In realizing the world’s sustainable development needs, an estimated investment of approximately US$5.0 trillion to US$7.0 trillion per annum from 2015 to 2030 is required. Giving the impacts of COVID-19 and its economic devastation, this gap is likely to magnify as investments continue to dwindle unless both public and private sectors collaborate and step forward. Public finance accounts to around 75% of the current infrastructure investment in ASEAN, with private capital, flows coming mainly in the form of commercial loans. Private finance would need to scale up to meet the financing levels needed to achieve the sustainability agenda. In consideration of that, the capital market is best placed to ensure efficient mobilization of private-sector investments to complement public funding. These pressing funding needs, coupled with greater awareness and appreciation of the sustainability agenda, has led to the acceleration of the growth momentum of sustainable finance globally. (Green Finance Opportunities in ASEAN, (2017): United Nations Environment Programme and DBS)
Financial products such as green bonds and social bonds are globally recognized as a means to channel funds to sustainable projects. These financial instruments are structured similarly with their vanilla counterpart, except that the use of proceeds are to fund infrastructure or projects that produce environmental or/and social benefits.
A general approach to sustainable financing
Organizations have a wide range of options to choose from when financing a project with sustainable objectives. An optimal financing structure would be influenced by various factors, such as the size of the organization, project-specific requirements, and market conditions. Adapted from the Climate Bond Initiative’s Green Financial Instrument Guide, this guide aims to highlight the general steps to raise finance for sustainable projects, without considering the details of different financing structures
Step 1: Develop a green/social/sustainable asset strategy and process
- Develop an investment strategy at the corporate level
- Define the eligibility criteria for projects/assets and develop a selection process. The eligibility criteria should encompass a breadth of ESG criteria, which ideally reflect ESG issue that the issuing institution is also addressing internally. Depending on the defined eligible projects/sectors, the list of ESG criteria will have to be expanded and, if suitable, customized to projects/sectors
- Identify qualifying green/social projects or assets
- Set up monitoring and reporting procedures. Adjust due diligence procedures and governance structures as necessary. Internal capacity building and/or hiring consultants/ ESG experts might be necessary
Step 2: Determine the appropriate source of financing
Once the assets have been identified, the issuers need to determine the most appropriate way to secure finance. Financing can be obtained through:
- Direct investments: equity, debt and project finance, including public-private partnership
- Semi-direct investments: pooled vehicles, including securities, covered bonds, investment trusts, venture capital and equity funds
- Indirect investments: public listed equity, corporate bonds, participation in debt financing
Step 3: Deal structuring
A deal structure can be a combination of different sources of financing, depending on the characteristics of the assets, the company, and macro-economic factors. In identifying the appropriate deal structure, an organization can:
- Consider the need for partnerships (i.e. co-financing or access to expertise or network)
- Determine the financing structure from public and/or private equity and debt
- Evaluate the need for credit enhancement mechanisms such as due diligence report identifying project risks, cash flow projections or valuation
- Prepare necessary documentation required by regulations
Step 4: Debt origination
Debt origination involves several parties that help the issuers structure and execute the transaction. The parties involved in the origination process are:
- Arranger: Structures deal in conjunction with the issuer; coordinates transaction execution
- Legal advisor: Prepares bond prospectus, transaction documentation, legal opinion
- Auditor: Prepares audit report and signs off on financial disclosure in the prospectus
- Credit rating agency (optional): Prepares credit rating report and assigns a credit rating
- Underwriter: Structures bond, manages transaction and acts as a book-runner
Step 5: Post-issuance reporting
After issuance, the issuers should publicly disclose on proceed allocations, with details on the financed projects and the management of any unallocated proceeds, at least annually.
- Report annually: To confirm that the funds are allocated to green/social/sustainable projects/assets. Best practice in the market is to define key performance indicators and disclose the environmental or social impacts and outcomes of the projects in absolute terms and relative to an appropriate benchmark
With the first issuance of the world’s first green Sukuk under the SC’s SRI Sukuk Framework in 2017, and Malaysia as the leader in the global Sukuk market with a 49% share of global Sukuk outstanding as at the end of August 2019, there is significant potential in the sustainability debt market. To take the current growth of the Malaysian bond and sukuk market to the next level, this guide will specifically zoom into how to issue sustainable debt instruments.
For debt issuance, firstly issuers should prepare green/social/sustainable bond/loan framework that reflects above professionalization (see four key areas to be covered below). A bond/loan framework should be drafted and published prior to the first bond issuance.
There are available guidelines and standards published to guide the issuance of sustainable financial instruments in four key aspects as follows:
- Use of proceeds: Proceeds raised from the issuance of the bonds/financial instruments are utilized only to fund any activities or transactions relating to the eligible projects. Eligible green/social project categories need to be defined
- Process for project evaluation and selection of the eligible projects: Establish internal processes for evaluation and selection of the eligible projects
- Management of proceeds: Proceeds allocated for the eligible projects are credited into a designated account or otherwise tracked in an appropriate manner
- Reporting: Annual reporting of the key information of the financial instrument such as the amount allocated, amount utilized, amount unutilized and the impact/expected impact of the projects
The list of available guidelines and standards for green, social and sustainable financial instruments are as follows:
It is market best practice to obtain an external review on the sustainability credentials of the selected projects as well as the compliance with guidelines and frameworks. An external review can take the form of assurance report, second party opinion, rating or verification report for certified climate bond.
- Assurance report is an external party confirmation of compliance with the guideline or standard.
- A second-party opinion is an external assessment of the issuer’s green/social/sustainable bond framework, confirming standards compliance and analyze the eligible projects categories.
- Rating is an evaluation of the green/social/sustainable bonds against a third-party rating methodology.
- Verification reports for Certified Climate Bonds is a third-party verification, pre- and post-issuance, which confirms that the use of proceeds adheres to the Climate Bonds Standard and Sector Criteria.