By Marc Naidoo is a sustainable finance and emerging markets partner and Jennifer Kafcas is a derivatives and finance partner in the London office of international law firm, McGuireWoods.
Hot off the heels of the “green boom”, fixed income investors and market participants alike are taking notice of the so-called “Blue Economy”, that being, generally defined as those economic sectors which have a direct or indirect line to marine resources. This is all the more important given that the OECD projects that by 2030 the “Blue Economy” could outperform the growth of the global economy following the trend of responsible assets outgrowing traditional assets under management globally. It is against this backdrop that global financial markets are paying very close attention to developments in this area. What are some of the current issues facing the regulation and promotion of a sustainable “Blue Economy” and the next steps for the creation of a market place for financial products relating to these assets?
Sustainable Blue as an Asset Class
The ocean, as an asset, has an annual economic value generation of at least USD 2.5 trillion (making it the world’s seventh largest economy by asset class). Yet its importance lies away from pure economic metrics as from a “life on earth” perspective, the ocean absorbs 25% of all CO2 emissions and generates 50% of the world’s oxygen. Unlike certain other asset classes, the “Blue Economy” is uniquely complex and interconnected facing a raft of environmental threats, whether from rising sea levels, climate change or exploitation of natural resources, which makes the development of a sustainable “Blue Economy” all the more important. In tackling these issues, as in the “green” space, a sustainable funding opportunity exists.
One of the key challenges with respect to the development of “sustainable blue” as an asset class is how to define the “Blue Economy” and how this translates into “eligible blue investment categories” and piloting investable products that show positive return and impact on ocean resources. With this aim in mind, the European Commission issued the Sustainable Blue Economy Finance Principles in 2019, which will undoubtedly serve as a base for future regulations that will be more granular in addressing concerns within the sector. In addition to these principles, the European Union published their Sustainable Finance Taxonomy in 2019, which will serve as the central reference point for all sustainable finance.
We anticipate “blue” regulations addressing what constitutes sustainable practices within ocean infrastructure alongside the creation of a market standard definition of “sustainable blue financing” to be possibly used as the basis for use of proceeds under future transactions (including deep sea mining, fishing, offshore oil rigs, tourism and desalination). We may also see an iteration of the Green Bond Principles (but specifically in relation to “blue”) which will provide standards in respect of monitoring and reporting mechanics required on “blue” focussed deals. As things stand, the regulatory environment is complicated by the fact that there are numerous definitions identified by various industry players as to what “sustainable blue financing” means. The leg work has certainly started, and if 2020 truly turns out to be the year of “blue”, then the market (and credit decisions associated with relevant projects) will be able to operate under a standardised set of principles. These advancements should create a more liquid and investable market and lead to “eligible blue investment categories” and derivatives products set out below.
As with any project or company, there are inherent risks or exposures arising in respect of the underlying cash flows of the business or capital structure. Derivatives products are a key investment tool used by investors and companies alike to mitigate these risks. In an ESG related product such as a “blue” project and/or financing structure, these risks may be hedged either by the arranging bank/lenders or by way of a third party financial institution. A firm understanding of the development of the market will be essential to capitalise on the significant opportunities that the “Blue Economy” presents. The first step here will be the “blue regulations” set out above which will form and guide key credit, trading, operational and pricing decisions. These will also play an important role in how financial institutions structure the derivative itself and key contractual terms (including any sustainability margin adjustments and credit spreads) set out in the relevant derivatives documentation. The derivatives market has already developed a sustainable derivatives product, and is currently watching the development of “blue” regulations in order to “blue up” derivatives products.
While this article summarises key regulatory changes likely to come in to play in 2020 to support the growth of the “Blue Economy”, we note that a “blue” bond was issued last year by the Republic of Seychelles which has led to a heightened focus by institutional investors and regulators on the “Blue Economy”. Going forward, it will be interesting to see (a) how future regulations will be implemented in 2020; and (b) if the “Blue Economy” can leverage the successes and/or improvements from the green finance space. Regulations and granularity will provide some comfort to investors, which would then (along with de-risking mechanisms such as blended finance and a sustainable derivatives market) mobilise much needed capital into this invaluable asset.