June 2022 • Topic: A reality check on ESG • by Christopher Breen
This report shows that while green finance in Europe has grown rapidly to more than €300bn last year alone, it is still a long way short of the sort of levels required for Europe to meet its net zero targets – and still only represents about 12% of all capital markets activity. The report drills behind the headline numbers, analyses the growth and trends in different sectors and types of green finance over the past five years, and highlights some of the challenges ahead.
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For a UK-specific version of the report, drills down into activity in the UK market, and highlights some of the big differences in green finance between the UK and EU please click here.
The growth and penetration of green finance
In recent years, the climate emergency has risen to the top of the global political, business, and financial agenda. In response, the EU and the UK have established themselves at the forefront of building clean and more sustainable economies. The recent invasion of Ukraine has increased the urgency of addressing this problem: while many European governments have (temporarily?) turned back towards fossil fuels, the war has focused minds on energy security and the potential for renewables and other forms of clean energy to reduce Europe’s dependence on fossil fuels and accelerate the shift towards a more sustainable and resilient energy supply.
One of the most critical tools to enable this transition is finance: if Europe is to invest anything like the sums needed to meet its net zero commitment by 2050 it will need massive funding from the capital markets. The broad estimates of the sums involved range from around €600bn to €1 trillion per year in green investment. This report provides a ‘reality check’ on Europe’s progress so far in green finance and shows that while it has grown rapidly, it is still a long way short of where it needs to be.
Green finance is about a lot more than green bonds. We estimate that European capital markets raised more than €750bn in green finance from 2017 to 2021 across bond, equity, and loan markets, with more than €300bn raised in 2021 alone. While our estimate is higher than others, these numbers probably need to double or triple again – and quickly – to enable the sort of investment required. In addition, our report raises questions about the role of carbon intensive industries in driving the transition and the role of the capital markets in funding them.
This report addresses the following questions:
Here is a short summary of this report:
1) Rapid growth
The value of green finance raised in the capital markets in the EU and UK has risen significantly over the past five years to over €300bn last year. Since 2017, green finance activity has increased fivefold across bond, equity and loan markets, and it doubled last year alone. We estimate that more than €750bn has been raised by corporates, financials, and governments in green finance over the past five years, with corporate activity playing the leading role. Green finance is about a lot more than labelled green bonds, which account for about two thirds of overall green finance activity. Our headline estimate is higher than some other estimates because we have included our estimate of explicitly green activity in equity markets, loan markets, and venture capital.
2) Towards net zero
Although green finance is big and growing fast in Europe, the level of activity is a long way short of the sort of investment that European governments, corporates, and financials need to fund the transition to a clean energy economy and meet their net zero targets. The range in annual investment required in Europe is between €600bn and €1 trillion, which suggests that green finance activity will have to double or even triple again – and quickly – to ensure that the European economy is on track to reach net zero.
3) A lack of penetration
For all of the noise around green finance and the urgency of addressing the climate emergency, green finance still only represents a relatively small proportion of capital markets activity in Europe. Overall, we estimate that green finance accounted for just 12% of capital markets activity across bond, equity, and loan markets last year. The good news is that this penetration is increasing: over the five-year period it was just 7%, but the overall penetration of green finance doubled last year. Penetration is highest in the corporate bond market (16%), slightly lower in loans (12%), and much lower in equity markets (5%).
4) An important metric
Despite the growth in green finance there is a disconnect between the amount of capital being raised by ‘good’ companies whose primary business activity is actively trying to address climate change (such as renewable energy firms), and ‘bad’ companies whose primary business is actively delaying the transition to net zero (such as fossil fuel companies). Over the past five years, ‘bad’ companies have raised 18 times as much money in capital markets as ‘good’ companies, although this ratio fell last year for the first time below 10 to one. This (perhaps simplistic) ratio reflects the difference in scale and maturity of these companies, but we think it’s an important metric to watch.
5) Playing catch up
The UK is lagging behind the EU in green finance: UK issuers raised €106bn in green finance over the past five years, representing 14% of all green finance in the capital markets in Europe. This share is significantly lower than the UK’s share of over 20% in all capital markets activity in Europe. This is reflected in the lower penetration of green finance in UK capital markets: over the past five years, green finance accounted for just 5% of all capital markets activity in the UK, roughly half the level as in the EU and roughly where the EU was four years ago.
6) A debt-driven market
The vast majority – over 95% – of green finance activity in Europe comes from the bond and loan markets. Labelled green bonds are by far the biggest single component of green finance, raising €425bn over the past five years and nearly €200bn last year alone. Companies raised a further €225bn in green finance in the loan markets, including nearly €100bn last year. Corporates are the biggest issuers in the bond market, representing about 40% of all activity over the past five years, ahead of governments (35%) and financials (25%). Across all green finance, corporates account for 60% of activity.
7) A small role for equity
Equity markets – including public equity markets and venture capital investment in cleantech – have raised just €26bn in green finance. This is less than 4% of all green finance and reflects the relatively small scale and immaturity of the standalone green sector in public equity markets. However, activity is growing fast: green equity has increased from €1bn to €13bn over the past five years and doubled last year alone.
8) The good, the bad, and the neutral
The profile of companies that are driving the green finance market is perhaps surprising. Using our taxonomy of ‘good’ and ‘bad’ companies from a climate perspective, just over a fifth (22%) of all green capital markets activity by corporates came from ‘good’ companies such as standalone renewable energy firms. ‘Bad’ companies accounted for more than a quarter of activity (27%) and this green finance adds up to just 12% of their total capital markets funding. Perversely, green finance probably needs more ‘bad’ companies to raise money (because these companies have the highest impact on emissions) and more ‘good’ companies to raise money to accelerate change.
9) How ‘green’ is green finance?
Not all green finance is created equal. We estimate that around 40% to 50% of green bonds are ‘dark green’ and are being invested in projects that will play a significant role in actively driving the transition to net zero. In the loan market, we estimate that only around 40% of all SLLP loans (based on Sustainability Linked Loan Principles) are green in terms of their use proceeds. It is also important to avoid the trap of double counting green finance: more than 50% of the money raised in the green bond market can be allocated by issuers to (re)financing existing projects, and issuers are able to apply this funding retrospectively to projects that are more than two years old.
10) The challenges ahead…
One of the main findings of this report is that while green finance in Europe is growing fast, it is still not enough to meet the required levels of investment for Europe to fulfil its net zero commitments. Policymakers and issuers alike will either need to adjust their targets and expectations (not a great idea) or find new ways to raise more green capital at scale. An essential part of this will be improving the transparency and clarity of green finance, including: better and more consistent definitions of green and not green activity; more information about use of proceeds from green finance; and more robust KPIs, transition plans, and targets. Perhaps the biggest challenge is going to be designing a sensible transition framework: companies that play a significant role in driving climate change need access to capital need to invest in net zero, but they need to be held accountable for their progress.
Methodology & acknowledgements
This report focuses on the size, growth, and penetration of green finance in Europe, which for the purposes of this report is the EU and the UK. We define ‘green finance’ as capital which funds projects that progress the transition to a clean energy economy, such as solar farms, wind turbines, hydroelectric projects, and electric vehicles. In addition to ‘labelled’ green bonds, we analysed activity in the equity, loan and venture capital markets to identify ‘green finance’ based on the use of proceeds of the capital raised. We also split corporates into three (perhaps simplistic) buckets from a climate perspective of ‘good’, ‘bad’, and ‘neutral’. Each bucket relates to a company’s primary activity and whether it is progressing or delaying the transition to net zero. This helps us better understand how different types of companies are using different types of green finance.
With thanks to Sheenam Singhal and Seethal Kumar for their research on this report, William Wright for his support and feedback, and Dealogic and Preqin for providing access to much of the data.