Chapter 5. Green and Sustainable Finance: Markets and Instruments

Question 1

What is Sustainable Finance?

Answer 1

It refers to any financial activity that considers sustainability across asset classes (equity, debt—bonds, loans—, commodities, or derivatives) and different products and services (corporate loans, mutual funds with shares of sustainable firms).

Question 2

What is Green Finance?

Answer 2

It refers to sustainable finance focused on environment-related risks and opportunities—often, but not necessarily, climate change.

Question 3

Mention other topics than climate change that fall under Green Finance:

Answer 3

• Waste management
• Water usage
• Conservation of natural habitats
• Mitigating biodiversity loss

Question 4

What is Climate Finance?

Answer 4

It refers exclusively to financial flows relating to climate change, whether mitigation or adaptation, but it has historically been associated with the public sector more than private-sector funding.

Question 5

What are sustainable financial products varieties?

Answer 5

• Use of proceeds. The financial instrument is earmarked and ring-fenced for sustainable use (e.g., green bonds)
• Sustainability targets linkage. The financial instrument is linked to sustainability targets, such as an interest rate penalty or reward for achieving a specified target.
• Sustainability as selection criteria. It could be for inclusion (e.g., in a sustainable equity fund) or targeted engagement with a company’s management.

Question 6

What is a bond?

Answer 6

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). Owners of bonds are debtholders, or creditors, of the issuer.

Question 7

What are Green bonds?

Answer 7

They are bonds whose proceeds are earmarked for environmental projects.

Question 8

What are the Green bonds innovations?

Answer 8

• They are separately labeled
• Their proceeds are ring-fenced
• The (planned) use of their proceeds is reported both to prospective bondholders ex-ante and current bondholders once projects are implemented

Question 9

What is ICMA?

Answer 9

International Capital Market Association.

ICMA is a not-for-profit association (Verein) under the Swiss Civil Code. It brings together members through regional and sectoral committees focusing on a comprehensive range of market practice and regulatory issues, prioritizing sustainable finance and three core fixed-income market areas: primary, secondary, repo and collateral.

Question 10

What are the core components of the Green Bond Principles?

Answer 10

1. Use of Proceeds
2. Process for Project Evaluation and Selection
3. Management of Proceeds
4. Reporting

Question 11

What are Social bonds?

Answer 11

They are bonds with earmarked proceeds for projects that will bring social benefits.

Question 12

What are Sustainable bonds?

Answer 12

They are a combination of Green and Social bonds in that they are meant to address both environmental and social objectives simultaneously.

Question 13

What are SDG bonds?

Answer 13

They are bonds linked to UN Sustainable Development Goals, covering social, environmental, and economic goals.

Question 14

What are Green loans?

Answer 14

They are loans that have been made for environmental and climate-related projects.

Question 15

According to Green Loan Principles, what are the expectations for this kind of loan?

Answer 15

Green loans are expected to ring-fence, and borrowers are expected to report on the use of their proceeds. In specific jurisdictions, green loans are sometimes governed by slightly different national rules, most notably in China.

Question 16

What is SLB?

Answer 16

It’s a Sustainability-Linked Bond in which the coupon paid by the issuer is linked to the issuer firm’s achievement of pre-agreed sustainability targets.

Question 17

What is SLL?

Answer 17

It’s a Sustainability-Linked Loan whose interest rate is linked to a company’s achievement of specific sustainability benchmarks.

Question 18

What is the most widely used approach by investors and lenders to gauge the performance of investee or debtor companies?

Answer 18

ESG scores and ratings

Question 19

Mention some ESG scores drawbacks:

Answer 19

• They are a heterogeneous space with little standardization
• The methods to calculate them are typically proprietary
• They are not consistent with each other and are thus hard to compare
• There’s a huge proliferation of ESG ratings, with an estimated 600 now available globally

Question 20

Regarding ESG Scores, what are the Exposure indicators?

Answer 20

• Business Segments
• Geographic Segments
• Co-spec indicators

Question 21

Regarding ESG Scores, what are the Management indicators?

Answer 21

• Strategy
• Programs & Initiatives
• Performance
• Controversies

Question 22

What are the primary sources for ESG scores and ratings?

Answer 22

1) External providers
2) Discussions with the company
3) Corporate sustainability reports
4) Regulatory disclosures.

Question 23

How does ESG grounds divestment is applied?

Answer 23

• Funds are excluding sectors such as weapons, tobacco, alcohol, and gambling.
• Banks are announcing the phase-out of new coal lending
• Banks are committing to restrict, exclude, or additional requirements for the financing of tar sands, offshore oil & gas, hydraulic fracturing, and Arctic oil projects

Question 24

To which processes can ESG issues be integrated?

Answer 24

Throughout the investment, management, and operational processes, from initial investment to regular portfolio and risk management analysis.

Question 25

For what reasons do financial firms practice engagement with company management around sustainability?

Answer 25

• Gaining credibility with clients
• Mitigating financial risks resulting from ESG-related issues
• Aligning with corporate strategy
• Pressure from regulators

Question 26

As per the SustainAbility Institute by ERM, to what parts of the investment and operational process can ESG be integrated?

Answer 26

• Internal research
• Investing and lending decisions
• Portfolio analysis
• Risk management and internal audit

Question 27

To count as “green,” activities must make a substantive contribution to at least one of six environmental objectives, which are:

Answer 27

• Climate change mitigation
• Climate change adaptation
• The sustainable use and protection of water and marine resources
• The transition to a circular economy
• Pollution prevention and control
• The protection and restoration of biodiversity and ecosystems

Question 28

What is the regulatory trend concerning economic activity?

Answer 28

Defining the underlying economic activity being financed and pinning down the definitions of sustainable activities in greater detail.