Sustainable financing has two distinct financing frameworks, though there are some overlaps between the characteristics of each:
What is green finance?
Green finance is the financing of public and private green projects or investments (including preparatory and capital costs) in:
- environmental goods and services (such as water management or protection of biodiversity and natural landscapes);
- the prevention, minimization and compensation of damage to the environment and to the climate (such as energy efficiency or dams).
- the financing of public policies (including operational costs) that encourage the implementation of environmental and environmental-damage mitigation or adaptation projects and initiatives (for example feed-in-tariffs for renewable energies); and
- components of the financial system that deal specifically with green investments, such as financial instruments for green investments and structured green investment funds, including their specific legal, economic and institutional framework conditions.
There are several form of green financing, such as project financing or green bonds. Project financing is a vehicle for assembling a consortium of investors, lenders and other participants to finance, on a nonrecourse or limited recourse basis, large-scale infrastructure projects. A green bond is a fixed-income debt instrument and, like any other bond, offers a financial return. However, its distinguishing feature from so-called vanilla bonds is that it is issued for the specific purpose of funding new or existing sustainable projects or other uses beneficial to the natural environment.
A use of proceeds approach is core to green finance. For example, bonds and loans cannot be labelled ‘green’ unless the proceeds are utilised to finance a green purpose or project.
Green Loans are aligned to the Loan Market Association's green loan principles (discussed below).
Sustainability Linked Loans
Sustainability linked loans can be used by borrowers for general corporate purposes, rather than exclusively towards green projects. Rather than being 'activity based', as is the case with green loans, sustainability linked loans are based on investments that change behaviour or practices with the intended outcome that financial inventives of a project or investment, and its sustainability outcomes, are aligned.
A central feature to sustainability linked loans are mechanisms in the loan documents for a margin discount to apply to the cost of debt for a successful project (one that provides the anticipated financial and sustainable outcomes) or a margin increase to apply to the cost of debt for an unsuccessful project.