The Top Ten Things to Know About ESG Finance in 2024

ESG has become more and more of a key factor in investment, reflecting a growing awareness of sustainability issues among issuers, investors and regulators alike. As we navigate through 2024, it is crucial to stay informed about the latest developments in ESG finance including the evolving regulatory landscape and market dynamics. 

Here are the top ten things to know about ESG finance in 2024:

1. SLB SPTs and the Paris Agreement

By tying financial returns to sustainability outcomes, securities lending and borrowing (SLBs) incentivize companies to set and achieve ambitious environmental targets. In 2023, a third of SLBs were in alignment with the Paris Agreement, an increase from previous years. However, the majority still fall short in 2024 (despite the decline of SLB issuances in 2024), primarily due to their greenhouse gas (GHG) reduction targets and coverage of scope 3 emissions, highlighting the need for continued progress and setting more ambitious and fulsome targets and the materiality of step-ups and callability terms. 

2. A New Pricing Model for SLBs? 

Something that could drive SLB issuances would be a new pricing model for SLBs. The AFII Sustainability-Linked Bond Handbook has introduced a model that conceptualizes SLBs as options (equal to the expected coupon step-up) where an investor should pay a premium to buy this option. The model suggests that SLBs should have a “greenium”, being a function of a combination of the financial impact of the step-up AND accounting for the probability of a step-up being paid by the issuer - with the step-up adjusting accordingly and in turn making these products potentially more economically attractive to investors. 

3. ENEL's Missed SPT

However the risks of setting Sustainability Performance Targets (SPTs) that are unachievable has already been seen. ENEL, the largest SLB issuer, missed its SPT in April 2024, resulting in a 25bps step-up on ten of its bonds. Although the financial impact seems minimal relative to the company's revenue, this event has put the spotlight on the potential consequences of not meeting SPTs, especially as more bonds approach their test dates scheduled for later in 2024 and 2025. This event serves as a warning to other issuers about the potential costs associated with non-compliance and underscores the importance of setting realistic and achievable SPTs and the need for robust strategies to meet these targets. 

4. Emergence of New Sustainable HY Instruments? 

Despite their popularity in other markets, transition and blue bonds have yet to make a significant impact in the high-yield (HY) market in particular. It has been suggested that these instruments will gain traction in 2024, potentially influencing the HY market as issuers and investors become more and more comfortable with new, sustainable financial products but they are yet to be tested. As these instruments gain traction, they could encourage issuers to innovate and investors to support new types of sustainable debt products that the current instruments do not offer for issuers. 

6. EU Green Bond Standard

The EU Green Bond Standard is set to come into effect in late 2024, that is set to raise the standards for green bond issuances by setting higher transparency and reporting requirements. Notably, the EU taxonomy now also permits EU Green Bonds to finance nuclear energy projects. 

5. ESMA's Green Bond Proposals

Relatedly, the European Securities and Markets Authority (ESMA) has launched a consultation on rules for external reviewers of EU Green Bonds. In its proposals, ESMA aims to standardize registration requirements and contribute to developing a level playing field through lower entry costs for applicants. These developments could lead to a more standardized regulation of external reviewers.

7. Revision of SBTi's Stance on Carbon Credits

The Science Based Targets initiative (SBTi) has revised its position on carbon credits, now permitting their use in scope 3 emissions targets and potentially reflecting a more pragmatic approach to achieving emission reductions. This shift indicates a more relaxed approach to offsets and has elicited a range of responses from market participants and influencing the market dynamics of carbon trading. 

8. Corporate Sustainability Due Diligence Directive (CSDDD)

The European Parliament has now voted to adopt the CSDDD, which aims to enhance sustainability in supply chains. However, the directive's scope has been narrowed to apply only to larger companies and has loosened its stance on “materiality”, potentially limiting its impact. Regardless, the CSDDD still represents a significant step towards integrating sustainability into corporate governance influencing how companies approach due diligence and reporting. It remains to be seen if this will materially increase such in-scope companies reporting and disclosure in general in the near-term. 

9. SEC's Emissions Reporting Rules

On March 6, 2024, the U.S. Securities and Exchange Commission (SEC) issued a final rule that requires comprehensive climate disclosures in annual reports and registration statements for public companies.  The SEC's decision on mandatory emissions reporting rules sets a precedent for transparency and accountability in the disclosure of corporate emissions data. Although the final rule scales back the original proposal by excluding mandatory scope 3 emissions reporting, it still marks a shift towards greater emphasis on the standardization of sustainability reporting on the whole. It remains to be seen where these augmented disclosures will be included in existing disclosure frameworks (such as in the Management Discussion and Analysis (MD&A), business and risk factor sections of prospectuses). 

10. Upcoming Elections

The political climate is a critical factor in the ESG landscape given policy decisions can have profound impacts on the prioritization of climate action and sustainable finance. With key elections scheduled in 2024 in major economies like the EU, U.S., and UK, the outcomes could influence the direction of climate policies and the implementation of ESG-related regulations (as mentioned above).

In Europe, the anti-climate right wing parties may gain votes and seats at the expense of the centre-left and green parties. Whereas in the U.S., Trump has pledged to reverse Biden's Inflation Reduction Act. While the short-term impact of the elections may be limited, the long-term implications could be substantial, depending on the political will to advance or hinder progress towards sustainability goals.

Summary

These ten points illustrate the ESG finance's intersection with regulatory developments, market innovation, corporate accountability, and political dynamics. Understanding these elements is essential for investors, issuers and other stakeholders to navigate the evolving landscape of sustainable finance effectively throughout 2024.

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