Keith Mullin, KM Capital Markets: Green finance has become one of the single most important driving themes in international finance, and one that has captured the attention of banks, companies, investors, governments and the general populace. The finance sector sits in the middle of this debate. What can the finance sector – banks, investors, companies issuing in capital markets, and the related financing ecosystem – do to further the green agenda?
From a banking perspective, climate change risk has moved from being a notional governance risk to something that is already starting to be viewed as a risk on the same level as market risk, liquidity risk, funding risk, credit risk, as well as regulatory and supervisory risk. It’s impossible to ignore.
From an inter-governmental perspective, there are a number of initiatives at play; it’s truly a global topic. In this session, we will seek to capture the essence of what’s going on in the institutional finance sector and what various players are doing.
I’d like to start with the Green loan market. The Loan Market Association, along with LSTA in the US and APLMA in Asia, recently issued Sustainability-Linked Loan Principles, following up on the Green Loan Principles. Clare, could you bring us up to date with the Green loan market and the Sustainability loan market?
Clare Dawson, LMA: The Green loan market got going somewhat later than the Green bond market but has been growing quite rapidly. It’s still very dominated by loans in the European market, but we are seeing companies across the world doing Green loans; we’ve had some in Latin America, in Asia and the US as well.
When the LMA decided to look at producing Green Loan Principles, we were obviously aware of the Green Bond Principles that ICMA had produced. Our sister organisation in Asia, APLMA, was also looking at Green loans as that market had started to develop in Asia. The Green Loan Principles are very heavily based on the Green Bond Principles for two reasons. We didn’t want there to be arbitrage possibilities between the two sets of principles depending on whether you were doing a bond or a loan. We felt that the standards should be maintained across the two products.
Also, of course, it’s quite possible that banks might want at some point to securitise their Green loan books, so clearly it’s helpful if the Green loans that underlie a securitisation follow the same principles as the Green Bond Principles. The loan principles follow the same core elements as the bond principles – use of proceeds, project evaluation and selection, management of proceeds, reporting, and there’s a section looking at review.
Where there is a bit more flexibility in the Green Loan Principles compared to the Green Bond Principles is in the area of review. The relationship between the lender and the borrower is, generally speaking, considerably closer than the relationship between a bond issuer and investors. Therefore, while we encourage third-party review, we do say that, in certain circumstances, it may be possible for the borrower to self-evaluate because of its relationship with the lenders and their understanding of the company generally as part of their overall credit and due diligence process.
In the area of reporting, loans are generally private so borrowers may be reluctant to put quite as much information in the public domain about a loan as they have to about a bond. We acknowledge that there should be some flexibility in terms of the information that’s put in the public domain, although we encourage that to be done.
We worked with APLMA on the first iteration of the Green Loan Principles. Subsequently, during the course of last year, LSTA joined in with this as the US loan market had started to look at Green loans. We published a second iteration of the Green Loan Principles, which acknowledged that it might be possible to fit a revolving credit facility and not just a term loan under the Green Loan Principles if you stuck with the use of proceeds and fulfilled the other key elements as well.
We’ve subsequently produced the Sustainability-Linked Loan Principles, again in coordination with APLMA and LSTA. That was very much in response to lenders, who were telling us that this is a very rapidly growing part of the market. Effectively, the difference between the two sets of principles and the two products is that, in sustainability-linked loans, you’re not looking at use of proceeds. You’re looking at the overall performance of the company and how that relates to its overall corporate and social responsibility strategy, and setting out very clear and challenging targets to improve overall sustainability performance. That target setting is a key principle of the Sustainability-Linked Loan Principles as opposed to the use of proceeds.
The targets are intended to be challenging, to be based off recent data and the recent performance of the company so that it is setting a genuine course for improvement. They look at the whole company performance. I think this is important because not all borrowers have specific projects or specific assets that they are looking to either purchase or produce at which they can target specific use of proceeds. But if they can look at the overall sustainability of their entire company and link that to a set of targets, we believe that opens up the market to a wider range of companies to engage with this sort of financing, which is all targeting the same aims.
Keith Mullin, KM Capital Markets: The growth of the green market is obviously fuelled by issuers and investors. Ines, could I ask you to talk generally about the overall funding requirement you have at Tideway, why you chose Green bonds and what specific challenges and opportunities you saw as a result of having issued in the green market?
Ines Faden, Tideway: Tideway is building the London super sewer. We’ve raised about £2.5bn in the past three years and have a little bit more to raise. The company was created to address a sustainability issue – pollution in the tidal River Thames – so it made sense to align the financing of the company with the company’s mission.
We are a pure-play issuer, so the low-hanging fruit. Some people have said it’s really easy for us to issue in this market and I would agree. But you have to start somewhere and this market needs to grow. A couple of years ago, we came up with a Green bond strategy. Since then, we have been issuing Green bonds. We’ve issued six to date. We did one in the public market [a £250m 10-year in November 2017] and have done five as private placements. We’ve issued fixed-rate, inflation-linked (both CPI and RPI), cash bonds and deferred bonds (with up to five years’ deferral). We’re very flexible, and issuing green has been positive.
We worked with S&P on the second-party opinion and we’re now considering “greening” our past issuance, since all the money goes to construction of the tunnel, which is a green asset. So we may just harmonise that. It’s not very difficult for a pure-play. We had to produce a framework and we got our second-party opinion; overall, we’re pleased with the benefits. Our shareholders were very happy, ditto our stakeholders. As a regulated entity (we have some UK government support), it was very pleasing for those parties too.
Interestingly, the dynamic from all different areas around financing was also very positive inside the company; for the first time, people showed some in the financing aspects. We were very pleased with that.
Keith Mullin, KM Capital Markets: The European Investment Bank has been at the centre of the Green bond market since its inception. What is your perspective now, Dominika? How has the market changed and how do you see it evolving?
Dominika Rosolowska, EIB: The EIB has been issuing Climate Awareness bonds since 2007 and has done around €25bn-equivalent across different currencies. Back in 2007, the interest of the market was less pronounced than today, and there was no clear framework. The reason we ventured into this area was European policy at the time. We are the bank of the European Union so we follow EU policy in all aspects, and this includes climate action and environment.
Last year, we started issuing Sustainability Awareness bonds to complement our Climate Awareness bonds. They are basically two sides of the same coin. CABs have a focus on climate change mitigation, while SABs look at everything beyond climate – other environmental and social objectives.
Being the EU bank, we are also part of the discussion within the European Union on sustainable finance. We were part of the High-Level Expert Group for Sustainable Finance in 2017 and we are now part of the Technical Expert Group on Sustainable Finance (TEG), which has come up with proposals to the European Commission on four work streams, notably the EU taxonomy and the EU Green Bond Standard.
Anticipating what is going to come out of this discussion, we have redrafted the use-of-proceeds of our CABs and SABs to align with the EU taxonomy [which was published on June 18] – the EU taxonomy consisting of the differentiation between the environmental objectives that you pursue with the activities themselves, plus technical criteria that will be elaborated by the TEG and will help market participants determine whether something is green or sustainable or not.
When it comes to classification as to what is green, and the question of lending and funding and what Clare was referring to with the loan principles versus the bond principles, the necessary identity of green definitions between bonds and loans is a crucial aspect.
The first article of the European Commission’s regulation proposal of May 24 2018 [Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment] says that you need to determine the greenness of an economic activity to be able to establish the greenness of a related investment. What underlies Green bonds is activities in the real economy. In the end, this is what we are trying to influence, to have markets steer the shift. It is only if the two are the same in terms of what classifies as green that you can achieve that.
What the TEG is trying to do is build a chain of measurement and disclosure of impact on the environmental objectives – a flow of reliable information from the real economy to financiers, be they financial institutions or multilaterals like ourselves, and then to the capital markets and the investors that require this information from issuers.
Last year, we started granting Green loans – [the first EIB Green loan was to Spanish utility Endesa for €335m for 15 wind farms and three solar plants] – to borrowers that want to highlight their engagement in green activities, under the condition that these activities live up to the requirements of our Green bonds.
Keith Mullin, KM Capital Markets: From the other side of the market, Stuart, we keep reading about how many assets under management are behind the green cause. There seems to be a lot of, I wouldn’t call it activism exactly, but investors seem to be pushing a lot more on companies to green their activities. How do you see the investor side having evolved in the last few years around the green cause? Is “activism” the right word to use?
Stuart Kinnersley, Affirmative Investment Management: That’s a good question. In the Green bond market, there’s been a lot of focus on the issuer and whether the issuer is “greenwashing”. The focus of the debate has started to turn actually on the investor. Are the investors themselves greenwashing? Are they being consistent? It’s a really pertinent question for today.
What I feel about the Green bond market and its importance is not just the numbers; we’re getting this composition change in terms of moving from supranationals to corporates. From 2016 onwards, we actually had greater issuance coming out of the corporate sector compared with the supranationals and government-related entities. This is important in terms of market breadth and depth.
However, even more important is the role of the Green bond market in terms of the broader financial markets, and within the overall economic system. I often hear that impact investing is a relatively recent fad or trend. In truth, all investing has always had an impact. The problem is that the impact, for many years, has been quite negative and unknown.
What we should be talking about when discussing the Green bond market is positive impact investing. I was at The Economist’s sustainability conference recently and one of the questions posed was: ‘Are we living in an economic system and a financial system that are broken?’ because neither adequately factor in the negative externalities that are being generated from many of the investments of today.
That’s a really great segue to the Green bond market. It’s changed the narrative in that you have a financial instrument that can actually demonstrate a positive impact over and above financial return. In time, I’m hoping it will create the template for the financial system that looks at that third dimension. Not just the two-dimensional risk-return but what is the underlying positive impact or externality? Where is the money going? What’s the transparency? So the end-investors become more educated about the investments they make. Creating this lens will help us address climate change and other challenges facing the world.
Going back to your original question on activism, yes, generally for a bond instrument, all investors used to care about was whether they were going to get their money back and were they going to be paid the coupon. Actually, there was no real legal right to challenge where that money was going and for what purpose. Now I see a change in the narrative as a result of Green bonds promoting transparency and outcomes, as well as financial returns. This has unleashed the potential of bond markets. I strongly believe the debt market will be the main driver of scalable sustainable investing in the future, as it has the ability to consider all stakeholders, whereas the equity market still remains dominated by short-term shareholder considerations.
It’s really important for us. At Affirmative, we only identify and invest in debt instruments that have a positive externality over and above the financial return. We don’t think there’s a compromise to the financial return. We run various strategies against mainstream benchmarks and we’ve been able to do that by focusing on a relatively small part of the debt market. Our engagement and activism is very much about knowing where the money is going, the level of transparency, and commitment to reporting.
But we also look at the issuer itself and ascertain whether the issuer is responsible and so, with regard to activism and engagement, we’ve been very vocal about reporting. There’s no point us saying we are positive impact bond managers unless we can provide the evidence or proof that the instruments we invest in are generating positive impact. We have a lot of engagement in terms of making sure the reporting evidences and justifies what issuers say they’re doing.
Keith Mullin, KM Capital Markets: Moving to the sellside, Cristina, how has the green theme evolved in the last year or so from your standpoint as an investment bank intermediary? How important is green within the ecosystem that you’re dealing with, of issuers and investors?
Cristina Lacaci, Morgan Stanley: When thinking about how the market has evolved in the last year, we have changes to regulation and bond structuring. On regulation, as Dominika was mentioning, the EU Action Plan on Sustainable Finance will give us a platform and some guidelines to continue structuring the bonds. When you look at the regulations, what is important is that they’re broad enough in terms of the type of eligible projects, in terms of the activities and the sectors, to make sure that you take into account the specifics of each corporate and each business model. That’s very important when you look to structure Green or Sustainable bonds.
The other part, which I think is even more relevant, is the fact that investors – and Stuart was alluding to it – are placing much more importance on the sustainability strategy, on the environmental footprint, on the mitigation plans of corporates. I would even say that’s not only relevant for Green bonds; it’s becoming much more relevant for corporates in general.
You start to see investors engaging with issuers not only in the context of marketing a Green bond but also asking them how they’re going to reduce their CO2 emissions, making sure they set targets and that their business model is starting to shift, especially in carbon-intensive sectors. This has been the key development we’ve seen in the last year.
Of course, for issuers, it’s important to look at both. It’s about the credentials, the ESG strategy of an issuer, as well as making sure that you then meet the regulations, the use-of-proceeds categories and that you also tick the box when it comes to meeting the requirements that some Green bond funds have.
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