IFR Green Financing Roundtable 2019 participants

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 u

Keith Mullin, KM Capital Markets: If the market morphs from a market where issuance is assessed purely on the use of proceeds to perhaps a more convoluted situation where people have to weigh up the overall footprint of the issuer, how do you calibrate that? Who decides and how do you decide whether the footprint of the issuer is sufficiently sustainable, environmental, to then pass muster at the corporate level? CBI plays quite a big role in that calibration. Most of the Green bond indices are defined by your imprimatur, so you have quite a big role to play here. If the market shifts from assets to issuer, it strikes me that that creates some quite significant challenges. Monica Filkova, Climate Bonds Initiative: It does pose a challenge, and historically investors have looked at companies more than the way they’re financed, in the sense that you look at the company and decide if it meets your requirements. One of the ESG requirements could be: ‘don’t invest in oil’. If one of your requirements is ‘don’t invest in oil’, how do you participate in a Green bond that’s issued by a company in the oil and gas sector? It remains a challenge. The way we look at it is really defined by the activities and assets. We’ve actually seen a lot of issuance from utility companies as they fund their transition to a greener asset portfolio and that is expressed in renewable energy in the context of the energy sector. They keep coming back to the market. What that tells us is that they’re really engaged with this transition strategy. As a general point, we acknowledge that transition is required. It would be great if you could just snap your fingers and we’ve transitioned, but the reality is companies need to move from A to B. One way to indicate that transition is by labelling. One of the main achievements of the Green bond market is the label itself because it has support from a very wide stakeholder group. Whether you agree about a particular bond and whether it meets your definition of what a Green bond should be is, in a sense, not quite so important. What the label achieves is a communication of corporate intentions. CBI recently conducted an investor survey. One of the things we confirmed is the level of engagement: a lot of the investors we spoke with – even though they’re bond investors – are engaging with companies. The questions they are asking are about the wider strategy. We see that sentiment, that Green bonds are part of a strategy, over and over again. One of the things that keeps coming across is that, if you label something green as an issuer, you’re taking on an obligation to report. You’re taking on an obligation to keep investing in the asset you said you would invest in and, from the reporting, people can see you are doing what you say you will do. It’s not just words; it is followed up by actions. That gives us comfort that, when companies engage with the market, it is part of a wider environmental strategy. The way we look at the market is very much from the assets. That’s why we look at transitioning companies; we look at pure-play companies; we look at various institutions that are looking to fund or facilitate the issuance of debt, whether that’s loans, bonds, some other form of debt to finance the transition to a low-carbon economy. When we do our screening, we’re looking to see that practically all of the funding is going towards climate assets so once you invest in those assets, those assets will continue providing a climate benefit. Simply put, if you invest in a wind farm, the wind turbines will keep spinning year after year so once you’ve made an investment, that’s positive; it has a long-term impact. We screen out companies that are allocating a substantial amount, for example, to general corporate purposes or categories that are unclear. In China, the Green bond catalogue allows up to 50% to be invested in general corporate purposes. We tend to screen out quite a lot of companies for that because it’s unclear t

Keith Mullin, KM Capital Markets: If I could just extend that point, we touched on it earlier, but what about brown issuers? They need to be incentivised to issue in this market as well. From a pure climate change mitigation perspective, having a big oil company do something which “greens” its activities, even if it’s a small percentage, is potentially more important from a planetary perspective than it is for a pure-play company to do a Green bond, where carbon emission mitigation is reduced. This is one of those knotty questions that the market needs to grapple with. Stuart Kinnersley, Affirmative Investment Management: It is knotty. Because of COP21, we talk about targets for 2030/2050, but actually, we know that action has to happen now and it’s not about tweaking at the margins. If fossil fuel companies are committed to changing their business model and moving to low-carbon transition, we will support them. But if it’s just doing a PR exercise at the margin, we’re not really interested. Actually, it’s really dangerous for that to happen because this market will not be the driver of change that we need it to be. Having pretenders join the ride at this stage will create diversions and slow down progress. Keith Mullin, KM Capital Markets: But there’s also the question of how quickly that happens. There are people out there who will say: ‘we can just shut down coal tomorrow’. It’s a reasonable thing to say but it’s not necessarily a realistic or practical thing to say. Ines Faden, Tideway: Coal is, actually. It is realistic to shut coal; gas and others, not so much. Stuart Kinnersley, Affirmative Investment Management: No, but I think it’s the ambition to change. You’re right, we have to be realistic. But when a lot of fossil fuel companies are still budgeting to pump trillions of dollars into exploration and research to find new fields on the basis that carbon-capture technology will allow those emissions to be mitigated, there needs to be much more ambition to change. Darko Hajdukovic, London Stock Exchange: Going back to what Ines said, that companies have to run their own business, this is something that has to become business-as-usual for them. I always get asked by issuers: ‘What’s in it for me? Climate change, conscience - all fine - but if I’m going to convince my board, I need to give them something extra. Am I going to get better pricing?’. Until last year, we were saying it’s just good to be issuing and there is an element that the perception of the company changes. But, actually, last year, there were three pieces of detailed research that looked at pricing. They found that certain issuers of Green bonds achieve better pricing. What I found fascinating, though, was that one of the studies found that the issuers who issue Green bonds achieve better returns on their equity by 1.7% over a 20-day period after they’ve listed their bonds. That is pretty material. It’s not just about climate change mitigation, but also it makes good business sense to do it. Keith Mullin, KM Capital Markets: Clare, just on that specific point, in your Sustainability-Linked Principles, there are incentives for issuers if they meet certain sustainability targets. There’s a material pricing benefit to them over the course of that facility that we haven’t seen in the bond markets at this point. I’m curious to understand what impact you think that’s going to have? Clare Dawson, LMA: There are two aspects that borrowers look at. One is the wider picture: you’ve got borrowers who are committed, generally, to improving their own performance. Clearly, if they are going to get pricing incentives, that’s going to be very attractive. It’s certainly something that can act as a motivating factor for companies to undertake some extra work they might have to do in order to meet the requirements, from filing reporting requirements and the evaluation process and potentially getting external review. I think it certainly broadens the market. The loan market