2024 Outlook – Sustainable Finance

Roman Dubczak: Hello, everyone. I’m Roman Dubczak, Deputy Chair of CIBC Capital Markets. Thanks for joining my colleagues and I as we discuss the past year and emerging trends in sustainable finance. Reflecting on the past year, a number of sustainable finance trends continue to influence and shape the trajectory of this important and evolving market, including mounting investor pressure to implement net-zero targets and the need to scale transition finance to fund the shift to a low carbon economy. However, investor pressure across the financial landscape, such as from net-zero alliances, covering financial institutions, asset owners and managers, and insurance companies, have faced their own set of challenges. While ESG related sentiment in certain jurisdictions, like the US, has waned and many jurisdictions are feverishly developing appropriate transition taxonomies. As we look to the new year ahead, will 2024 be accommodating to sustainable finance market participants? And how will these trends impact market volumes and the pace of transition? To provide you with insights on these developments and a look ahead, I’m excited to lead today’s discussion with two of our experts, Sid Samarth, Managing Director and Head of Sustainable Finance, and Amber Choudhry, Managing Director, Debt Capital Markets. Sid and Amber, happy New Year to you both. Welcome. And let’s, Sid, kick off with you. Reflecting on the past year and obviously we touched on that in the preamble, what are the highlights there and what do you think some of the observations are as to what stood out in the market in the past year?

Siddharth Samarth: Well, Roman, thanks for having me on today. And while reflecting on last year, I would say it felt a little bit like a rollercoaster ride. Lots of ups and downs and the landscape continue to evolve and the expectations continue to evolve. However, progress is being made and it’s happening across policy, technology and financing. On the policy front, we now have approximately 90% of global GDP covered by net-zero targets. Governments continue to put policies in place to accelerate and mobilize activities which can be funded by sustainable finance. And what’s interesting is that we are seeing an increase in the number of participants in this market, particularly from governments who are looking to fund these policy decisions. And I’m sure Amber is going to touch upon this in her market update as well. Now, this drive-by-policies is increasing funding towards technology, which is going to support for a more sustainable future. Investment in energy transition has risen over 40% since 2020 and renewables are being deployed at double the rate that we expected back in 2020. However, more needs to be done, particularly with the market backdrop that we’ve had. Rising inflation, supply chain constraints have all affected, I would say, a number of investment decisions and we saw the cancellation of a few offshore wind projects in the US and in Europe as an example. That said, we ended the year with a number of ambitious announcements coming out of COP28,with the commitment to triple the world’s installed renewable generation to at least 11,000 gigawatts by 2030 and a pledge by 20 countries, including Canada and the US, to focus on really tripling global nuclear energy by 2050related to nuclear and tied to financing. We saw nuclear being included as an eligible green activity in Japan’s green transformation framework and Canada also including nuclear. In their updated green bond framework, which was announced in the Fall economic statement. On the financing side, the world of sustainability and its incorporation into financing and capital allocation continue to evolve. GFANZ, which you referred to, which is really leading a coalition of leading financial institutions committed to mainstreaming decarbonization, grew in size and they grew in size from approximately 450 members two years ago, to end the year at about 675 members. And they now represent approximately $120 trillion in assets under management. This happened against a backdrop where the Net-Zero Insurance Alliance actually saw a number of exits, in part due to concerns raised on antitrust issues. And now this is something that a number of market participants are keeping an eye on as this anti-ESG sentiment in part, drove that thinking over there. And as we’ve seen that, in certain states in the United States. This had an impact on sustainable finance issuance in the market. And we saw some market participants stay on the sidelines as they assessed the impact of this movement. That said, I think we continue to see a number of institutions who are under the umbrella of GFANZ progressing their commitments to net-zero via transition plans, and they’re going to go about disclosing how they’re doing this. The last observation that I’ll touch upon, is what we saw this year, is a movement really from voluntary to regulatory. And what I mean by this is until a couple of years ago, factoring sustainability into business decision making was driven more voluntarily. What has become quite clear now is that the initiatives are driving things forward, moving from a voluntary lens, to a regulatory lens. And there have been always a few regional differences in terms of the speed of implementation. However, they’re all pointing in the same direction. So overall, lots of progress from a policy technology and financing perspective. However, there were a few speed bumps along the way and the rate of change will continue to evolve as we move forward over here.

Roman Dubczak: Now Amber, Sid mentioned COP28, which focused global attention on accelerating climate action and managing its costs. Sustainable finance is critical to unlocking these ambitions. What kind of activity have you observed in the global sustainable finance market this past year? How did the year finish from an issuance perspective. and any notable transactions you want to mention?

Amber Choudhry: Thanks, Roman. So for the global sustainable finance market, let’s start first with how the year finished. According to Bloomberg, they estimate that both ESG label loans and bonds in calendar 2023 was approximately $1.3 trillion. I’m going to call it roughly an 80-20 split between bonds and loans. It’s great to say that we hit the trillion dollar mark again. In 2021, the market first hit $1 trillion when we had $1.9 trillion of issuance. Now, I will note interest rates were quite a bit lower then. Then in 2022, the market was $1.6 trillion and in 2023 we ended at $1.3 trillion. So some consistent themes we saw in the global sustainable finance market in 2023 are as follows. One. Green bonds remain the most popular bond product, and they’re approximately 60% of the market. That’s about $500-$600 billion of issuance per year since 2021. The Euro continues to be the most popular currency and has been the most popular currency since the market started. The second most popular currency is US dollars, which I would say is expected. But what was not expected is the decline in US dollar issuance, which is something you kind of mentioned earlier. So if you look at Euro issuance, it was only down 15% as compared to 2022. But if you look at US dollar issuance, it was down 30% as compared to 2022. So you mentioned ESG sentiment in the US is waning. And I know Sid’s going to discuss upcoming elections globally in 2024. I think it’s going to be interesting to see in 2024 how much US dollar issuance gets done in the market. Other themes we saw, too, is if you look at social issuance and sustainable issuance, which includes social eligible expenditures, that’s relatively consistent, if not slightly higher than 2022. So social themes remain important. And then if you look at the linked products, there was a decrease in sustainability linked loans, but that, as this product matures, that’s to be expected. And there was a small decline in sustainability linked bonds as we wait for this product to gain more traction. Now let’s look at Canadian dollar issuance here in Canada, and all these figures are in Canadian dollars. In total ESG labeled bond issuance in Canada was approximately $18.4 billion in 2023. The governments were $9.7 billion, approximately 7% of their market and the corporate and financial issuance was $8.7 billion, or 8% of their market. This is down from 2022 when ESG label issuance was $24.5 billion. And the decline comes on the government side. Governments were $17.7 billion as compared to $9.7 billion. So that’s an $8.7 billion decline. Now, the one thing I will note is in 2022, we had a government of Canada bond deal in Canadian dollars and that was $5 billion. So that’s a big part of the decline. And now, talking about the government of Canada, Sid mentioned that they updated their framework to include nuclear as an eligible green expenditure. They’ve also stated that they plan to issue another green bond under the updated framework before their fiscal yearend March 31st, subject to market conditions. So in 2024, that could really increase government financial issuance. Bank and corporate ESG label bond issuance increased by a small about, $1.9 billion. And that was really helped given that two Canadian financial institutions started doing sustainable bonds in the Canadian debt capital markets. Both FCDQ and National Bank issued for $500 million each, both a sustainable bond. Our largest corporate issuer in the market last year was Hydro One. They started doing sustainable bonds in January of last year. Earlier this week, Hydro One did another green and sustainable bond issue, issuing $800 million via two tranches.

Roman Dubczak: Great. Thanks Amber. So Sid, with that in mind, what are you looking for in 2024? And what should we flag for our clients in the coming year?

Siddharth Samarth: There’s a lot going on in the world of sustainable finance, however, there are three key themes that I find particularly exciting as we step into the new year. The first is, and we’ve touched upon this is transition finance. This is something that the ecosystem and market participants have been trying to solve for some time. As appropriate, really, guardrails are developed and considered for what qualifies as transition finance. In the last year, we have seen some promising signs in the form of transition taxonomies, which are being developed and which we expect will facilitate the creation of this market will result in more capital flowing into activities which are not just green. Mobilizing capital for transition finance, we expect, will accelerate decarbonization, particularly for a number of the hard to abate sectors. Things that we’re keeping an eye on include Japan and Singapore’s criteria, which was published earlier this year. And we are watching as to how broadly this is adopted in the market. In addition, we have Australia, which is expected to come out with its transition taxonomy later this year. And given that that the economy really has a lot of similarities to that of our own economy over here in Canada, particularly through the lens of natural resources. I do expect a lot of focus on this. Closer to home, the Government of Canada also has announced funding for the development of Canada’s own transition taxonomy, which is announced in the fall Economic Statement. From an investor perspective, we’ve heard from investors that they would like to deploy capital towards transition to diversify their portfolios and as well as to contribute to the decarbonization of the economy. So transition finance is really a great tool for achieving that objective. The second area that we’re keeping an eye on is blended finance. Now the concept of blended finance is not new. However, we are seeing strong interest from government entities to assist with the mobilization of capital for sustainability initiatives. Structured in the correct manner, this has the potential to mobilize and crowd in private capital, and this is something particularly helpful for the banks where we’re in an environment, where there’s increased requirements to hold capital against a loan book, or it can be used in circumstances where there’s a need to ramp up technology on a commercial scale. The last one that I’ll highlight is sustainable supply chain. This one is interesting in part, since we’re beginning to see regulatory requirements for our clients to focus not only the environmental footprint, but also on the social footprint of their supply chain. And we’re seeing that just come out of Europe as an example. Two examples of recent regulatory guidelines. Sustainable supply chain finance in this instance, can be leveraged by corporates to really incentivize the behaviour of their supply chain. And we hope to see more related to this over the next year. Now, the big elephant in the room and Amber, you’ve mentioned this is what’s going to happen with the elections. The World Economic Forum has pointed out that 2024 is going to be a historic election year, with elections in 50 countries expected to be scheduled. The focus of the Western world from a climate lens is going to be on US and Europe as these two have a significant impact on the pace of climate change. That society will be calling for. So overall, it’s going to be an interesting year with opportunities at our doorstep and really the speed of adoption in the hands of the people.

Roman Dubczak: So, Amber, picking up on Sid’s comments, what interesting developments will we see in the actual financing markets in 2024?

Amber Choudhry: Roman, as you know, we just finished our fifth annual ESG survey, and you’re going to be doing a deeper dive on the survey results with our colleague, Shaz Merwat. But two of the topics that Sid mentioned, transition finance and blended finance. We tried to get some investor comments in our survey, and it’s going to help us see what we can expect in 2024. So first, let’s elaborate on transition finance. In 2023, if we embrace the word ‘nuclear’. Mentioned the Government of Canada updated their framework, so did Bruce Power. So did Brookfield Renewable. I really think in 2024 we’re going to embrace the word ‘transition’. So Canada released a green and transition taxonomy roadmap in March 23. Sid mentioned Australia. They released two methodology reports in December of 2023. These reports helped define ‘green’ and ‘transition’. Which sectors and activities will be eligible, as well as the process for determining sustainability objectives and social considerations. But really the one to watch, which Sid mentioned, is Japan. In early December, Japan released the English versions of their transition framework and their second party opinion. Japan is expected to be the first sovereign to issue transition bonds in the global sustainable finance market. The expectation for issuance could be as early as February. Terms could be five and ten years. The deal will be denominated in Japanese yen and in the area in the equivalent of US $10 billion. They’re going to do the deal via the Dutch auction and some of the bonds may be certified. So we, in our ESG investor survey, asked the Canadian investors about transition finance. From our investor survey,80% plus of investors now have an ESG mandate. So there’s no need to convert anymore. ESG is ingrained in the investor portfolios. The need to reduce climate change is still one, if not the most topical pressing ESG concern. And we can see that in all of the headlines that have been happening recently. And we’ve had some discussion here about COP28and one of the things that COP28 was really focused on is that if we’re going to focus on energy transition, that does not need to preclude fossil fuels. COP28 also told us the increasing amount of money is required to fund net-zero. Numbers coming out of that conference include talking US $7 trillion to US $10 trillion per year required over the next 30 years to get to net-zero. Now, this compares to the US $1.3 trillion of global sustainable finance issuance in 2023. So we’re talking about significantly increased funding requirements. We feel we are shifting away from stating climate targets, to actually funding this transition. This is where we see the opportunities on the fixed income side and feel that fixed income investors are going to realize that we need both green funding and transition funding in order to achieve net-zero. The second topic I want to bring up is blended finance, and one item of blended finance, is financing linked to carbon credits. To give you a deal comparable, the IBRD, which is also known as the World Bank, did the US $50 million five year carbon bond, which where use of proceeds was used for a water purifier project in Vietnam. In that transaction, investors forego ordinary interest payments on the bond, and as the water purifiers are used, they generate carbon credits. Given that the investors forego the initial interest payment, they then receive a regular semiannual payment that’s equal to the sale proceeds of those carbon credits during each six month interest period up to a stated maximum. So basically the investors are helping to fund the creation of this project and receive a potentially higher return based on the succession the number of carbon credits produced. From our survey, we asked the Canadian investors about carbon credits and we learned that the Canadian investors are getting comfortable for companies using carbon credits as part of their decarbonization strategy. But they’re still a little hesitant to invest in carbon credits. This is a multiyear process, but again, the challenge of net-zero is one that requires the carbon crediting system to work. And at CIBC, we believe we will get there over time and these types of blended financings may become more common.

Roman Dubczak:  Great. So Amber and Sid, thank you for your observations and your views today. So I’m taking away, there’s greater clarity as to what we’re working for in terms of sustainable finance. There’s greater discussion and debate, if you want to call it that, on the phrase ‘sustainable finance’. That being said, the need for sustainable finance continues to grow and grow and grow as it turns out. And at CIBC, we’ve maintained our leadership position in the last year and hope to see that continue to grow as this market evolves and not just from a Canadian perspective, the US and globally as well. So kudos to both of you for a great 2023 and here Sid, some great leadership in 2024. So thanks and thank you for joining us again today. We appreciate you spending some time with us and we look forward to seeing you again soon.