Sustainable finance’s next big act will tie social targets to returns 

 Alfonso Garcia Mora

COMPANIES’ efforts to improve their environmental, social and governance credentials have given birth to a new type of debt that links interest rates to ESG performance. But the majority of these instruments’ targets are mostly linked to issuers’ environmental impact, and not the impact they may have on the people they employ or the communities they affect. With the pandemic bringing social issues to the fore and calls for the transition to Net Zero to be just, this could soon be about to change. 

As key decision makers from central banks, sovereign wealth funds, financial institutions, private banks, government agencies and businesses from around the world convene this week for the Singapore Sustainable Investing and Financing Conference, organised by BlackRock, International Finance Corporation (IFC) and Temasek as part of Ecosperity Week, a question on the minds of many will be what’s next for the sustainability-linked finance market. It now boasts over US$1 trillion of issuance since 2017, making it the world’s fastest-growing type of sustainable debt. While more prevalent in Europe and North America, its rise in Asia is gaining traction, with big-ticket issuers from carbon-intensive sectors with green ambitions and ESG-focused investors driving demand. But as of April, just 22 per cent of these loans and bonds globally have included social and governance targets. Gender equality and worker safety are the most prevalent social targets. Other examples of social metrics include labour rights, education, and supply-chain performance.

While any significant efforts to support the transition are absolutely needed, it is becoming increasingly important to also focus on targets aimed at narrowing societal gaps in gender and diversity, education, community relations, human rights, and labour standards, among others. This should also apply to those sectors that support the energy transition in Asia, where the sheer scale of what’s needed in the world’s largest-polluting region means that reducing emissions is as much a social challenge as it is a technical and financial one. Companies need to support workers in developing the skills needed to transition, for example. But more broadly, it is important that the transition does not have unintended consequences for society, especially for those segments of the population that are more vulnerable.  

Social cohesion erosion and livelihood crises are now cited as the most severe global risks over the next decade after climate action failure, extreme weather, and biodiversity loss, according to the World Economic Forum, highlighting the urgent need for action from both the public and private sectors. 

The good news is that sustainability-linked finance with social performance targets is on the rise. Singapore-based food and agribusiness Olam has issued sustainability-linked debt with returns tied to its performance supporting farmers. IFC recently signed an agreement with Anglo American for the first sustainability-linked loan in the mining sector globally that focuses exclusively on social indicators. The loan has education and livelihood targets tied to the company’s host communities in South Africa. We also invested in a sustainability-linked loan issued by Turkey’s IZSU that will reward the municipal-water utility if it hires at least 300 female contracted employees by the end of 2025 into jobs where women are underrepresented. In France, Saur, a provider of water and sanitation services, has a sustainability-linked framework with a metric tied to the sustainable use of water. The company hopes to undertake several strategies to achieve the metric, such as through the distribution of water-saving kits and targeted communication campaigns. 

But a lot more needs to happen to grow this nascent market. As it is so new, companies, banks, and development-finance institutions and multilateral development banks such as IFC – which, in addition to investing, also advise issuers on metrics, benchmarking, reporting, and structuring of social key performance indicators (KPIs) – will need to work together and find innovative ways to advance this agenda. Innovation in social KPIs is critical, from moving beyond conveniently measurable targets such as workforce diversity and worker safety, to tying targets to the sustainability of supply chains, the resilience of the communities in which issuers operate, and expanding access to basic services such as clean water, reliable transport, and affordable housing for the underserved. Linking compensation to social targets can also help keep executives aligned, as could higher step-ups and step-downs in coupons and interest rates should companies achieve or miss targets. 

Given the broad number of aspects that need to be considered, it is critical that we define standards, create clear taxonomies and guidelines, and encourage more transparency in reporting on social-impact measurement if we’re to scale up this market. Governments and regulators must also expand the scope of sustainable-finance regulation and ESG disclosure standards, with the aim of aligning financial flows with their own sustainability objectives and increasing transparency in the private sector. 

Companies considering sustainability-linked finance may also consider, when feasible, pairing green targets with social ones. Climate change has a strong societal angle. One notable example of this is that it could drive 216 million people to migrate within their own countries by 2050. This will disproportionately impact the poorest and most vulnerable, particularly in Asia and the Pacific, where most climate refugees originate. 

Ultimately, as public awareness of social inequalities rises in the wake of Covid-19 and increased climate action, it is important that the transition to Net Zero is as inclusive as it is green. 

The writer is regional vice president, Asia & Pacific, of International Finance Corporation