 2011, The Climate Change Finance Unit (CCFU) was formed under the Ministry of Finance. It included the implementation of sustainability disclosure requirements. The Security and Exchange Board of India (SEBI) made it compulsory for top hundred companies by market capitalization listed on NSE and BSE to publish Business responsibility reports every year since 2012.
In line with the agreements of 2015 Paris agreement which pledges to reduce carbon emissions by 35% from 2005 standard,and to achieve 35 percent of installed electric power capacity from non-fossil sources by 2030. Government of India has also put in place many financial incentives for sustainable efforts one of them is subsidizing the installation of solar panels and and the beneficiaries can avail incentives on the excessive power generated if they generate more than 15 kilowatt hours of power in a year by selling it. Further, to reduce the upfront purchase price of electric vehicles and accelerate the growth of infrastructure supporting electric vehicles like charging stations etc, Government of India launched two phases of Faster Adoption and Manufacturing of hybrid and Electric vehicles(FAME) in 2015 and 2019, which helped in the growth of credit flow into the sector. State Bank of India offers green car loans to promote the growth of electric vehicles at interest rates 20 basis points less than normal loans.
Although there are major challenges for green loans in India, like false claims of environmental compliance and high cost of issuing green loans for banks and lack of public awareness. Green finance is still - over the past few years- a growing priority in the Indian financial sector. With proper policy changes and public awareness measures sustainable financing can gain momentum in this direction.