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    >> “Climate Solutions” is also available as a podcast and an e-book.

    By Aldo Romani

    When Zilu asked Confucius what his first priority would be if he were entrusted with the government of the state, the master replied, “To rectify names.” The key to good government, Confucius tells us, is that words should mean the same thing to everyone. This applies to capital markets, too: investor confidence relies on clear rules and definitions.

    The last global financial crisis undermined the credibility of finance and plunged it into a deep crisis of legitimacy. Arjun Appadurai has identified the origin of this crisis in a “failure of language” caused by derivative finance. Finance must now re-establish trust by building confidence in the promises it makes on the green use of capital.

    If we are to boost support for projects that truly fight climate change and protect the environment, we need to make sure that we develop a common language for green finance. Only then can investors know that they are buying something truly “green” and understand the impact of their money. This is even truer in another essential and still largely unchartered dimension of sustainable investment: “social” investment.

    The good news is that Europe is moving towards this common language. An EU classification of sustainable financial instruments based on the sustainability of the underlying economic activities is at the heart of the European Commission’s Action Plan on Financing Sustainable Growth. This EU Sustainability Taxonomy will measure how the financed activities contribute to sustainable objectives in a more reliable and comparable manner.

    When adopted, the Taxonomy will provide a shared definition of core aspects of sustainability, so that a consistent set of standards can be developed for sustainable investment (for example, green loans and green bonds). That is vital to ensure that policy signals as well as issuer and investor disclosures can be used as a basis for conscious and informed decisions in the market. It is also essential to ensure that competition is fair and effective, so that real value is produced for society.

    The development of the green and sustainable bond market, inaugurated by the European Investment Bank in 2007, is particularly significant here, since this market moves faster than other product segments and acts on expectations rather than in a backward-looking perspective. It is, therefore, particularly effective in shedding light on sustainability objectives and their actual implementation on the ground.

    Green bond market potential

    Driven by investor demand for clarity, the green bond market has already shown its potential, developing to over €700bn in little more than a decade, with exponential growth in the past five years. Further growth, which is directly linked to the expansion of loans and other investments that are eligible for allocation from the bonds, is key to our chances of developing a sustainable economy with the help of finance. 

    © DR

    While most green bonds are issued by banks, it is increasingly common for corporations to issue their own bonds. Big brands in the technology, utilities, automotive and consumer products sectors are among those that have done so.

    The Taxonomy is bound to align investment and issuance classification, since the EU Green Bond Standard prescribes  alignment with it. The European Investment Bank, the largest supranational issuer, is also the first issuer to have tuned the documentation of its green and sustainable bonds to the upcoming Taxonomy in order to permit a gradual extension of loan eligibility for allocations in line with evolving EU legislation.

    The European Investment Bank is a member of the European Commission´s Technical Expert Group  which has worked on the Taxonomy and the related EU green bond standard. The EU bank´s contributions build on the expertise of both project evaluation specialists in the Projects Directorate and sustainability funding officers in the Finance Directorate, who have worked together for years on the development of best practices. Their work has helped the organisation of the green and sustainable bond market since its initial stages. The European Investment Bank has thus been able to chair the Green Bond Principles, non-binding market guidelines coordinated by the International Capital Market Association, in their first three years.

    The tangible progress we have observed bears testimony to the capacity of the bond markets to engage globally in politics, science, technology, finance and civil society on a pragmatic discussion on what is “green” and more generally what is “sustainable”.

    The greatest challenge is not to find investors willing to buy the bonds. Rather it is to build mutual understanding and confidence between issuers and investors along the entire investment chain and across multiple jurisdictions. This is what ultimately links finance with the real economy and facilitates cross-border capital flows to serve goals of global relevance.

    Climate Awareness Bonds for accountable climate change mitigation

    With its inaugural Climate Awareness Bond in 2007, the European Investment Bank promised to allocate the funds exclusively to disbursements to eligible renewable energy and energy efficiency projects, with higher transparency on investment flows—not only approved loans—and ongoing monitoring of their expected impact over time. This is important, since market conditions may constrain the actual flow of funds and, as projects are implemented, the initial impact assumptions may change.

    In this way, Climate Awareness Bonds introduced the notion that it is possible to report on actual investments by sustainability objective, rather than by mere sector, as per current prevailing practice. This highlighted the possibility of a systematic measurement of the impact of the economy on the environment that the capital market can understand and steer. One recent consequence is the emergence of “green loans,” which earn their label because they respond to capital market requirements and are eligible for green bond allocation.

    This has become increasingly important because there are more and more investors who want to invest in climate action and are keen to prove climate commitment—and impact—to their shareholders.

    Let us consider the energy efficiency renovation of apartment buildings, for example. The investor should be able to gauge how effective the investment is by:

    • accurate reporting of the energy saved and
    • the amount of greenhouse gas emissions avoided as a percentage of the total project cost.

    This has become increasingly important because there are more and more investors who want to invest in climate action and are keen to prove climate commitment—and impact—to their shareholders.

    It is a trend that regulators can use to promote sustainability, by asking investors to measure and report impact in a uniform manner, sourcing relevant information in the real economy and using official technical screening criteria that can help comparative analysis.

    Capital markets require simple, comparable and reliable information, which policymakers are then encouraged to facilitate in the form of clearer and more coherent policy signals.

    Pragmatic interaction of markets and policy

    Experience on the ground has also shown, however, that neither science nor markets are capable of achieving sufficient consensus among different actors with regard to core objectives, the combination of diverging priorities and the methodology to be used for objective impact measurement. The intervention of official authorities like the European Commission is therefore required for the coordination of an iterative process leading to the definition of such aspects by cooperative agreement of all relevant constituencies.

    Rather than diminishing the role of capital markets versus the institutional framework, this observation highlights their complementarity. Capital markets require simple, comparable and reliable information, which policymakers are then encouraged to facilitate in the form of clearer and more coherent policy signals. In addition, capital markets are global, fostering international cooperation among official authorities.

    A versatile institution like the European Investment Bank can act as an interface, testing solutions on the ground and providing feedback to markets and official authorities. A case in point is the “White Paper on the need for a common language in Green Finance” that the European Investment Bank and the Green Finance Committee of China Society for Finance and Banking jointly published in 2017 (a second edition was published in 2018). The document, the result of months of technical work and market consultations in cooperation with the World Wildlife Fund, provided a framework to compare the China Green Bond Endorsed Project Catalogue with classifications used by the European Investment Bank and other multilateral development banks as well as external reviewers.  That’s important because China, the EU and multilateral development banks have the largest share of the green bond markets.

    The findings of the paper, together with a concrete classification proposal for climate change mitigating activities fed into the work of the EC's Expert Groups on Sustainable Finance and provides a reference for further work in the context of the International Platform on Sustainable Finance that the EC officially presented at the International Monetary Fund Annual Meetings in Washington–with the support of the People’s Bank of China and the European Investment Bank - in September 2019.

    Credibility from transparent disclosure and third party certification

    Investors used to evaluate their performance based only on financial returns. It now appears more and more important to understand where the money is going, for what purposes it is used and how its impact is measured. In addition to alignment of the use of proceeds with the Taxonomy, the EU Green Bond Standard foresees that issuers describe their strategy and intended practice in a green bond framework and publish both allocation and impact reports, with accredited verification and certification at least of allocation reports. How does this model compare with the European Investment Bank’s practice?

    1. The documentation of the EU bank’s Climate and Sustainability Awareness Bonds (“CAB” and “SAB”) has already been tuned to the upcoming Taxonomy in order to permit a gradual extension of loan eligibility for allocations in line with evolving EU legislation. This will be achieved through progressive adaptation of eligibility criteria and establishment of the required procedures and Information Technology-infrastructure

    2. The European Investment Bank’s projects are earmarked as eligible for CAB and SAB allocation during their appraisal
    3. A project can be between 0 and 100% CAB or SAB eligible. For example, if the percentage of eligible renewable energy components amounts to only 40% of the total project cost, CAB proceeds will be allocated only to 40% of each disbursement to that project
    4. Dedicated project experts determine and review CAB- and SAB-eligibility on an ongoing basis to ensure that eligibility percentages and allocations are up to date. (It may happen that the scope of some projects changes after the original approval, requiring a change in new allocations)
    5. Allocations are made only to new disbursements that follow the issue date of the bonds; they are performed daily on a first in first out basis by an IT-tool, without manual intervention by the back-office
    6. Twice a year, allocations to eligible projects are frozen and booked in the European Investment Bank’s systems as a basis for the verifiable preparation of allocation and impact reports
    7. Once a year, the European Investment Bank publishes a Climate Awareness Bond Framework including detailed description of strategy and administration as well as allocation and impact reports
    8. The Climate Awareness Bond Framework is audited and assured by an independent auditor with “reasonable assurance”–a higher degree of assurance than the limited assurance that is still customary in the market.

    This provides investors with high confidence that the reported data is correct, as well as trust in the integrity of the procedures to record, monitor and report.

    Sustainability Awareness Bonds for broader sustainable development

    The action plan on sustainable finance is not just limited to climate change mitigation. The EU is designing a policy framework for broader sustainable development. In its regulation proposal, it underlines that the EU is committed to the implementation of the UN’s 2030 Agenda for Sustainable Development and takes on board in all its actions and policy initiatives the Agenda’s Sustainable Development Goals.

    Our €500 million Sustainability Awareness Bond in September 2018 marked the European Investment Bank’s first capital market move in this direction. Sustainability Awareness Bonds complement Climate Awareness Bonds by extending the same approach from climate to further areas of environmental and social sustainability. Investors were keen to back the new product, with demand exceeding €1 billion. In the fall of 2019, the issue was increased to €1 billion and complemented by a second SEK 2 billion Sustainability Awareness Bond.

    © MINSA

    The EU bank’s €50 million loan to the Juan Diaz Water Treatment Plant in Panama City was the first project allocated with both Sustainability and Climate Awareness Bond proceeds. In 2018, the Sustainability component, allocated from Sustainability Awareness Bonds, amounted to €13.1 million. The climate change mitigation component amounted to €1.5 million. Specifically, the plant’s water treatment capacity will be doubled from 190 000m3 to 380 000m3, benefitting 450,000 people in the area.

    In 2018, €3.2bn of CAB proceeds were allocated to 76 projects in 29 countries.  SAB proceeds were invested in 15 projects in 12 countries.


    With its CABs and SABs, the EIB is able to attract some investors that do not normally buy EIB paper.

    More clarity on sustainability may facilitate riskier projects

    Clarity on what is “green,” favoured by the further growth of the green bond market, may also entice investors willing to take more risk, facilitating access to credit for those who are not able to access mainstream capital markets directly, such as, for example, sustainable small businesses. This may take the form of loans with preferential pricing or a stake in funds that can consider investment in risky green bonds.

    The European Investment Bank will, for example, invest up to €60 million in a fund managed by Amundi, the largest asset manager in Europe, to buy high-yield green bonds, green loans, and green securitised credit. The EU bank and Amundi's Green Credit Continuum programme will provide up to €1 billion to finance green investments in the EU.

    Green and sustainable loans and bonds are no longer a niche product. There is potential for substantial market growth.

    On 14th November 2019, in the context of the EU Action Plan on Financing Sustainable Growth and the taxonomy regulation that Commission, Parliament and Council of the European Union are presently discussing, the EIB Board of Directors approved a new energy lending policy, as well as ambitious climate action and environmental sustainability objectives for the EU Bank:

    • By the end of 2020: Alignment of EIB Group financing activities with the principles and goals of the Paris agreement.
    • From the end of 2021: End of financing for fossil fuel energy projects.
    • By 2025 and from then on: Gradual increase in the share of financing dedicated to climate action and environmental sustainability to reach 50% of new operations.
    • 2021-2030: Support EUR 1 trillion of investments in climate action and environmental sustainability.

    In the near future this policy will be complemented by measures to ensure a just transition for those regions or countries more affected so that no one is left behind.

    Climate solutions if you are a ….

    • Policy maker: Provide clear policy signals (objectives and targets) and significant thresholds for sustainable investments
    • Investor: Buy green bonds and recognize the good value of green finance
    • Financial institution: Reclassify and measure the impact of your investment portfolio

    Aldo Romani is Head of Sustainability Funding at the European Investment Bank in Luxembourg.

    >> “Climate Solutions” is also available as a podcast and an e-book.