Posted inESG

Environmental investments hit by crisis despite outperformance

Financial market actors have responded to the crisis by deprioritising environmental finance, and this despite sustainable products outperforming, a report has found.

The International Network of Financial Centres for Sustainability (FC4S Network), together with the UN Environment Programme, United Nations Development Programme and Unep Inquiry, released a working paper titled Implications of the Covid-19 Pandemic for Global Sustainable Finance.

The FC4S Network is a partnership between the world’s financial centres and the UN Environment Programme serves as its secretariat.

By assessing the responses to the crisis, the paper aims to understand the implications for sustainable finance markets and inspire response strategies.

It also seeks to set out a framework for assessing what levers may exist to strengthen the role of the financial system in supporting a low-carbon recovery.

While social issues have become the focus, environmental finance has at present fallen in importance, the paper found.

It writes that “a few actual steps have been taken to integrate sustainability priorities into monetary policy decision-making”.

However, the authors expect that the debate on the appropriateness of ‘green stimulus’, and optimal instruments, is likely to evolve in the coming months – with a major focus on monetary policy operations, including quantitative easing.

They believe that green securities can play an important role among the many existing forms to raise capital and fund stimulus (see below box).

Source: UN Environment Programme

Financial supervisors are likely to strengthen their focus on long-term risks with exponential characteristics, which could potentially lead to a more granular assessment of climate risks.

Another sign of environmental finance suffering is a significant drop in the issuance of green bonds.

While March 2020 saw the issuance of some notable green bonds, data from the Climate Bonds Initiative suggests that monthly issuance has declined by approximately 90% from February (see figure 3 below).

This comes despite the authors’ findings that environmental, social and governance (ESG) investments have outperformed.

Among the key findings of the paper are:

  • Evidence shows that ESG-related investments, both funds and indexes, have mildly outperformed benchmarks in the crisis.
  • Investor confidence in ESG funds appears to remain strong.
  • Sustainable debt markets appear to show a similar story of slight outperformance and continued investor confidence.
  • Green bonds are retaining value better than mainstream corporate debt. Over the longer term, green debt may outperform other types of debt instruments intended to support capex investments.
  • Pipelines of new greenfield low-carbon projects (eg renewable energy) are likely to be significantly reduced for the foreseeable future, both in developed and emerging markets. The length of time that project financing is put on hold will be crucial for future development of wind and solar industries, especially in nascent markets in emerging economies.
  • Drive for ESG alpha – surge of focus on social issues. ESG factors have proven important for many investors seeking to assess the impacts of the pandemic on corporates.
  • Fossil fuel stranded assets version 2.0. While for certain sectors environmental dimensions of cor­porate ESG performance may decrease in significance in comparison in social issues, sectors with high environmental risk exposures (eg fossil fuels) are likely to face in­creasing environmental scrutiny.
  • Shift to disclosure of more granular and quantitative ESG and Sustainable Development Goals (SDGs)-related informa­tion.

Building resilient economies

The paper also says that economies evolving from the crisis need to address the root causes of the pandemic in order to recover.

These root causes are the outbreak itself (biodiversity loss and destruction), and its spread (lack of inter­national coordination) – as well as the norms and practices that are leading to an economic disaster (weak social protection, inadequate public investment in disaster response, etc).

The authors see the possibility of two pathways for economies depending on how they react: either an integrated model – linking social, economic and environmental resilience – or the opposite (unequal, unbalanced, isolationist and destructive).

Three major shifts in thinking are needed to achieve resilient economies, the paper states:

  • Integrating scenario-based analysis of exponential risks into all policymaking;
  • Placing resiliency at the core of social and economic organisation; and
  • Linking economic, social and environmental health together, through a new agenda for public-private collaboration, and strengthen financial system governance.

Marcos Mancini, head of international partnerships at Unep Inquiry, commented: “If there is one thing that covid-19 has emphasised, it is that natural capital underpins our economies. The health of people and the planet are one and the same.

“The 90% decline in green bond issuance is a matter of concern. If we aim to rebuild more green and resilient economies, we need to maintain healthy debt ratios and encourage all debt to be aligned with the SDGs.”

The paper is a work in progress document and will be updated going forward. It was supported by EIT Climate-KIC, Europe’s climate innovation initiative.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.