ESG Financing: Where is the Money Going?

ESG has been a long-rising movement in capital markets and corporate governance for many public companies. It has risen from a publicity-based issue to an investor relations issue, and now to an action item for the Securities and Exchange Commission (“SEC”) as they begin to consider formal disclosure requirements.

Additionally, ESG has moved from a law journal pipedream to a bona fide investor metric per institutional investor demand. Currently, the largest growth area in the ESG realm is sustainable finance. Institutional lenders have committed trillions of dollars to funding projects that focus on ‘sustainable finance,’ projects that focus on financing ESG-based companies and their goals. This new initiative has risen with respect to lending initiatives, green bonds, and public company initiatives.

As a general background, the market has thoroughly backed ESG initiatives. There has been a monumental exodus in funds devoted to traditional energy—from roughly $46.7 billion in 2015 to $8.3 billion today—to renewables, from $21.4 billion in 2015 to $54.2 billion today. Part of this migration is surrounding the fact that ESG-based funds offer an investor-relations highpoint, but more so that they have consistently outperformed key indexes like the S&P 500.

And just as the capital markets have taken notice of ESG initiatives from the institutional investor standpoint, the SEC has announced that it plans to create a standardized set of disclosures around ESG-based investing and initiatives in the next several years.

While it is too far away to predict those exact metrics, already prevalent metrics around board diversity, pay ratio and carbon footprint-limitations are likely key items that the SEC will look to since they are already in the process of becoming market practice disclosures. From a capital markets perspective, public companies can expect to see increased reporting disclosure requirements within the next two to three years as the SEC seeks to ensure that companies reporting on ESG initiatives are genuinely devoting funding to such initiatives and taking action.

Further, as major institutional investors like Blackrock, StateStreet and Vanguard have announced board-diversity requirements, the SEC may take such united action as an identification of a key data point.

While previous ESG initiatives have largely focused on public companies’ ESG initiatives at the board level, sustainable finance is a more direct commitment to the ESG space and to local communities. Sustainable finance is a new outgrowth for ESG. To this end, Citi, Goldman Sachs, J.P. Morgan and PNC have all pledged over one hundred billion dollars (and in some cases trillions of dollars) to investing in sustainable initiatives. This investment can take numerous forms, from investing in minority-owned businesses and affordable housing on a local level, to investing in carbon sequestration projects on a large-scale level. Additional key areas where there will likely be growth are healthcare and accelerating low carbon economy.

Green bonds

ESG investing is not limited to institutional lending and project finance. It also offers an additional avenue for ESG-focused companies to raise capital through ‘green bonds,’ which are generally bonds that are earmarked for the sake of raising funds for ESG initiatives.

More specifically, they are issued by an entity that is willing to link its assets and activities to its balance sheets to prove that it is engaging in the green activities that the bonds are funding. Borrowers under green bonds must meet established ESG metrics in order to maintain a lower interest rate, lest they be punished by a higher cost of debt for failing to meet a pre-set target.

In general, green bonds represent a large growth opportunity for ESG companies in the energy space since they allow public companies—especially traditional energy-focused companies—seeking to engage in green initiatives and find sources of funding to take on important, sustainable projects.

As E&P companies are looking to expand into carbon sequestration, renewables and other sustainable sources of energy, green bonds and ESG finance will offer key funds to allow these traditional oilfield companies to transition to a different side of their field. Because there is such an abundance of funds—and their respective firms—looking for investment projects within the sustainable energy field, E&P companies may be uniquely positioned to take advantage, to expand carbon sequestration efforts in correlation with seeking additional capital in 2022.

Sustainability-linked bonds

Green bonds have also expanded into sustainability-linked bonds as a more general outcropping. The purpose of a sustainability-linked bond is to provide funding to companies that are committed to sustainability-based goals beyond environmental and social concerns. And, interest rates are additionally linked to tailormade ESG goals, providing a further incentive to participate in and meet ESG benchmarks.

This alternative to a purely environmental and social linked bond provides further opportunities to companies that are focused on the sustainability initiatives that are included in ESG and whose initiative progress may be hard to quantify against traditional metrics.

Conclusion

Given the boom in ESG-focused investing and increased ESG reporting disclosures that are being required from institutional investors, ESG finance is a key growth area for both companies and investors.

Since major (and local) banks have been purposefully earmarking funds to invest in ESG initiatives and ESG funds are markedly outperforming the S&P 500 index, there will likely be explosive growth within the ESG sector over the coming years. In order to maximize returns and opportunities within this area, borrowers, public companies and lenders should be ready to move on ESG projects to take advantage of early market opportunities.

About the author:

Mike Blankenship is the managing partner of Winston & Strawn’s Houston office. He focuses his practice on corporate finance, M&A, private equity, special purpose acquisition company (SPAC) offerings and securities law, and regularly counsels public companies on strategic transactions, capital markets offerings, and general corporate and securities law matters.