Sustainable finance has become a critical part of global economic strategies, with companies and investors alike shifting toward environmental, social, and governance (ESG) considerations. Among the financial instruments contributing to this trend, commercial paper (CP) has emerged as a potentially valuable tool within the sustainable finance market.
The paper, “The Role of Commercial Paper in the Sustainable Finance Market“, examines the viability, current market data, and considerations surrounding sustainable CP, providing insights into how it could support sustainability strategies, despite its short-term nature. It was published by the International Capital Market Association (ICMA) in October 2024. The ICMA is a well-established organization based in Zurich that works on the regulation and development of international capital markets, focusing on areas such as bond issuance, trading, and sustainable finance.
It was developed in collaboration with ICMA’s Commercial Paper Taskforce, which includes members of the ICMA’s Commercial Paper and Certificates of Deposit Committee as well as inputs from members and observers of the Green and Social Bond Principles (referred to as “the Principles”). The purpose of the Taskforce was to explore the role of conventional commercial paper in the sustainable finance market, track emerging practices, and assess relevant standards to establish best practices in the sustainable commercial paper market.
The publication serves as an informational document for market participants and is not intended as legal or financial advice. ICMA emphasizes that the contents are based on inputs from various sources and that some figures may vary due to continuous updates in data collection processes
What are Commercial Papers?
Commercial paper refers to short-term, unsecured debt typically used by corporations for liquidity management, lasting between 90 and 365 days. While primarily seen as a short-term tool for managing liabilities, CP is increasingly being integrated into sustainable finance through “Use of Proceeds” and “Sustainability-Linked” CP programs.
The paper estimates the sustainable CP market to potentially be worth up to EUR 300 billion, a fraction of the sustainable bond market but still substantial.
In this article we explore the key findings of the paper and provide an analysis of the challenges and opportunities CP presents in the context of sustainable finance.
Sustainable Commercial Paper as a Financing Instrument
The feasibility of using CP as a sustainable financing instrument is one of the paper’s key discussions. While CP is traditionally used for short-term funding needs, its alignment with long-term sustainability objectives can be challenging. The main issue lies in reconciling the short-term nature of CP with the extended timelines typically required for sustainability investments.
CP is frequently issued to manage short-term liabilities such as operational expenses or working capital, rather than to directly finance long-term sustainability projects. This raises questions about how effective CP can truly be as part of an organization’s broader sustainability strategy.
One notable solution is embedding CP within a Sustainable Financing Framework. This structure helps ensure that the proceeds from CP issuance are aligned with long-term sustainability goals, even though the instrument itself is short-term. For example, issuers can use CP as a bridge to longer-term bond financing for sustainable projects. Moreover, consistent tracking and reporting are essential in demonstrating the impact of CP, especially when its proceeds are continually refinanced.
Types of Sustainable CP Programs
The paper categorizes sustainable CP into two types: Use of Proceeds CP and Sustainability-Linked CP.
- Use of Proceeds CP is issued to finance or refinance eligible green, social, or sustainable projects. A company might issue this type of CP to raise funds specifically for renewable energy projects or social housing. A notable feature is that 68% of these programs are exclusively dedicated to green and sustainable projects, while the remaining 32% allow for both sustainable and conventional CP issuance.
- Sustainability-Linked CP, on the other hand, is linked to the issuer’s performance on specific sustainability key performance indicators (KPIs). For instance, a company could tie the issuance of CP to its progress in reducing greenhouse gas emissions or improving gender diversity in leadership roles. However, challenges remain, particularly in aligning short-term KPIs with the longer-term nature of many sustainability targets.
Both types are seen as useful tools for embedding sustainability into an organization’s capital structure, though their success relies heavily on robust frameworks and transparent reporting.
Market Data and Trends
The paper highlights some interesting trends and statistics. As of August 2024, there were 33 sustainable CP programs in the European Union, with 23 categorized as Use of Proceeds CP and 10 as Sustainability-Linked CP. Among the Use of Proceeds programs, the majority are geared toward green projects, and approximately EUR 85 billion in capacity is available exclusively for sustainable initiatives.
For Sustainability-Linked CP, the focus is primarily on KPIs related to greenhouse gas emissions, renewable energy usage, and social factors such as gender diversity. This demonstrates the growing integration of corporate ESG goals into short-term financing mechanisms. Penalties for failing to meet sustainability targets are typically reputational or involve making donations to charities or NGOs, rather than financial repercussions for investors.
Critical Remarks
Despite its potential, the sustainable CP market faces several limitations and challenges. First, there is an inherent dissonance between the short-term nature of CP and the long-term vision required for sustainability projects. Sustainability-Linked CPs, while promising, are particularly vulnerable to this issue. Setting meaningful sustainability targets that can be met within the brief timeframes of CP is difficult, which can lead to the risk of targets being watered down or rendered ineffective. For example, a company aiming to reduce greenhouse gas emissions over a decade may struggle to demonstrate sufficient progress within the 90-day to 365-day lifecycle of CP.
Another critical point is the challenge of accurate impact reporting. CP is often continuously rolled over, meaning that its proceeds may be used to refinance existing issuance rather than directly fund new projects. This complicates the tracking and allocation of proceeds, making it difficult to assess the actual environmental or social impact of the financing.
Moreover, while the alignment of CP programs with the broader Sustainable Financing Frameworks of issuers is a positive step, the market still lacks clear, standardized guidelines for many aspects of sustainable CP. The paper calls for further development in best practices for external reviews and reporting to ensure transparency and avoid the risk of “greenwashing.”
Right Structures and Safeguards Needed
The paper provides a comprehensive overview of the growing role of commercial paper in the sustainable finance market, acknowledging both its potential and its limitations. Use of Proceeds and Sustainability-Linked CP represent promising tools for companies looking to integrate sustainability into their short-term financing. However, challenges such as the short maturity periods, difficulties in setting meaningful sustainability targets, and the complexities of impact reporting remain significant hurdles.
Further guidance and refinement of best practices will be crucial to ensuring that sustainable CP can meaningfully contribute to long-term sustainability goals. In particular, developing clearer frameworks for reporting and impact measurement, along with more ambitious KPIs that align with the long-term nature of sustainability, will be essential for the growth and credibility of this market.
The sustainable CP market may still be in its infancy compared to the sustainable bond market, but its potential to play a role in supporting the global shift towards sustainability is clear. With the right structures and safeguards in place, CP could become a powerful instrument in the sustainable finance toolkit.