50 Shades of Green Finance: An Untapped Opportunity for Private Equity

Latham & Watkins LLP

Sustainable finance and its surrounding infrastructure offers growing potential for deals and green innovation.

The global sustainable finance market has expanded rapidly in recent years, approaching US$320 billion in new issuances in the first 10 months of 2019. Sustainable finance — which is dominated by green bonds, but also includes sustainable bonds, sustainability-linked bonds and loans, and social bonds — represents a growing opportunity for private equity-backed businesses to tap into burgeoning demand from asset managers to put capital to work in investments that meet sustainability criteria. Further, recent M&A activity in environmental, social, and governance (ESG) ratings businesses demonstrates an increasing demand for ESG measurements and metrics from investors and regulators, presenting new PE investment opportunities. In our view, sustainable finance and its surrounding infrastructure — especially companies that support and assess compliance — offers potential beyond mere demonstration of green credentials.

Green bond issuers are not limited to businesses focused heavily on environmental objectives, such as solar or renewables companies, but can include a wide variety of entities able to articulate their story for making positive impacts, or seeking to improve their historical performance. There is no centralised authority on what constitutes a green bond or a sustainable business activity. Issuers often comply with voluntary process guidelines known as the Green Bond Principles and may also obtain third party validation in connection with their issuance.

Green Innovation Brings Flexibility to Borrowers

The space offers flexibility and opportunity for innovation. For example, Italian power company Enel’s recent bond provides for a 25 basis point margin increase, depending on the percentage of Enel’s power generated by renewables. A similar concept has been increasingly seen over the past two years in revolving credit facilities, with margins linked to sustainability targets. Other innovations include “green striped” bonds, in which a designated fraction of the bond complies with the relevant green bond norms and investors only attribute sustainability features to that extent. These products reflect the call by Mark Carney, Governor of the Bank of England, for “50 shades of green”, and demand for a less binary approach to sustainable activities and climate change mitigation.

Why Invest in Sustainability Tools and Index Providers?

The past year has seen a number of deals among companies that provide data, audit, and analytics around sustainability / ESG credentials, in a sector that has traditionally been dominated by boutique providers. With a growing amount of capital also flowing into impact investing and social impact funds, and calls from the EU to tackle greenwashing, businesses and investors are looking to mark the boundaries of sustainability. Consequently, demand for impact due diligence and third party advisory firms is rising.

Further, companies are looking to meet investor demand for heightened reporting on environmental and climate change risks (such as those recommended by the Taskforce on Climate-Related Financial Disclosures). Beyond the UN’s 17 Sustainable Development Goals, businesses globally, both public and private, are increasingly expected (and in many cases required) to report on a growing range of environmental and climate change intentions and metrics. Key drivers of this trend include the European Union’s Non-Financial Disclosure Directive and groups like the Sustainability Accounting Standards Board. In our view, businesses and investors will need assistance to navigate a rapidly evolving web of overlapping international, national, local, and sector goals, guidelines, rules, and regulations — making this a sector to watch.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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