Sustainable finance has undergone a paradigm shift. The next decade will be all about “transition finance,” says Jacob Michaelsen, head of Nordea’s Sustainable Finance Advisory team.
“We’ve entered a new era in sustainable finance. Transition finance is no longer just a bullet point on a list of key themes to watch in the coming year. It is the theme that all the others now fall under,” he says.
Modern sustainable finance originated back in the 1980s and 90s in the form of “socially responsible investing,” where the focus was on deselecting investments in industries considered harmful, such as alcohol, firearms and tobacco. In the last decade, the focus shifted to positive impact in the form of green bonds, with the funding going towards specific projects with a positive environmental impact.
Today, with the advent of sustainability-linked structures such as sustainability-linked bonds and loans, the focus is on transitioning. The bond and loan proceeds can go towards general corporate purposes, and the financing is tied to the organisation’s material and ambitious sustainability targets.
Such structures can cover most topics, including social concerns, but have so far mostly been related to the climate transition. Companies are already today expected to have clear “transition plans” in place for climate and increasingly other areas, such as biodiversity and ecosystems.
“Today we spend much more time on transition-focused discussions. That has to be the way of thinking as we need to get to a low-carbon economy, and getting there requires a transition,” says Michaelsen, noting that the financial industry is a key facilitator.
“We need to have all the tools, processes, products and alignment in place to facilitate that transition,” he adds.
Transition finance is no longer just a bullet point on a list of key themes to watch in the coming year. It is the theme that all the others now fall under.
Looking ahead in 2024, Michaelsen highlights a range of other key themes to watch. He notes that all are factors driving towards this new “transition finance” regime, concerning different aspects of the underlying infrastructure that’s needed.
When it comes to market themes, he notes that policy action is still the driving force. The past few years have seen a slew of new regulations and policies. European Union officials have emphasised that now is the time for “stocktaking” and “implementation.”
Focus is also shifting beyond climate, for example, to biodiversity. Nature-related frameworks, such as the Taskforce on Nature-related Financial Disclosures (TNFD), now exist for many of the equivalent climate-related ones, such as the Taskforce on Climate-related Financial Disclosures (TCFD).
Focus is shifting beyond climate, for example, to biodiversity.
Greenwashing concerns remain high, and increased scrutiny from regulators will keep the pressure on market participants to not cross the line. Michaelsen argues that it’s a concern that should be balanced with the need for action and innovation, as he wrote in this article in 2023.
From an industry perspective, “materiality” is one of the core concepts in the new era of sustainable finance. It means being relevant or significant. It is a key feature of sustainability-linked bonds and loans, where the selected sustainability targets must be material and ambitious.
The Sustainable Finance Disclosure Regulation (SFDR) is another key focus this year and one of the most significant pieces of EU ESG regulation in recent years, according to Michaelsen.
More broadly, when it comes to ESG reporting, 2024 is crunch time. 2023 was a big year for standards in the ESG reporting space, with the creation of the International Sustainability Standards Board (ISSB). Now the clock is ticking as the first batch of companies covered by the Corporate Sustainability Reporting Directive (CSRD) will need to start reporting for fiscal year 2024.
From a product perspective, the EU Green Bond Standard will be a focus this year. The final legislation for the voluntary standard was adopted in 2023, and we expect further alignment to take place in 2024, according to Michaelsen.
He notes that sustainability-linked bonds will remain a key tool for the market, but more work is still needed. The sustainability-linked bond format faced significant headwinds in 2023, with several issues raised around the structures and the ambition level of the sustainability targets.
Finally, Michaelsen emphasises that product innovation will be continue to be critical in 2024 in order to address major sustainability challenges and close the significant funding gap. He points to Nordea’s Sustainability-linked Loan Funding Framework as one such innovative structure, which allows investors to invest in Nordea’s sustainability-linked loan financing activity. In 2023, Nordea issued an inaugural EUR 1 billion bond under the framework.
“This type of innovation is crucial as it helps direct money to the places it needs to go to drive the transition,” he says.
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