Learn, develop, adjust – an evolutionary approach to ESG

Sustainable finance continues to gather momentum in 2021, with record labelled issuance and ‘greeniums’ developing into the norm for pricing these instruments. A recent thesis questions the efficacy of such developments, however – instead calling for a sustainable-finance market that considers entities as a whole rather than their individual assets.

Quo vadis sustainability? A critical analysis from the perspective of public capital markets participants was authored by Andre Rothermel, short-term funding and ESG officer at L-Bank in Karlsruhe, for his master’s thesis at the FOM University of Applied Sciences.

The thesis asks several key questions about the way the sustainable-finance market is developing. These include the contribution of the financial sector to sustainable development, the role of the public sector, how sustainability changes the raising and investment of capital, and what influence stakeholders can exert.

The key findings of the research question the current path of sustainable finance and what an ideal future market – one that materially influences the real economy – looks like.

Rothermel says his thesis ultimately revolves around the idea that capital markets are moving toward a “capital allocation 2.0” model that adds considerations of shareholder and regulator responsibility, and transformation of the real economy to Harry Markowitz’s traditional capital-allocation considerations of liquidity, risk and return.

The process of this transformation is already in place, evidenced by the massive swelling of funds allocated to sustainable investments. Rothermel’s thesis adds to the conversation about whether the current trajectory of sustainable finance will result in the desired outcome of a sustainable future.

Sven Lautenschläger, international funding officer at L-Bank in Karlsruhe, says it is important, as sustainable finance is increasingly incorporated into mainstream markets, that these conceptual debates are had rather than simply allowing market inertia to dictate development. He says the thesis challenges some aspects of L-Bank’s current environmental, social and governance (ESG) strategy, and is helping to form its future (see box on facing page).

The massive expansion of green, social and sustainability (GSS) bond issuance volume is evidence of tectonic shifts occurring in the real economy and in financial markets. As impressive as the engagement signalled by GSS bond issuance volume is, however, it is not a standalone solution to the manifold issues the world faces in transitioning to a low-carbon economy or in ensuring a more just development of global economies.

“To achieve a sustainable real economy, issuers need to publish information not only for their labelled bonds but for the whole organisation. By providing this, investors can have better access to the data they need to implement their own sustainable investment strategies.”

Rothermel explains that market price signals, even in labelled-bond issuance, do not fully account for the fact that economy and ecology are intrinsically linked. The cost of climate-damaging behaviour thus remains insufficiently priced.

Rather than investors simply analysing the impact of a GSS bond transaction, Rothermel says a more meaningful approach is to analyse all a borrower’s activities. “It is no use having information just for what a green bond is financing. To achieve a sustainable real economy, issuers need to publish information not only for their labelled bonds but for the whole organisation. By providing this, investors can have better access to the data they need to implement their own sustainable-investment strategies,” he tells KangaNews.

This is an approach L-Bank itself champions, having resisted the trend of establishing a use-of-proceeds issuance programme in favour of backing its constitutional mandate to be a wholly sustainable entity. Lautenschläger says issuers need to classify the entire asset side of their balance sheets according to sustainability standards for whole-of-business sustainability assessments.

These standards should be forward-looking, says Rothermel. He adds that public-sector issuers should continue to act as role models in sustainable finance by pioneering stronger disclosure standards.

L-Bank maps its strategy

L-Bank is applying a future-focused lens to both sides of its balance sheet as it seeks to evolve its business to meet rigorous sustainability standards. Maintaining a dynamic approach and contributing to market development are key principles.

Andre Rothermel, short-term funding and ESG officer at L-Bank, says one of the limiting factors in sustainable finance at present is the fact that most metrics focus on an institution’s past and current performance, despite the risks of climate change being concentrated in the future.

L-Bank considered this on the asset and liability sides of its balance sheet when forming its environmental, social and governance (ESG) strategy.

Sven Lautenschläger, international funding officer at L-Bank, says the UN Sustainable Development Goals (SDGs) provide a mapping tool for L-Bank’s lending with which it can measure the impact of development-banking activities such as loans to low-income families and SMEs.

“SDG mapping is becoming industry standard and gives investors an idea of which sectors we actively support and which ESG topics we are focused on,” Lautenschläger says. “When we began mapping the business in this way, we found that the most significant part of the SDGs is exactly what our mandate asks us to do”.

The asset side of L-Bank’s balance sheet is perhaps where its approach is more revolutionary. For its regulatory holdings of high-quality assets, L-Bank is aiming to align its portfolio with the Paris Agreement target of keeping global warming to 1.5 degrees or less. Lautenschläger says this KPI was chosen specifically for its forward-looking lens.

An issue L-Bank faces is that data currently available from most issuers is not sufficient to assess an investment portfolio against the Paris target. As such, L-Bank is asking issuers to begin providing the data it requires to make this measurement.

Lautenschläger tells KangaNews this engagement with issuers is crucial to improving the overall level of data provision in financial markets. He adds that L-Bank may reconsider its investments in issuers that cannot provide sufficient data.

Until L-Bank can properly assess whether its portfolio is meeting the Paris Agreement target, it will manage its portfolio according to a best-in-class approach, targeting a minimum average rating from MSCI sustainable ratings.


Lautenschläger argues that when ESG assessment is incorporated across an entire institution it should effectively be priced into an issuer’s curve. At present, borrowers typically have a green curve that sits inside their vanilla curve.

Rothermel surveyed issuers and investors for his thesis, and all attested to the existence of a greenium. This has been argued to incentivise more borrowers to implement GSS bond programmes and therefore to help funnel more capital into sustainable outcomes.

In his thesis, Rothermel says the signalling effect of the greenium is a crucial building block for the further development of the sustainable-finance market. However, if sustainability becomes more widely and accurately measured at a whole-entity level rather than just for individual transactions, greeniums should become obsolete.

Given green bonds are not inherently of greater credit quality than vanilla bonds from the same issuer, any discount is most likely the result of a supply-demand imbalance. Lautenschläger contends that effectively penalising investors for doing good is neither a suitable nor sustainable way to build a market.

He says transparency in the sustainable-debt market is not sufficient to assess whether any pricing advantage gained from GSS bond issuance is manifesting in sustainable outcomes. “Issuers should have one funding curve that considers all information relevant to the borrower,” he argues.

Incorporation of ESG considerations into credit ratings will help enable transition to an entity-level assessment of ESG, according to Lautenschläger. “At the moment, rating agencies give separate scores for ESG performance and financial performance. But ESG risks can clearly be understood as financial risks, so should be integrated. Once they are merged, it is difficult to see any justification for a difference in spread between green and conventional bonds.”

The possible eventual disappearance of greeniums in financial markets does not necessarily mean institutions will have no incentive to transition their businesses. It is likely or even inevitable that a ‘brown premium’ would emerge for institutions lagging either in sustainability performance or transparency, according to Rothermel.

In any case, Lautenschläger says a pricing incentive should not be the necessary precursor to action. “Sustainability is not about cost, it is about impact. Mitigating against the warming of our planet should mobilise capital. We should not be concerned with the near-term cost of acting or reporting on this because the long-term impact of not doing it will be much greater – for issuers and investors.”