Azerbaijan's financial sector undergoes "green" transformation CBA embarks on a new undertaking

The recent pandemic, energy, food, and climate crises, as well as the war in Ukraine and the following civilisational rifts, changed the usual framework of the global economy, accelerating the reshaping of traditional financial mechanisms. The current trends indicate the end of the era of neoliberalism, which has lasted more than 40 years, and the formation of a qualitatively new capital market that meets the ESG criteria of environmental, social, and corporate governance responsibility. Our country is gradually moving along a similar path of financial sector transformation. So, the day before the Central Bank of Azerbaijan (CBA) approved the road map on sustainable financing for 2023-2026.

A series of crises in the global economy and very controversial ways to overcome them have exacerbated all the long-standing imbalances in the world economy, widening the already enormous gap between the rich and the poor countries. But at the same time, there is a growing global awareness that economic problems cannot be cured by a liberal free-market model based on the maximisation of profits alone. Uncontrolled money emission to support national business is the privilege of the USA and a few highly developed countries. For the rest of the world, it leads only to increased hyperinflation.

Today, big businesses in Europe, the US, and leading Asian countries are rethinking the basic principles of the corporate market, distribution of profits, and channeling of financial flows: until recently, the higher the profit margin and the higher the dividend payout to shareholders, the better. Today, corporate and social responsibility issues are coming to the fore, with companies contributing to public welfare and addressing climate change. Such approaches, which originated about a decade ago predominantly in the corporate sector of European states, are now widely disseminated in various regions of the world and have been called ESG criteria: environmental, social, and corporate governance responsibility. Consequently, these approaches have formed a sustainable concept - responsible investing, which provides for profits while unconditionally complying with ESG criteria.

One of the basic principles of responsible investing is that investors should include ESG criteria in their decision-making process. For example, when assessing environmental performance, attention is paid to whether the company seeks to reduce its negative impact on the environment. Such activities may include, for example, a company's efforts to reduce waste, promote biodiversity and combat the effects of climate change. Social indicators are related to human capital management: creating favourable working conditions for employees, ensuring gender equality, and protecting local communities. Among the management factors are a transparent tax strategy, the fight against corruption, and alignment of the company's goals with shareholders, including minority shareholders.

It is noteworthy that about ten years ago investments into companies meeting ESG criteria were rather a tribute to fashion and were not considered a guarantee of high returns, however today more and more investors believe in the cost-effectiveness of such undertakings. Responsible investments are becoming increasingly profitable, identifying leaders and laggards in their respective industries, and according to Julius Baer Banking Group experts, nearly half of the world's wealthy clients claim to already own ESG assets.

"Green" bonds are considered an effective tool for responsible investing. These are securities that companies issue to raise funds for renewable energy projects, waste management, biodiversity conservation, green transport, green construction, etc. In accordance with the principles of green investment, the issuers of such securities should monitor the targeted use of funds and ensure the transparency of all processes in the implementation of projects. The first green bond, ClimateAwarenessBond, was issued by the European Investment Bank (EIB) in 2007. Since then, the EIB has issued around $37 billion worth of green bonds in 16 different currencies and the proceeds from the bonds have been allocated to 266 projects in 57 countries around the world. Overall, according to Climate Bonds Market Intelligence, the total value of green bonds issued worldwide was close to $1 trillion by the end of last year and is expected to reach $5 trillion by 2025. The classic areas for ESG investment include low-carbon infrastructure, hydrogen fuel production, energy storage, electric charging stations, solar and wind power generation capacity, energy efficiency investments in municipal and industrial sectors, recycling, etc.

Notably, new trends in green investment are fully supported by the UN in the framework of the 2030 Sustainable Development Goals (SDGs). In 2021, the participating countries of the G20, chaired by Italy, formed the Sustainable Finance Working Group (SFWG) to formulate a framework for developing investment trends that contribute to achieving the UN goals and the Paris Climate Agreement, and developed a corresponding Roadmap. This document identified three priority areas for sustainable finance: achieving coherence and comparability in approaches to aligning investments with the SDGs; addressing information gaps through improved sustainability reporting and transparency of information; and strengthening the role of international financial institutions (IFIs) in achieving the SFWGs. The intended outcome of these measures is an increase in financing for a fair and affordable climate transition, steps for sustainable development, including environmental protection and biodiversity conservation, as well as social aspects such as affordable renewable energy and poverty reduction.

Azerbaijan will face similar challenges, where the day before the Central Bank approved a roadmap for sustainable finance for 2023-2026. The purpose of the roadmap is to ensure the resilience of domestic financial institutions to the risks posed by climate change and their compliance with other ESG criteria - social and governance, as well as the implementation of opportunities associated with the transition to a sustainable economy. The Central Bank believes that the implementation of the roadmap contributes to a healthy, sustainable, and efficient financial sector in Azerbaijan. It is noteworthy that the CBA policy of introducing ESG criteria in the financial sector of the country is welcomed by the World Bank (WB) and the International Finance Corporation (IFC), ready to support all initiatives of Azerbaijan on the way to decarbonisation and formation of a financial system resistant to climate, social and other risks.

"The roadmap has been developed taking into account best international practices and includes measures to integrate climate change and ESG criteria into the national regulatory framework and scope of control over the country's financial sector, including the integration of financial institutions (banking, insurance, capital market) into strategic decision-making and risk management processes. It is also planned to form relevant market standards and ecosystem of sustainable financial instruments," the CBA said. Climatic and environmental as well as social and governance factors are identified as the most important objective in drawing up the roadmap. To this end, the reform of the financial sector includes the creation of a legal framework and procedure for issuing green bonds, the development of the road map and taxonomy of sustainable finance (a classification system for economic activities), the inclusion of climate risks in the financial control framework, and measures to create a regulatory framework for green loans.

The first concrete steps in the transition to a low-carbon economy are foreseen as early as this year. "In 2023, Azerbaijan plans to issue green bonds, and negotiations with 3-4 private companies with Azerbaijani capital are currently underway in this direction," Sanan Shabanov, an investment specialist at the Asian Development Bank, said late last year. According to him, recently there has been a growing interest in this area, and the number of participants in the local ESG market is expected to gradually increase in the future.