Evolution of Sustainable Finance and the Surge of Climate-Focused Financial Instruments

Sustainable finance encompasses any financial product or service that takes into account sustainability. Green finance specifically pertains to financing for environmental purposes, while climate finance focuses on funding initiatives related to climate issues. However, it’s worth noting that climate finance often involves the use of public-sector funds.  Both sustainable finance and climate finance have experienced significant growth in recent years. The primary contributors of financial support for climate projects are public-sector development banks. The expansion in membership and overall size of private-sector coalitions focused on climate and sustainability underscores their significance. 

  •  Green bonds are bonds where the proceeds are designated for environmental projects. They incorporate various features: they are individually labeled, the funds are set aside, and the intended use of the funds is disclosed to potential bondholders beforehand and to current bondholders once the projects are carried out.
  • Other sustainable financial instruments encompass social bonds, where the proceeds are set aside for social benefits; sustainability bonds with both environmental and social advantages; green loans, which are similar to green bonds but are structured as loans; and sustainability-linked bonds and loans, where the bond’s coupon or the loan’s interest rate is linked to the attainment of sustainability goals. 
  • The market for sustainable funds is extensive and expanding, including funds comprised of sustainable instruments (e.g., green bond funds) and funds holding shares in sustainable companies. 
  • Many financial institutions engage in ESG integration, which involves utilizing and gathering data on significant ESG (Environmental, Social, and Governance) issues, incorporating it into investment and lending decisions, and engaging with the companies in which they invest.
  • As the market has matured, there is greater regulatory involvement and a move to standardize definitions across borders.
Figure 1 : Annual Issuance of Bonds over the years (Source: Calculus Carbon Research)

Green bond issuance has grown significantly in a short amount of time, reaching USD 270 billion in 2020. Social and sustainability bonds have likewise grown quickly in issuance, although with a later start and from a lower baseline. In 2020, when the world was hit with the COVID-19 pandemic and many institutions wanted to raise money to help address its impacts, it saw a particularly large upsurge in social and sustainability bond issuance compared to previous years. According to the credit ratings agency Moody’s, this trend is set to continue in 2021, with forecast issuance of USD 375 billion in green bonds, USD 150 billion in social bonds, and USD 125 billion in sustainability bonds.

The realm of sustainable finance is rapidly expanding, encompassing green, social, and sustainability bonds, and engaging in ESG integration for a more comprehensive impact. This growth trend, especially notable in green bonds, is set to continue, reflecting a heightened commitment toward environmental and social initiatives. The rise in issuance during the COVID-19 pandemic, particularly in social and sustainability bonds, underlines the urgent need to address global challenges and signals a promising trajectory for future investments in climate-focused financial tools. As the market matures, there’s an increasing call for standardized definitions and regulatory involvement, marking a critical phase in sustainable finance’s development. The forecasted issuance in 2021 underscores the sustained growth of the green, social, and sustainability bond markets.

If you are interested in learning more about the voluntary carbon market, we invite you to interact with Calculus IQ. This tool can help you explore different aspects of the market, including project types, retirement volumes, and more.

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