Surety carriers have a unique opportunity to support the green transition, grow emerging industries, and promote sustainable financing practices. However, challenges must be addressed.
Surety bonds play a vital role in managing risks across major projects by providing financial guarantees that ensure delivery, and mitigate against potential losses. As the world accelerates its focus toward sustainability, the surety industry must keep up and make a positive contribution to financing a more sustainable and resilient world.
Whilst there is growing recognition across the industry of the need for sustainable practices, for many surety carriers, doing so poses challenges.
The industry’s ability to adapt and develop suitable bond products will be pivotal in supporting sustainable financing and achieving the UN’s Environmental, Social, and Governance (ESG) goals.
Carriers need to genuinely support sustainable and emerging industries, promote corporate investment in net-zero decarbonisation, and embed ESG practices to ensure the surety bond industry maintains a relevant value proposition into the future.
To increase transparency and boost environmental and social responsibility across the finance industry, the European Union’s Sustainable Finance Disclosure Regulation (SFDR) mandates ESG disclosure obligations for asset managers and other financial market participants.
As of March 2021, banks, insurers, investment firms, and other financial institutions must report sustainable investment practices in a standardised format so investors can make informed decisions. Non-compliance with the SFDR can have adverse consequences, such as disciplinary action from local financial authorities, and negative signalling to current and prospective clients and investors.
Moving towards net-zero
It is more important than ever that surety carriers introduce products that are tailored to help their existing clients pursue more sustainable initiatives.
Given that approximately 50% of surety bonds are for the financing of major construction projects such as rail, road, and marine infrastructure, there is a clear need for the industry to support sustainable infrastructure. The construction industry is moving towards net-zero, focusing on low-carbon materials, circular building methods, waste reduction, and regulatory compliance. Surety carriers must adapt to support these changes.
Adapting and aligning surety underwriting practices will mean shifting focus from the traditional assessment of financial statements, to assessing projects through a holistic lens, considering factors such as climate resilience, and the viability of innovative technologies.
For some time now, surety carriers have recognised climate change as a major risk that will impact their underwriting practices. They increasingly incorporate ESG into risk assessments and recognise the strength of sustainable and resilient projects that can withstand future environmental challenges.
Some carriers are setting targets for responsible underwriting and investment, and have announced future plans to phase out coverage for certain activities such as fossil fuels projects.
Balancing innovation risks
With surety carriers aiming for zero losses, they still show hesitation towards financing renewable projects such as solar energy or wind farms. Their reluctance to issue bonds for projects in emerging industries or those involving innovative technologies stems from the difficulty in assessing the associated risks.
Contrastingly, in established sectors where success is proven, carriers can confidently calculate the risk through historical data and experience.
Often, newer industries involve start-ups that invest in transformative technology, but lack a track record. This causes carriers to hesitate to issue bonds, making it difficult for projects to go ahead without exposure to risk.
Without access to bonds, these innovators resort to using their available capital, and take on larger risks – in turn, limiting their ability to grow and realise the full potential and impact of their innovations.
Emerging industries also come with the risk of delays, which can be lengthy, resulting in contractor bankruptcies. One such example is the EDF nuclear reactor in Flamanville in north-western France, which started construction in 2007 but has yet to be completed.
The project was expected to take four years and cost €3 billion. However, a range of issues have caused delays of over a decade, with EDF currently expecting nuclear fuel loading to be scheduled in early 2024, with costs continuing to mount.
In a more positive sign, some progress is occurring as renewable energy becomes more mainstream and is increasingly backed by larger corporations. Whilst this encourages surety carriers to participate, progress is slower than the pace required to meet transition goals.
As innovation extends beyond solar and wind farms to new industries, the cycle of risk and uncertainty will also continue to grow.
To address this, surety carriers must adapt their underwriting approach to include a better understanding of the business models and risks associated with emerging industries. One major challenge lies in establishing a common understanding across the industry of sustainability.
Different stakeholders have varying definitions, making it challenging to apply a consistent approach. Aggregating various sources of data and improving access to information through digitisation for more accurate information can give carriers the information they need to assess sustainability and risks more accurately.
Collaborating with external experts, such as engineers and industry-specific consultants, can also help assess viability.
New carbon markets
The emergence of carbon credit markets has created opportunities for surety companies to issue bonds that cover carbon credits, supporting companies in their decarbonisation efforts.
Companies are striving to meet their net-zero targets, necessitating the purchase of carbon credits. We see this in companies such as Total Energies and other petroleum giants who are buying carbon credits to demonstrate their commitment to reducing emissions.
Issuing bonds to cover these credits could ensure accountability and provide a secure financial mechanism to support decarbonisation. Whilst such bonds do not yet exist, increasing demand for carbon credits could secure a new market for the surety industry to play a crucial role in providing the necessary financial guarantees to ensure market integrity.
An internal view
Whilst surety bonds can support the green transition, carriers must go beyond simply shifting support from coal to renewable energy projects, and assess their own operations. Major surety players like Atradius are proactively aligning with ESG principles. They are implementing policies to achieve net-zero targets, adopting digitalization to reduce paper usage, and enhancing efficiency.
By digitalising their internal processes, surety bond carriers can transition to e-bonds, eliminating traditional paper bonds, which still account for around 95% of bonds worldwide.
These efforts signal the industry’s growing commitment to sustainability and demonstrate the potential for surety carriers to adapt and align their practices with sustainability. Not only does digitalisation reflect a more sustainable approach, but it comes with organisational benefits such as speed, efficiency, accuracy, and competitiveness.
Whilst the environmental aspect of ESG has drawn attention, a comprehensive approach that includes social and governance factors is also important. However, the surety industry is not currently a frontrunner in this area, and more work is needed.
Encouraging employee engagement can contribute to the social goals of ESG, and whilst many carriers engage in these practices, they can also consider how to better support the social aspects of the projects they underwrite.
This would go some way to addressing growing pressure from employees who want to work for companies that prioritise all ESG factors, as well as external pressures from banks, clients, and stakeholders.
Creating a sustainable future
Surety can play a vital role in financing and supporting net-zero in several ways, with the future of surety intertwined with sustainability principles.
Carriers have an opportunity to support their clients’ decarbonisation efforts, while also adapting their own practices to align with sustainability goals. By introducing new bond products that promote decarbonisation, and by investing in emerging industries, surety carriers can contribute to a more sustainable future.
However, to fully embrace sustainability, they must overcome challenges in assessing project risks, change their underwriting perspectives, and diversify data sources. By doing so, the surety industry can play a vital role in supporting the transition.