Top 5 predictions for sustainable finance in 2021

1. European Commission: All in.

The current European Commission has wasted no opportunity to demonstrate its commitment to sustainability. The original action plan on sustainable finance (announced under the governance of the previous commission) is currently undergoing review. The draft outline was proposed last year, with three main focus areas, including:

1. Strengthening the foundations for sustainable finance
2. Increased opportunities to have a positive impact on sustainability for citizens, financial institutions and corporates
3. Reducing and managing climate and environmental risks

We expect the final outcome to be to be largely in line with these areas.

This updated action plan aims to make large contributions to the objectives of the European Green Deal. Also with the original Technical Expert Group, or so-called “TEG,” now firmly retired, the Platform on Sustainable Finance looks set to pick up the mantle. The key issues of the platform have already been set:

1. Advise the Commission on the technical screening criteria for the EU taxonomy, including on the usability of the criteria
2. Advise the Commission on the review of the Taxonomy Regulation and on covering other sustainability objectives, including social objectives and activities that significantly harm the environment
3. Monitor and report on capital flows towards sustainable investments
4. Advise the Commission on sustainable finance policy more broadly

Find more information on the Platform on Sustainable Finance here.

Key developments to look out for:

• Expect to see new EU Taxonomy Technical Screening Criteria for the remaining environmental objectives of:
  – Sustainable use and protection of water and marine resources
  – Transition to a circular economy
  – Pollution prevention and control
  – Protection and restoration of biodiversity and ecosystems

• Draft legislation on the EU Green Bond Standard to be proposed, likely during H1
• More details on the Renewed Strategy for Sustainable Finance

2. Social bonds going mainstream

2020 was the year that social bonds went from niche towards mainstream, with the Covid-19 crisis being the clear catalyst for the change. During 2020, the global market for sustainable bonds grew more than 65%, to a staggering USD480 billion. This huge rise in sustainable bonds was largely driven by the intensive issuance of bonds related to social projects trying to mitigate the consequences of the pandemic. This resulted in 40% of the social bonds issued in 2020 being pandemic bonds, equivalent to almost USD60 billion.

The massive sevenfold jump in social bond issuance during 2020 was partly driven by the European Union’s temporary aid program, “SURE”, which saw almost EUR40 billion issued in the social bond format. Already in 2021, a further EUR10 billion have been issued in 2021 under the program, with another EUR50 billion expected to be issued during the remainder of the year. However, even as the social bond market is growing rapidly, the majority of the issuers are within the SSA segment. For social bonds to go mainstream, both corporate and FIG issuers need to join the market in bigger numbers.

Key developments to look out for:

• Expect 2021 to bring more clarity and alignment on definitions for social objectives and targets, possibly coming from the new Sustainable Platform.
• As supply continues to grow, it will become more relevant for investors to focus on the label, and hence we expect investor demand to increase, possibly with some investors setting up new dedicated social bond funds (as we have seen in the green bond space for years).

3. Sustainability-linked bonds gaining speed

2020 saw the launch of the Sustainability-Linked Bond Principles. Since then supply has picked up dramatically. The early issuers of sustainability-linked bonds (SLBs) have originated from a range of different industries, giving us a glimpse of the versatility and flexibility of this relatively new instrument. One sector in particular looks to be ripe for SLB issuance, namely shipping. Indeed, January saw the issuance of the first SLB in the sector when Odfjell brought a NOK850m to market, with a KPI linked to a higher redemption price. For more on sustainable finance in the shipping industry, including SLBs, watch the recording from Nordea’s inaugural “Sustainable Finance and Shipping Forum”.

Although the interest in sustainability-linked bonds is certainly high, it is important to note that it is still a nascent “market”, and there is significant scope for further development and harmonization of standards and practices. Of these, most critical will be around finding the right balance and structure of the appropriate bond characteristics (i.e. step-ups, redemption price, carbon offsets, etc.). Obviously, a continuous focus on fine-tuning the relevant definitions of “materiality” (of the KPI) and the “ambitiousness” (of the corresponding targets) will also be key.

Finally, investor interest in the SLB format has been high from the outset. That said, actual demand remains less clear than for green bonds, where there is a visible, and additional, demand from the number of dedicated green bond funds.

Key developments to look out for:

• More supply. We need more transactions to learn from and study the market reception.
• Industry collaboration and initiatives to provide better clarity and definitions of key concepts, such as “materiality” and “ambitiousness”.
• It seems like early days still (both in terms of supply and broader market recognition of the format), but 2021 might see the launch of the first ever dedicated SLB fund.
• The interplay of SLBs with the broader topic of “transition finance” (see below). With the entrance of the sustainability-linked structures, the relevance of so-called “transition bonds” (in the use-of-proceeds sense) has been called into question. See this article for more.

4. ‘Transition finance’ debate to continue

The topic of “transition finance” is arguably one of the most substantial and important ones for the market to address in the coming 12-18 months. It touches on many different aspects of the broader market’s development, such as sustainable debt issuance, policy development and overall capital allocation. Furthermore, its scope has widened to focus on what has been referred to as a “just transition”, that is, factoring social considerations in addition to the more commonly agreed-upon focus on climate.

To address this, at least the climate part, the International Capital Market Association (ICMA), last year released the Climate Transition Finance Handbook to provide further guidance on the topic and how to incorporate it into funding considerations.

The challenge with transition finance lies in how to address it in the financial markets. In the simplest form, so-called “transition bonds” have been proposed, although with sustainability-linked bonds now entering the market, the concept of transition bonds seems less likely to be a part of the route of transition finance.

Key developments to look out for:

• ICMA announced the Climate Transition Finance Handbook in December last year. The Handbook is likely to play a big role in the development and rise of “transition finance”. 2021 will be the year in which the guidance provided in this Handbook will be put to practice.

5. Increased overall momentum and harmonization

The sustainable finance train has picked up speed in recent years. During 2020, social bond issuance drove sustainable debt to record highs. With sustainability continuing to rise on the agenda for all kinds of stakeholders, we are likely to see this development continue in 2021.  Encouragingly, we are also starting to see tangible signs of harmonization, for example on reporting standards, with the alignment between Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB).

Finally, with Joe Biden now officially in office, the US is expected to start playing a more dominant role in the global sustainability scene (not least through joining the Paris Agreement). With Europe still being the gravitational center for global sustainable finance both on policy and market activity, it will be interesting to follow how the two regions work together, possibly driven also by a sense of competition.

Key developments to look out for:

• Company commitments (such as Science Based Targets Initiative and TCFD reporting) will continue to grow.
• Harmonization on reporting (e.g. SASB/GRI) to continue and broader consensus around investor expectations (for instance, the UN Principles for Responsible Investment now requires TCFD reporting by signatories).
• Europe has largely been leading the work globally on sustainable finance policy. With the US on the scene, we may see closer collaboration around initiatives such as the EU Taxonomy and more.

About the authors:

Jacob Michaelsen, Head of Nordea Sustainable Finance Advisory

Oskar Hagman, Nordea Sustainable Finance Advisory