Going green: the changing face of corporate finance

Corporate finance is evolving. Top management teams and senior company executives are under growing pressure to adopt management practices and investment choices that are both socially responsible and financially rewarding. These objectives can sometimes be at odds with each other.

The pressure for firms to be socially responsible is growing at a rapid pace. This is true especially in the Greater China region, which is fast establishing itself as a specialist hub for energy finance. To see this, one might consider two defining milestones of 2017, affecting corporations operating in the region.

Firstly, in November this year, China’s nationwide carbon trading platform will be launched. It is set to become the world’s largest carbon trading market. Immediately, thousands of companies will be confronted with the need to employ carbon trading specialists.

Secondly, in the early months of 2017, listed companies in Hong Kong started mandatory disclosure of environmental governance indicators including energy consumption and emissions levels.

These features imply that conventional notions of corporate finance and governance need revising. Top management teams require a new corporate vocabulary, and a rank-and-file workforce with new skills.

There is a new demand for energy and environmental finance specialists throughout the corporate hierarchy.

Burnishing a large corporation with a new lexicon and associated skill-set is potentially very costly: re-training/hiring new staff to conduct environmental accounting; creating environmental and social governance reports for stakeholders and the wider public; and possibly putting in place a dedicated team of analysts and traders to develop and implement carbon trading strategies.

The birth of the green bond

Among scholars and practitioners, there is however a growing consensus that socially responsible businesses are rewarded for their efforts. Benefits range from intangible gains in reputation and brand value, through to tangible cost reductions arising from (more) careful waste and emissions management, and/or the creation of secondary markets for the waste they generate in production.

There is a lot of interest by corporations in identifying ways to enhance their environmental credentials at a minimal cost. In this vein, green project financing has emerged as a popular choice. A meteoric growth has occurred in the market for green finance, driven in large part by the development of a financial product known as a “green bond”, with corporations like Apple, Repsol, and SolarCity being among many noteworthy issuers.

Let’s look at some key facts behind the market for green bonds. The first labelled green bond was issued by the European Investment Bank in June 2007. Just three years later, close to 60 labelled green bonds had been issued in 15 different currencies, with an average value of US$50 million. EDF, a global electricity company in France, issued the first corporate green bond in 2013.

The green-bond trend has been sweeping across various fields for the past decade, and is expected to march on. As of September 2017, about 1,150 labelled green bonds have been sold with an average issue value (for bonds issued so far this year) of US$214 million. The maturity dates of the bonds have been stretched to 2064. China is understood to be responsible for around half of all issuances and market value.

So what is a green bond?

Simply, a green bond is much like a traditional bond but for one key difference. Investors agree to provide capital for some agreed rate of return, but with the requirement that the proceeds are invested into “green” projects. These can range from technological upgrading and efficiency improvements, through to renewable energy projects and beyond.

So far, Apple has raised US$2.5 billion in capital through green bonds. Oil company Repsol issued a US$500 million green bond targeted at financing efficiency improvements that will lead to considerable emissions reductions and improve their social image. SolarCity – recently acquired by Tesla – has made a habit of using green bonds, and has now issued more than 100 of them to help finance its operations.

It is the simplicity of green bonds, and their similarity to traditional financial products, that drives their appeal. There is little distinction between green and regular (or black) bonds. Since corporations frequently issue black bonds to help raise capital, they are familiar with the instrument. The jump from black to green involves little additional knowledge or cost for the corporation. For the very same reason (ie. familiarity), potential investors can understand green bonds without facing a steep learning curve. This helps to ensure demand and market liquidity.

Opportunities abound in green financing

But there is still more to consider, since investors (such as large pension funds or perhaps family offices) can also obtain reputational gains from having a green component in their investment portfolio. The environmental credentials of green bonds are externally verified or certified. Accordingly, socially responsible investors are not required to conduct any additional due-diligence checks, thereby reducing the time and cost they face in making socially responsible investment choices. All such advantages are likely to result in an incrementally higher level of demand for green bonds when compared with black bonds with similar characteristics. Sensible assessment of the timing and value of involvement in green finance will be challenging tasks for corporate decision makers, especially the financial executives.

Challenges aside, opportunities abound. Infrastructure investment connected to China’s Belt and Road Initiative may also present commercial opportunities. With more than 900 planned infrastructure projects and committed investment already exceeding US$1.1 trillion, there will be exciting opportunities for green finance in Asia for years to come.

David C. Broadstock is deputy director for the Center for Economic Sustainability and Entrepreneurial Finance of The Hong Kong Polytechnic University