MSIZI KHOZA: Time for a fresh approach to ESG financing

Now that some environmental, social and corporate governance (ESG) activities have graduated to business-as-usual status, it may be time for lenders and policymakers to rethink how certain projects are financed. 

Over the past decade or so the financial services industry has played an important role in accelerating the adoption of decarbonisation technology and ESG practices through incentives embedded in financing instruments. 

By taking on a sustainability-linked loan a corporate can benefit from lower borrowing costs if it hits certain pre-agreed ESG targets, for example. This approach has boosted investments in solar energy and water efficiency technologies, among other things.

However, providing these incentives comes at a financial cost, which is ultimately borne by lenders’ shareholders — including low-income pension fund members. While ESG-linked financing helps mitigate investment risk for those shareholders and future-proofs their portfolios, the industry may need to be realigned with the needs of the day. 

For instance, the financial services sector could reserve ESG incentives for decarbonisation projects that are not yet economically viable on their own, such as enabling a manufacturing facility to switch from blast furnaces to heat pumps. This could prove more impactful than promoting a shift to clean electricity, which is now economically competitive on a stand-alone basis. 

Is it time to phase out ESG-financing support for investments in mature technologies, and narrow our focus on hard-to-abate activities and those that safeguard livelihoods amid the energy transition?

If so, African regulators have an opportunity to strengthen industry support mechanisms in a way that advances with their own decarbonisation goals. 

They could, for example, lower capital requirements for sustainability-linked loans, drawing inspiration from the EU’s previously proposed “green supporting factor”.

Green finance taxonomies can also be used to steer capital towards hard-to-abate sectors, in line with each country’s nationally determined contributions — or decarbonisation pledges. 

And regulators could minimise the regulatory burden that comes with taking on ESG financing mechanisms. Despite the benefits, some companies remain hesitant to use ESG-aligned loans as they would need to dedicate more resources to reporting and compliance.

Meanwhile, the state could also ring-fence a portion of the revenue it derives from carbon taxes to help scale up ESG-related financing. 

Policymakers could lend support in other ways as well, such as lowering tariffs on electric vehicles and building out a national charging network so that companies feel more confident to decarbonise their transport operations and reap the long-term benefits.

Indeed, financial incentives alone are not enough to spur genuine, across-the-board action throughout the economy. Complementary mechanisms, including penalties for noncompliance and the establishment of carbon budgets specific to each sector, may be needed too. 

But incentives certainly have their place. And make no mistake, this segment of the financial market is just as relevant as ever to corporates and national governments — even if it is no longer as prominent to the public eye. 

Just a few weeks ago China’s finance ministry issued the country’s first sovereign green bond, raising 6-billion yuan (about R15.3bn) to support the country’s climate and biodiversity programmes.

Issuers across the globe are using ESG financing to manage risk — for example, to reduce their exposure to assets that will become stranded amid the energy transition — and to capitalise on new opportunities to boost efficiencies, tap innovative technologies, and create jobs. 

The industry is helping to align private capital with public good, while also reducing systemic risks and creating a more sustainable and inclusive economy. In short, the fundamentals of ESG financing remain unchanged, and the underlying environmental and social risks we are seeking to address have not diminished. 

Investors are still concerned about their exposure to companies that could become less relevant as the energy transition shifts up a gear, and consumers remain attuned to societal challenges like grinding poverty and youth unemployment. All the while, extreme weather events are happening more frequently and with increased severity. 

However, it may well be time to take stock and ensure the capital being deployed is still generating solid environmental and social returns. 

To date, the big four SA banks have mobilised over half-a-trillion rand in sustainable financing. It remains a large and growing segment of the market, meaning ongoing assessments of our priority areas are needed. 

This inflection point offers us an opportunity to realign ESG financing in a way that maximises social and environmental outcomes and ensures widespread buy-in. 

• Khoza is managing executive: ESG at Absa Corporate & Investment Bank.