This article further discusses initiatives enacted by the Central Bank of Jordan in adopting sustainable finance practices.
Dana AbdulJaleelPartner, Banking & Finance
Carla Nocerino Trainee Lawyer,Banking & Finance
Sustainable development has emerged as a new paradigm in an effort to reduce carbon footprint. Modernised business practices have demonstrated a trend towards embedding corporate social responsibility and environmental, social and governance related matters into business strategy, in response to, the increased awareness and discourse of consumers and the general public to the overexploitation of the environment.
Banks and financial institutions are one of the key factors which influence economic growth due to their crucial role in providing capital to all economic sectors. Entities operating within the financial sector therefore possess the ability to both promote or hinder sustainable development depending on the willingness to advance financial investments and any conditions imposed on potential borrowing.
This article aims to explore the significance of green lending within the financial sector by first establishing the importance of sustainable financing in modern day life and defining what is meant by green loans and sustainability linked loans, highlighting the key the differences between them. This article further discusses initiatives enacted by the Central Bank of Jordan in adopting sustainable finance practices.
Sustainable financing is the integration of environmental, social and governance (“ESG”) considerations into investment decisions, whereby companies and corporations can leverage their ESG performance to secure a green or sustainable linked loan. The following factors typically determine how proactive and socially responsible a company’s policies and practices are:
environmental performance; this includes considering aspects such as climate change, waste management and energy efficiency;
social performance; this includes considering aspects such as diversity, inequality, inclusiveness, labour relations, investment in human capital and communities, as well as human rights issues; and
corporate governance, this includes considering aspects such as management structures, employee relations and executive remuneration.
As business strategies are evolving towards more inclusive and less on-profit practices, companies can no longer operate by prioritising shareholders as the dominant audience. Additional considerations need to be given to employees, communities, customers, regulators, and the planet. As a result, when choosing to allocate capital resources to support future business growth, banks and other financial institutions are integrating a company’s ESG awareness into the decision making process.
The importance of sustainable financing lies in the fact that the performance of the finance sector is strongly correlated with the performance of the economy. Every business is directly or indirectly reliant upon biodiversity and natural ecosystems. Naturally, climate change and the rapid deterioration of natural capital, as well as, other environmental issues, present a problem in the scarcity of materials available. The economic and social impacts in the decline of the ecosystem can be alleviated if ESG considerations are incorporated into economic and financial decisions.
From a lender viewpoint, sustainable businesses deliver financial returns in the short and long term, whilst also generating positive value for society and operating within environmental constraints. Organizations which fail to address environmental and social risks will be less resilient to these challenges, and so are regarded as higher rate investments.
The key financial instruments for sustainable financing are green loans and sustainable loans. Although the terms green loan and sustainable linked loan are often used interchangeably, they key difference lies in the overarching objective. Green loans place an emphasis on the use of proceeds, which should be used for solely green purposes. On the other hand, the defining feature of a sustainable linked loan is tied to the borrower’s performance against certain pre-determined sustainability criteria.
A green loan is defined by the Loan Market Association’s (“LMA”) ‘Green and Sustainable Lending Glossary of Terms’ as any type of loan instrument made available exclusively to finance or refinance, in whole or in part, new and/or existing eligible ‘green projects’.The definitions of ‘green’ and ‘green projects’ vary depending on sector and geography, however, the categories of eligibility contained in the LMA’s Green Loan Principles (“GLP”) include renewable energy, energy efficiency, climate and change adaptation that meet regional, national or internationally recognised standards or certifications.
The GLP establish a framework based on the following four key criteria:
Use of proceeds: The loan proceeds of a green loan must be applied for green projects only. All designated green projects should provide clear environmental benefits.
Process for project evaluation and selection: green borrowers are expected to communicate to lenders their environmental sustainability objectives, their process for determining the eligibility of their projects against eligibility criteria and details of any wider green standards to which they seek to conform.
Management of proceeds: the proceeds of a green loan should be credited to a dedicated separate account, or otherwise tracked by the borrower in an appropriate manner. This requirement is aimed at ensuring transparency in order to promote the credibility of green loans and avoiding the risk of ‘green washing’. By holding green loan proceeds separately, borrowers can more easily ensure that such proceeds are applied towards the purposes for which they are drawn, particularly where the facility may be used for more than one purpose.
Reporting: Borrowers should make and keep readily available, up-to-date information on the use of proceeds, including a list of the green projects to which the green loan proceeds have been allocated.
In contrast to green loans, the use of proceeds is not the distinguishing feature of a sustainability linked loan. A sustainability linked loan is defined by the LMA’s glossary as any type of loan instrument and/or contingent facility that incentivises the borrower to improve their sustainability profile over the term of the loan. Whereby, such borrowers enjoy a reduced margin for achieving pre-agreed ESG-related KPIs.
The sustainability linked loan principles set out a non-exhaustive list of the common ten objectives. These include reduced green gas emissions, reduced water consumption, generation or usage of renewable energy by the borrower.
The Government of Jordan is pursuing an ambitious reform agenda to implement more coherent sustainable investment strategies by strengthening co-ordination across ministries and engaging public and private companies in this initiative. In 2020, the Central Bank of Jordan has launched the National Finance Inclusion Strategy, which focuses on accessibility to businesses and individuals to affordable, suitable financial products and services. Further, increasing Government initiatives and funds are dedicated to renewable energy, water conservation, green homes, ecotourism, waste recycling and clean transportation.This falls within Jordan’s wider vision to transition towards a green economy. In 2017 the Government of Jordan launched a National Green Growth Plan, which focuses on expanding a sustainable economy that creates jobs, income for its citizens, and is resilient to external shocks and instability in the region.
A key component of Jordan’s green growth strategy is the availability of finance for projects. Currently, the majority of funding is provided by concessionary lending from development banks, as well as donor aid grants. As the cost of green technologies have become cheaper, the economics of many green growth interventions have changed, and there is now significant opportunities for Jordan to attract more private financing to help bridge the gap between Jordan’s green growth objectives, and the availability of existing finance.
An increasingly large number of finance projects have been launched over the past couple of years to further the promotion of green and sustainable finance, including the Jordan Renewable Energy and Energy Efficiency Fund, the Jordan Environment Fund, lthe Green Economy Financing Facility programme (GEFF) in Jordan and a joint programme launched by the United Nations and Jordan, the Jordan- Enabling an SDG Financing Ecosystem Programme. These funds are accelerating progress towards achieving the sustainable development goals for its 2030 Agenda for Sustainable Development.
The basic premise of the financial system is to allocate funding to its most productive use. Prudent corporate practices require capital to keep the business running as a going concern, whereby corporations resort to debt financing to fund business operations. Banks and other financial institutions are a key player in debt financing and can play a fundamental role in allocating such investments to green projects and companies. Thereby, acting as a catalyst to expedite the transition into a low-carbon and more sustainable economy. The Government of Jordan is working on tapping into and leveraging traditional and non-traditional sources of finances to promote its Sustainable Development Goals as part of its 2030 Agenda, in hopes of attaining a more green and robust economy.
For further information,please contact Dana AbdulJaleel or Carla Nocerino
Published in February 2023