2021 saw an unprecedented surge in ESG debt issuance which was arguably underpinned by growing investor appetite for sustainable and green-linked investments.
For example, UK insurer Aviva reported that the COVID-19 pandemic influenced the likelihood of taking ESG factors into consideration for over 55 per cent of respondents when deciding how to invest[i], whilst sustainability and green debt more than doubled year-on-year to US$680 billion in the first half of 2021 according to the Institute of International Finance (the IIF).[ii]
Growth In ESG-linked Financing
The IIF has reported that there was almost a four-fold increase to US$160 billion in the issuance of bonds with sustainability-linked pricing ratchets in the first six months of 2021 on a year-on-year basis.[iii] This was almost certainly driven by the fact that market participants recognised that implementing a sound ESG strategy facilitates access to new pools of capital and opportunities to lock in favourable pricing. For example, SSAB, which is a Swedish company that aspires to be the first fossil fuel-free steel producer, has issued a US$230 million equivalent five-year senior unsecured sustainability-linked bond with a maturity date of 2026. Under the terms of the relevant bond instrument, a redemption premium will be payable at maturity if SSAB fails to meet certain sustainability performance targets linked to greenhouse gas emissions. We expect that the volume of sustainability-linked bonds will continue to grow moving forward.
ESG-linked Financing In Asia
The IIF has also reported that around 85 per cent of all ESG-linked issuances of debt occur in Europe and North America.[iv] However, there is evidence that ESG-linked debt is gaining traction across other regions. For example, Chinese real estate company Minmetals Land, Japanese real estate group Mori Hills and India’s Adani Electricity Mumbai have brought, or are reportedly planning to bring, various sustainable and green bonds to market. In contrast to green bonds, where the use of proceeds is linked to qualifying green projects, general sustainability-linked financings have also been used for a variety of corporate purposes and are based on specific ESG targets rather than a limited set of green projects. This has further opened the market to a broader spread of issuers, which is a trend that we expect will continue moving forward.
Standards And Greenwashing
With a growing focus on ESG-linked products, the question of standards has intensified. Whilst there are now a raft of different regulations and proposals in the market, such as the Green Loan Principles, the European Green Bond Standard and the Sustainable Finance Disclosure Regulation, there are concerns that greenwashing may cloud the distinction between genuine ESG-linked debt issuance and opportunism. Lenders and other finance parties that are therefore committed to monitoring compliance with ESG targets need to agree upon reporting standards with the relevant obligor group and ensure appropriate external review mechanisms are implemented.
Offshore Vehicles In ESG-linked Finance Transactions
BVI and Cayman Islands companies are widely utilised in cross-border finance transactions, including those with ESG-linked elements. These jurisdictions have a variety of features that make them attractive to lenders and other finance parties, as well as borrowers and other obligors, on ESG-linked financings. Some reasons for this are as follows:
ESG In Investment Funds From An Offshore Law Perspective
The emergence of ESG principles is not confined to debt finance, as the topic of sustainable investing has quickly gathered momentum in the investment funds space. Indeed, in its Supervisory and Issues Information Circular dated 13 April 2022 (the Circular), the Cayman Islands Monetary Authority (CIMA) recognises that ESG considerations and sustainable investing “is increasingly becoming the fastest growing investment strategy within the financial services sector”.
However, as has been observed in the boom of digital asset funds over the last few years, the emergence of a new investment strategy at such a rapid pace does present various regulatory issues. Indeed, CIMA notes in the Circular that whilst ESG strategies have the potential to make significant contributions to addressing matters such as climate change and in encouraging sustainable investing, as the regulator in the Cayman Islands, it must strike a balance between allowing this sector to flourish whilst also mitigating the emerging risks that are unique to this investment strategy.
It is perhaps for these reasons that in late 2021, the Cayman Islands government announced that it is due to consult on legislation which will introduce a framework for ESG criteria in the Cayman Islands and which will, in particular, target the issue of greenwashing with a view to enhancing investor protection. The International Organization of Securities Commissions (IOSCO) recognises the risk of greenwashing in its November 2021 report entitled ‘Recommendations on Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management’, where it recommends, amongst other things, that regulators should strongly consider reviewing their existing regulations that ensure accurate disclosure against sustainability standards and, where necessary, to make these more robust. Given the prevalence of Cayman Islands and BVI funds in the international funds market, these jurisdictions have a unique opportunity to be at the forefront of tackling these issues and leading the way in our view.
Greenwashing presents itself in a variety of ways in the funds market; ranging from inadvertently mis-describing an investment’s green credentials to a deliberate misrepresentation of them with a view to attracting investment as a result. The IOSCO has identified the following ways in which greenwashing typically presents itself in the context of investment funds:
It will therefore be interesting to observe what measures the Cayman Islands government suggests to tackle these issues in a meaningful way. Indeed, perhaps the greatest challenge faced by the Cayman Islands government is developing a framework that can be of universal application, given the varied and highly nuanced nature of ESG regulation across the globe.
This publication is not intended to be a substitute for specific legal advice or a legal opinion.
[iv] As above.
Peter is a lawyer specialising in banking & finance, insurance and corporate groups.
Santiago is a Senior Legal Consultant, specialised in the formation and launch of Cayman Islands and BVI mutual funds, private equity funds and venture capital funds. He also specialises in Corporate/M&A, Corporate Finance and Blockchain Technology.
Robert Farrell is a Partner in the Corporate, Funds & Finance Group at Loeb Smith. He specialises in investment funds, corporate mergers and acquisitions, and banking and finance. Chambers & Partners has ranked Robert as an “associate to watch” for several years, noting his ability to "handle complex mandates" with one interviewed client commenting that he shows “great prowess as a lawyer". Robert is also noted for his “can-do attitude that brings matters to conclusion swiftly and to the satisfaction of clients”.