Sustainable finance and SPACs: can we have both?

Introduction

The use of Special Purpose Acquisition Companies (SPACs) as an alternative method for businesses to go public has grown significantly in recent years. SPACs are fictitious businesses established purely for the purpose of raising funds through an initial public offering (IPO), with the goal of acquiring or combining with an existing private business within a set period of time. Through the merger or acquisition, the private company goes public without going through the standard IPO procedure.

SPACs have received much support in Asia. Refinitiv data shows that Asia-Pacific SPAC IPOs raised $17.6 billion in 2021, or 45% of all SPAC IPO proceeds worldwide. In comparison to 2020, when Asia-Pacific SPACs only raised $3.8 billion, this is a huge increase. Significant SPAC activity has been observed in Japan, Singapore, and South Korea, with Japan leading the pack with 29 SPACs created in 2021, raising a combined $6.4 billion.

Sustainable finance is a subject that has grown in significance throughout Asia in the wake of rising environmental consciousness. Financial services that support environmental, social, and governance (ESG) factors are referred to as "sustainable finance." The use and influence of ESG measures have recently increased in the ASEAN area. According to a recent HSBC report, ASEAN nations have a strong and growing commitment to sustainable finance, with investors paying close attention to topics like climate change, biodiversity, and human rights.

The epidemic has also increased the use of sustainable finance across Asia. According to McKinsey, Asian sustainable finance assets under management climbed by 38% in 2020, compared to a global increase of 21%. The paper also pointed out that while the COVID-19 epidemic had a detrimental effect on the world economy, it also gave Asia a chance to embrace sustainable finance and create a more resilient economy.

In summary, SPACs and sustainable financing are two issues that have attracted a lot of attention in Asia lately. It would be interesting to watch how these trends change over the next few years given the rising popularity of SPACs and the growing attention being paid to sustainable financing.

The sustainability implications of SPACs

Positive aspects

Capital availability: In 2021, Deloitte projected that private equity possessed close to $1.45 trillion in unspent committed capital, or “dry powder,” most of which had been sitting idle. Unlike typical IPOs, SPACs can immediately give a fast-growing firm a substantial quantity of money at a certain value, making them an efficient option to invest such resources towards sustainable funding.

Access to a bigger investment pool: SPACs provide sustainable businesses with access to a bigger investor pool. The environmental, social, and governance (ESG) aspects of economic activity or project are taken into account when making decisions about sustainable finance, and SPACs can support sustainable investment.

Opportunities for business leaders: According to a report by The Economist, over 1,500 business executives, government officials, entrepreneurs, and academics from the Asia-Pacific region gathered to discuss the future of sustainability in Asia, focusing on the path to net-zero, sustainable finance, climate risk and biodiversity, society and supply chains, and sustainable agriculture. SPACs offer a fresh source of funding as well as chances for business titans to engage in sustainable investing and financing.

High development potential: SPACs can open up a growth path for sustainable sectors, and the ASEAN Taxonomy is a framework that fits with the most advanced and prominent sustainability taxonomy in the world. SPACs will be a vehicle to finance climate- and sustainability-focused enterprises and bring them to the public market, as there are numerous new companies in the sustainable field that will expand and go public in the future.

Negative aspects

SPACs and short-termism: By facilitating quick access to cash without taking the long-term viability of the company into account, SPACs have been charged with encouraging short-termism. This short-term perspective can deter investments in long-term, sustainable economic endeavours.

Lack of openness with SPACs: One of the main issues with SPACs is that they are not transparent. SPACs are created as empty shell firms with no real purpose other than to buy a private company within a set time frame. Sustainable investments may be hampered by the lack of transparency in the acquisition process, which raises concerns about the SPACs’ governance and due diligence procedures.

SPACs and insufficient due diligence: SPACs have come under fire for their lax due diligence procedures, which may result in investments in companies that are not sustainable or that have an adverse effect on the environment and society. A lack of sufficient due diligence may expose investors to legal and reputational concerns.

SPACs with high degrees of risk: Because SPACs are speculative in nature, they also pose considerable risks to investors. Investors can struggle with a lack of knowledge about the underlying business, which could cause uncertainty about the viability and financial health of the enterprise. Investments in sustainable economic activities may be deterred by SPACs’ high levels of risk.

SPACs and their effect on ESG investing: Making investments based on environmental, social, and governance considerations is known as "ESG investing." SPACs could have both a positive and negative impact on ESG investing. On the one hand, SPACs might give investors access to prospects for sustainable investing. SPACs’ lack of transparency, shoddy due diligence procedures, and high levels of risk, however, can obstruct investments in sustainable economic activities and deter ESG investing.

The negative effects of SPACs on financial systems

Special Purpose Acquisition Companies (SPACs) have grown to be a common way to list recently. They have, however, also come under fire for any detrimental consequences for financial systems. The detrimental consequences of SPACs are detailed in the following data and statistics:

Increased market volatility: The volatility of the market has increased, and SPACs have been linked to this because of the way they are structured. In order to locate a private firm to merge with and take public, SPACs are created. As the market reacts to news of potential mergers and makes predictions about their results, this process may cause market volatility.

Concerns regarding the possible hazards of SPACs and their effect on market volatility have been voiced by Singapore’s Monetary Authority of Singapore (MAS). To increase investor protection and the calibre of SPAC listings, MAS has developed new regulations for SPAC listings. According to these regulations, SPACs must have a market capitalization of at least $300 million in Singapore dollars, and a minimum of 25% of the IPO proceeds must be placed in an escrow account.

The Securities Commission Malaysia (SC) has also taken action to control SPACs in Malaysia. The SC mandates that SPACs have an MYR150 million minimum market capitalization and that 90% or more of the IPO proceeds be held in a trust account until the SPAC finds and completes its purchase.

Despite these restrictions, there have been worries about the potential harm that SPACs could do to the local financial systems. For instance, the Malaysian stock exchange banned trading in all SPACs for two days in April 2021 due to concerns about insider trading and market manipulation. Similar concerns have been raised about the possible risks for investors in Singapore due to SPACs’ association with heightened market volatility.

Potential for fraud and abuse: The possibility of fraud and abuse using SPACs has also drawn criticism. Those looking to take advantage of the system may find the SPAC process appealing due to its quickness and simplicity. Investors were alerted to the hazards connected with SPACs in 2021 by the SEC, including the lack of transparency and the possibility of conflicts of interest [5].

SPACs have grown in acceptance throughout the Asia-Pacific region in recent years. For the first time, in 2021, there were more SPACs introduced in Asia than in the US, with 310 SPACs launched in Asia versus 283 in the US. But there are also worries about the increased likelihood of fraud and abuse in the area.

In 2020, Malaysia saw one prominent instance of SPAC fraud in the Asia-Pacific region. A SPAC sponsor’s licence was withdrawn by the securities watchdog of the nation, the Securities Commission Malaysia, for violating a number of rules, including making false claims in its prospectus and failing to do adequate due diligence on the target firm. This instance emphasises the necessity of tighter oversight and regulation of SPACs in the area.

Investors and businesses have developed a greater interest in SPACs, particularly in the ASEAN region. The first SPAC was introduced in Singapore in 2018, and a number of successful SPAC listings have subsequently taken place on the Singapore Exchange. The Monetary Authority of Singapore has warned investors about the dangers of SPACs, including the lack of transparency and the potential for conflicts of interest, and there are also worries about the possibility of fraud and abuse.

Negative impact on public trust in financial markets: The growth of SPACs has sparked worries about their potential negative effects on investor confidence in the financial markets. The rising number of SPAC IPOs and the possibility of fraud could reduce public confidence in the system. A lack of market confidence may also be attributed to several high-profile SPAC mergers’ failure to fulfill their promises.

The Malaysian Securities Commission revealed in February 2021 that it was looking into three SPACs for possible violations of listing regulations. In addition, the Securities and Futures Commission of Hong Kong has established recommendations for the regulation of SPACs and highlighted concerns about their use.

Concerns about the harm done to public confidence in financial markets also exist throughout Asia. 59% of investors in the Asia-Pacific are worried about the quality of SPACs, according to a KPMG survey. Research from the Asian Development Bank also emphasises the requirement for more accountability and transparency in SPAC transactions in order to uphold confidence in the financial markets.

Overall, there are worries about the influence of SPACs on public confidence in financial markets, even though they offer an alluring option for businesses wishing to go public. Investors are requesting more openness and accountability from regulators in Asia to reduce possible dangers, and regulators in that region are closely monitoring the use of SPACs.

The principles of impactful sustainable investment

Impactful sustainable investment is the practice of funding businesses, non-profits, or initiatives that advance social progress and the environment while also providing investors with a profit. The Sustainable Development Goals (SDGs) of the United Nations state that sustainable investment should seek to produce favourable environmental, social, and governance (ESG) outcomes. Among the fundamentals of effective, sustainable investing are:

1. Active ownership and engagement with investee companies to advance ESG best practices and reduce risks: Sustainable investors use active ownership strategies to advance ESG best practices in their investee companies. This entails interacting with the company’s management and board to have an impact on business choices that enhance ESG performance. By doing this, investors can assist in reducing sustainability risks and contribute to the long-term sustainability of the investee company and the larger ecosystem.
2. Application of ESG considerations to investment analysis and decision-making: The systematic integration of economically significant ESG issues in investment research and decision-making processes is one of the fundamental tenets of sustainable investing. When assessing investment options, this entails taking ESG risks and opportunities into account in addition to financial measures. Investors can evaluate the long-term viability of investee companies and make better investment selections by doing this.
3. Alignment with the Paris Agreement and the SDGs to make sure that investments support the transition to a low-carbon economy: Through investments in businesses that support the Paris Agreement and the Sustainable Development Goals (SDGs), sustainable investing seeks to aid in the transition to a low-carbon economy. Sustainable investors provide higher priority to businesses that have pledged to lessen their carbon footprint, advance sustainable development, and help realise the SDGs. Investors may aid in the shift to a low-carbon, sustainable economy by doing this.
4. Transparency and reporting on ESG performance to allow investors to track development and hold businesses accountable: In order, for investors to track developments and hold businesses responsible, sustainable investing also entails transparency and reporting on ESG performance. Companies that place a high priority on ESG aspects should provide investors with pertinent information about their carbon footprint, social impact, and governance practices. Investors can then assess the efficacy of ESG practices and hold businesses accountable for their sustainability performance.

How SPACs can run counter to these principles

SPACs have grown in popularity as a means of raising money and going public, but they might present difficulties for effective, sustainable investment. For instance, SPACs might not follow the following guidelines for impactful, sustainable investment:

1. Short-termism: SPACs can only acquire a target company for two years. Quick deal completion under time constraints may undermine ESG due diligence, resulting in investments in businesses that may not be in line with sustainable business practices. Additionally, the company’s long-term sustainability may be compromised by this short-term focus, which would have a negative effect on ESG factors.
2. Lack of transparency: Unlike conventional IPOs, SPACs offer little insight into the target firms and their ESG performance, making it challenging for investors to weigh the risks and possible rewards of the transaction. Investor decision-making may be hampered by this lack of transparency, which may lead to investments in businesses with subpar ESG performance.
3. Poor governance: SPACs are designed in such a way that sponsors receive a sizeable ownership stake in the combined firm, which lessens the interests of public shareholders. Due to sponsors’ possible preference for immediate benefits over long-term sustainability, this may compromise ESG supervision and responsibility. These problems are made worse by the lack of diversity on the SPAC board and the conflicts of interest brought on by sponsors’ participation in the choice and negotiation of targets.
4. Lack of alignment with ESG objectives: SPACs might not give ESG considerations top priority when making investment decisions. While SPACs with an ESG focus have outperformed non-ESG ones in terms of share prices, this does not imply that they give ESG considerations top priority when making investment decisions. Short-termism, poor governance, and a lack of transparency all have the potential to cause ESG factors to be overlooked in favour of immediate profits.

Conclusion and recommendations

Summary of key findings

SPACs have grown to be a common way to collect money and go public, however, they might not adhere to the tenets of impactful, sustainable investing. SPACs could be poorly governed, promote short-termism, lack transparency, and be out of step with ESG objectives.

Recommendations

The following suggested actions can be taken by investors, decision-makers, and regulators to lessen the detrimental effect that SPACs have on sustainable finance:

1. Increase SPAC transparency and disclosure standards, including risk and performance disclosures related to ESG, to help investors make more informed choices.

2. Encourage SPACs to adopt ESG guidelines and long-term sustainable investment strategies that support the SDGs and the Paris Agreement.

3. To ensure that SPACs work in the best interests of all stakeholders, including public shareholders and the environment, strengthen governance and oversight systems.

4. Encourage investors and the financial sector to learn about the advantages and potential hazards of SPACs and sustainable investments.

Call to action

In order to avoid a further financial crisis, the financial sector should give priority to long-term sustainable investment strategies that support ESG outcomes and are in line with the Paris Agreement and the SDGs. SPACs should be carefully considered to make sure they do not compromise sustainability objectives, despite the fact that they can be advantageous to investors and businesses. Businesses that put an emphasis on ESG measures not only reduce risks but also perform well financially, with sustainable funds garnering substantial investment flows. Therefore, it is crucial for businesses to effectively communicate their ESG initiatives and goals, motivating stakeholders to support them. A call to action can motivate readers to take action, such as making an investment in the company’s growth or joining as a minority partner.

Companies should put an emphasis on honesty, transparency, and repetition when developing a call to action, especially when outlining corporate responsibility initiatives and goals. Setting both short-term and long-term goals is crucial, as is examining the areas where the company may grow. The call to action should motivate readers to take action in support of the company’s sustainability goals by being sincere, attainable, and goal-driven.

Investors and other financial stakeholders are becoming more aware of the significance of ESG disclosure, nonfinancial performance, and a company’s commitment to environmental and social responsibility. In order to motivate stakeholders to support their long-term strategy and contribute to a low-carbon, climate-resilient economy that achieves prosperity and national development goals, businesses should make sure that their call to action is in line with their ESG activities and sustainability goals.