Sustainable finance is no substitute for net zero targets

More universities are adopting green financing. Their approaches must have verifiable outcomes and complement institutions’ overall strategies, says Anton Muscatelli  

June 10, 2024
Asian businessmen look at environmental activists protesting about Climate Change during the blockade outside the Bank of England in the heart of the capital's financial district
Source: Richard Baker / Getty Images

As universities embrace the transition to net zero, it is unsurprising to see more institutions adopting sustainable financing of their major infrastructure investments. The European Commission defines “sustainable financing” as the process of taking environmental (such as climate change mitigation or biodiversity), social (tackling inequality or inclusion) and governance, or “ESG” considerations, into account when making investment decisions, leading to more long-term investments in sustainable economic activity.

Borrowing associated with sustainability is an attractive option for universities, given the alignment with their strategic goals and the interests of students, staff and alumni. For universities with capital investment plans for green energy or net zero transitions, this form of borrowing makes sense. World Bank data show the global market for green, social and sustainability bonds (looking at both sovereign and sub-sovereign issuers) has grown from $114 billion (£91 billion) in 2016 to $948 billion in 2022 in terms of annual issuance.

Various borrowing instruments are applicable to funding university activities, from “sustainability bonds” and “sustainability-linked bonds” (or “sustainability loans”) to social bonds and green loans.

A useful distinction is between those bonds or private placements labelled as “sustainable”, where the focus is on the use of proceeds, and their equivalents that are “sustainability-linked”, where the university’s performance against organisational KPIs affects the borrowing cost.

The use-of-proceeds approach requires universities to set out eligible projects based on compelling cases – for example, investment in renewables infrastructure against the United Nations’ Sustainable Development Goals or for social impact. The selection of projects and how funds are used must follow principles set out by the International Capital Market Association. Recently we have seen several institutions issuing long-term bonds (UCL’s 40-year £300 million sustainable bond of 2021, for example, or the London School of Economics and Political Science’s 50-year sustainability private placement). In practice, many projects funded by this borrowing are “green” rather than social projects (linked to renewable energy, sustainable water management or clean transportation, for example).

In contrast, “sustainability-linked” borrowing incentivises universities to meet certain targets for carbon emissions or energy use, and failure to meet these will increase the loan cost. In general, sustainability bonds or private placements have longer maturities, while sustainability-linked borrowing is over shorter periods of time.

But what are the main considerations for universities contemplating sustainable finance?

First, there are clearly reputational gains from aligning an institution’s financing strategy to its sustainability strategy. It gains buy-in from stakeholders and imposes discipline in meeting the university’s goals. However, sustainable finance is not a substitute for adopting a credible net zero plan for emissions: it is a means to that end. Students and staff are likely to care more about whether their institution has a credible plan to reduce emissions by a certain date (and the extent to which any verifiable offset projects are used), than whether the projects are labelled as “sustainable finance”. In 2023, the Financial Conduct Authority tightened regulations around the labelling of investment products as “sustainable” because of fears of “greenwashing”.

Similarly, universities must heed warnings that sustainable financial frameworks and associated projects must have verifiable outcomes. This requires strong governance around financial frameworks overseeing borrowing that are fully integrated into the overall institutional strategy for sustainability/net zero.

Second, one cannot conclude that those universities that have not yet gone down the sustainable bonds or loans route are uninterested in sustainability. Internal financing reduces the need for external borrowing, and the recent increase in interest rates (yields on UK universities’ public bonds have risen from 2 per cent or below in 2021 to around 4-5 per cent in 2023) means those universities with stronger cash flow generation will want to wait before entering this market. In my view, we will not see a steady state of emerging university capital structures for another five to 10 years.

Third, there are other financial structures and instruments beyond purely borrowing. Those universities with land or capital assets that could be used for net zero (to generate renewable power, for instance) could look at shared ownership structures to raise investment funds and manage risks in projects.

Sustainable finance is undoubtedly a complex field. Universities must develop strong management expertise to navigate the intricacies of a still-evolving market. Above all, it requires robust internal governance to ensure financial strategy is complementary to overall institutional strategy, and not simply a bolt-on.   

Sir Anton Muscatelli is principal and vice-chancellor of the University of Glasgow and a professor of economics.

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