What to expect from the sustainable finance market in 2023

Following an eventful 2022 for financial markets, it is time to take stock our lessons from the previous year and apply them to the year ahead. Whilst we certainly are not wishing for an exact repeat of 2022, events showed that sustainable financing can remain relevant and resilient even while headlines lead our eyes elsewhere. We expect this theme to become more common throughout 2023. As sustainability becomes more embedded within organisations, discussions will be more detailed than dramatic.

This outlook is by no means a critique of the way in which organisations and financial markets are approaching sustainability, but more of a celebration of its normalisation. Sustainability has secured its place in the mainstream – we no longer need to beat the drums as loudly as we are already at the negotiating table. As such, we see the focus on detail and implementation in our trends for 2023 as a sign of progress.

Three trends to look for in 2023

With a financial markets focus, we outline our three high-level trends for 2023. Our standout trends are all multifaceted and interlinked but nonetheless deserve separate mentions.

Trend 1: Greenwashing – definitions, definitions, definitions

Greenwashing as a topic has been with us for some years but really started gaining traction within the world of sustainable finance as the U.S. authorities launched an investigation into the ESG claims of Deutsche Bank’s asset management arm, DWS. As we look to 2023, this is arguably the hottest topic that will drive discussions and influence decision making.

Despite the significant momentum the topic has gained in recent months, and the severity of the consequences, we are still left with a single question: “How does one actually define ‘greenwashing’?” While the answer depends on who is being asked, we increasingly see calls to establish a common understanding of greenwashing from institutions such as the European Supervisory Authorities (ESAs) and the UK Financial Conduct Authority (FCA). More broadly, the European Commission is expected to put forward a proposal for a directive to regulate “green claims” made by organisations.

The calls to define greenwashing are certainly fair. However, we must temper our enthusiasm and approach the problem with a clear mind. Although the consequences of greenwashing certainly are be undesirable, there’s also a risk of wielding the threat of punishment too severely and potentially stifling the investments and innovation needed. Significant risks may result from inaction rather than greenwashing alone.

Trend 2: Transition finance – what is it really?

As with “greenwashing,” the concept of “transition finance” is not a new addition to the market conversation. Similar to greenwashing, it seems to have now gained sufficient momentum to be market moving. This trend is not surprising: As we set about transforming the global economy to a low-carbon reality, different parties will have to move at different speeds and through several iterations and investment cycles.

Within the financial markets, this topic that has been discussed for some time and has even led to tangible developments such as “transition bonds.” Even “sustainability-linked” structures, supported both by the International Capital Market Association (ICMA) and the Loan Market Association (LMA), arguably have the concept of “transition finance” baked into them. More broadly a wide range of papers from leading institutions have been published in an attempt to clarify the concept and bring transparency to the discussion.

Despite these well-intended efforts, the topic remains as elusive as “greenwashing.” It is  unrealistic to expect that the concept of “transition finance” can be adequately defined through a top-down framework or similar. Instead, a globally aligned concept of “transition finance” will likely emerge in the form of a mosaic of different applications, some labelled and others not. 2023 looks like the year when we may be able to first get a glimpse of this.

Trend 3: Sustainable finance products – focus on innovation and quality

Outside of the Paris Agreement, one of the most important factors in the total redirection of the financial markets towards a sustainable modus operandi has been the rise of the green bond market (and sustainable finance products more broadly). Sustainable finance products are now a core and stable part of the market. The ICMA Green Bond Principles will in fact celebrate a decade next year.

As such it might be strange to consider this area within sustainable finance as a topical development for 2023. But look closer at the developments, and it seems that we might be on the verge of the second wave of products and innovation. Indeed, with “transition finance” as a theme gaining momentum, we are sure to see a resurgence of the “transition” label – and maybe this time it will stick.

The concept of “hybrid” structures may also soon enter the conversation within sustainable finance as market participants look to new and different ways to stay relevant to stakeholders. One such example is the recent “sustainability-linked loan bond” issued by Nordea Bank in September last year. (Full disclaimer: the authors of this article were the structurers of this framework.)

The novel structure combines a “use-of-proceeds” approach on the framework level with a “sustainability-linked” one on the asset level. That is, investors’ money will be allocated to assets meeting the definitions of the framework (like any other green bond framework). However the assets will not be assessed by the eventual use of proceeds but by the overall commitments of the borrowing entity (and at the time of issuance only climate related).

In addition to the drive towards new structures and tools, we should also expect to see a continuous focus on quality, specifically around definitions (such as on “materiality,” “ambitiousness,” and general EU Taxonomy-related categories), data and verifiable impact. Admittedly, this is a topic we have been working on already for some years and one that will require constant attention. Nonetheless, considering the pending launch of the EU Green Bond Standard later this year, additional Taxonomy categories to be launched and the overall increasing drive towards better quality ESG data, it is reasonable to note this as a key topic for this year.

Notable mentions

Wrapping up, we highlight a few notable developments that will carry our 2023 trends. Rather than grabbing the headlines, these developments will underpin the quality and detail focus that we foresee for 2023.

The first of these is regulation. Anyone focused on tracking the bundle of ESG-related regulatory developments can testify that it is a daunting task to say the least. Indeed, the regulatory drive of recent years has been one of the main engines of growth for the market, particularly within the EU, but simultaneously one of the main sources of uncertainty. We don’t see this changing in 2023.

Secondly, on the thematic side, we expect biodiversity to continue to gain relevance and drive development across the market, whether product-related, such as the recent World Bank SDG Bond raising awareness for biodiversity, or governance and disclosure-related, such as the Taskforce on Nature-related Financial Disclosures. Further, the adoption of the Kunming-Montreal Global Biodiversity Framework (GBF) at the end of 2022 will ensure that biodiversity receives more targeted focus over the coming years.

Finally, the drive towards increasing data quality will continue. As has become a sub-theme of this article, the conversations around the quality of ESG-related data have been ongoing for several years now. While we do not see these conversations coming to an end in 2023 (we can always work towards procuring better data), there are several reasons to believe that the search for good quality data will be a less significant barrier to progress than it has been in the past.

In addition to an ever increasing stock of historical data, against which we can measure our past progress and future ambition, our understanding of data requirements is becoming far more granular. We see this in relation to target setting, for example through the publication of new sector-specific guidance from the Science-Based Targets initiative (SBTi); in relation to disclosure requirements of the EU Corporate Sustainability Reporting Directive (CSRD), particularly through the increased scope of coverage; and in relation to data interpretation, either through common definitions such as those provided by the EU Taxonomy or our understanding of ESG-related ratings.