A broader approach to ESG

In response to market developments and the economic fallout of the Covid-19 pandemic, NRW.BANK adapted its approach to capital markets and environmental, social and governance (ESG) initiatives this year. Frank Richter outlines key milestones for the German lender, including the issuance of the bank's first social bond and a revision of its Green Bond Framework

Last year was a remarkable year in many ways. During the Covid-19 pandemic, we have had to weather many changes in the private and public sphere. NRW.BANK, for instance, relocated up to 75% of its staff into home offices. Thanks to good IT infrastructure, the agency's productivity has not been hurt by this unconventional working environment.Frank Richter

NRW.BANK has been active in mitigating the economic consequences of the Covid-19 pandemic. As part of the federal development network, it has channelled KFW – the German state-owned development bank – funds to the North Rhine-Westphalian region to assist the regional economy. On behalf of the regional government, NRW.BANK also administered its own programs to target infrastructure operators (such as airports and hospitals), municipalities, and small and medium-sized enterprises (SMEs) which were not covered by KFW funds.

During this period, there have been many milestones for the bank as our approach to capital markets and ESG factors have had to rapidly adapt as well. Our ESG focus has become both

broader and deeper; broader in the sense that the bank's first social bond was issued, and deeper in that the Green Bond Framework has been updated in line with the latest market developments.

NRW.BANK's inaugural social bond

The decision to enter the social bond market was made in the Autumn of 2019. Using ICMA's Social Bond Principles (SBPs), and in close cooperation with CA-CIB and HSBC, a robust framework was applied. A second-party opinion (SPO) was provided by ISS ESG and reporting by Wuppertal Institute. The impact reporting will be part of our sustainability report and will be published in June 2021.

NRW.BANK issued a use of proceeds bond that will refinance an asset pool (pool-to-bond approach) that intends to help provide affordable homes for young families, loans for businesses and schools, and to address structural economical disequilibrium in the region.

Affordable home ownership has been targeted towards young families specifically as they often struggle to access properties in the areas where home and flat prices are increasing rapidly.

According to the Federal Construction Child Allowance (Baukindergeld), couples qualify as along as their taxable annual income is lower than €75,000 ($90,400). The bulk of taxable income per debtor is below €50,000.

General loans to small- and medium-sized companies will target corporate demand for labor. With these loan programs NRW.BANK intends to stabilise employment levels and stimulate job creation. If the annual turn-over over the business is below €50 million then it qualifies. In cases where this number is exceeded, they still qualify if it is a "family business", meaning management corresponds to ownership.

Special loans granted to municipal and/or denominational school boards will be used for upgrading the school buildings to make them digital, accessible and energy efficient. The aim is to have a positive impact on the qualifications of students so that they become a valuable resource for the future workplace and that schools should be inclusive as well.

Economically disadvantaged municipalities will also receive funding. Municipalities with a GDP/Capita in the lowest (fourth) North Rhine-Westphalian quartile, with an unemployment rate above the regional average, will receive loans to improve public goods and services.

Our look-back period

We believe benefits from social infrastructure erode slowly. In other words, a longer look-back period does not harm the project's quality. As the Social Bond Principles do not specify a recommended length of look-back periods, we applied the EU Green Bond Standard (GBS), as drafted by the Technical expert group on sustainable finance (TEG), as reference. Here, operational expenditure can be refinanced by a green bond as long as it is not older than three years. Three years sounded reasonable to us and so we applied the EU GBS advice to our social bond framework.

Based on the defined targeted population outlined above and the fixed look-back period, we estimate the size of the social bond asset pool is approximately €8.5 billion. The distribution over the three years is more or less equal. However, we note that during cyclical upswings we tend to experience increased lending to SMEs, while lending to economically disadvantaged municipalities shrinks. The reverse is true during recessionary periods.

Pool-to-Bond approach

The asset pool is dynamic and rolling through time. At the beginning of each calendar year, the past year will be added to the pool, while the assets of the oldest year will leave the pool. Against this pool NRW.BANK can issue bonds in every currency and tenor as long as the volume of outstanding bonds is smaller than the available asset pool. Limitations occur only due to internal guidelines. For instance, usually our maximum maturity doesn't exceed 30 years, or the maximum issue size is not larger than €1 billion. The pool-to-bond approach also allows for more flexibility so that taps and commercial papers could be used.

Green and social bond performance

Investor reception

During June, NRW.BANK familiarised investors with the social bond framework. Some investors criticised the look back period and the thresholds, but the majority agreed and confirmed their interest.

Once the decision was taken to offer a 15-year €1 billion transaction, the books opened immediately. After 90 minutes the book closed with more than 100 individual orders mounting beyond €3 billion. Both are record levels for NRW.BANK.

After tightening in the book building process, the inaugural bond tightened further by 4.5 basis points on average in the first four weeks after pricing. The bond is listed at the Luxembourg Green Exchange (LGX).

EU GBS integrated Green Bond Framework

Immediately after finalizing the social bond transaction, we reviewed our Green Bond framework. The aim was to align it as closely as possible to the drafted EU GBS. Even though the standard and the taxonomy is not yet finalised, we believe the new framework – even if only temporary – is useful for market participants. We want to keep the green bond market buoyant and we want to issue regularly. Therefore a "wait and see" position does not suit us.

The updated framework prepared the ground for our first green bond that was issued in January 2021 and was well received by investors and the market, who applauded the bond and framework's alignment to the EU GBS and EU Taxonomy. As with our social bond, ISS ESG provided the SPO and Wuppertal Institute will be responsible for the impact reporting to be published in June 2022.

ISS ESG confirmed that the framework is in line with the draft EU GBS. In addition, assets we chose for the first transaction under the new framework correspond to the drafted EU Taxonomy. We met the technical screening criteria without harming other environmental objectives and the projects still comply with minimum social safeguards.

For the mitigation part of the bond, 40% of the green bond was focused on renewable energy i.e. on wind, solar power and transmission grids. The second largest block was focused on upgrading the existing housing stock and four university hospitals, at 37%. Finally, investments in clean transport (e-mobility, public and freight transport) completed the mitigation unit with a further 17%.

The remaining 6% supports adaptation efforts through restoration of the river Emscher and its tributaries. Increasing the climate resilience of the region is one of the top priority targets. The entire Emscher loan program has been aligned to the EU taxonomy since the summer of 2020 and, consequently, it benefits from the green refinancing curve where we pass funding advantages - generated by our green bond program – through to the lending side.

We made sure that the selected projects also contribute to the EU's Green Deal. Projects worth €500 million meet the required thresholds and all our projects are aligned with the do no significant harm (DNSH) criteria. They also comply with minimum labor, human or environmental standards.

Given that our mission is limited to the German Federal State of North Rhine-Westphalia and that we are focused on SMEs, private individuals or public sector entities, we only operate in a highly regulated market with regional clients. No stakeholders have had any concerns that we do not meet the DNSH criteria and minimum standards.

Other developments

In addition to these two important milestones, NRW.BANK made progress in several other areas this year with regards to its sustainability initiatives:

Since April 2020 the entire lignite and hard coal value chain has been excluded from our Sustainability Guidelines. Since January 2021 NRW.BANK has committed itself explicitly to the Paris climate goal and our loan, service and investment policies will contribute to climate neutrality by 2050.

Corresponding to NRW.BANK's broader funding approach, the Green Bond Investment Portfolio broadened its scope towards sustainability. All bonds corresponding with ICMA's Green or Social Bond Principles and the Sustainability Bond Guidelines qualify for the Sustainability Bond Investment Portfolio. Our ambition is to increase the volume up to €500 million at the end of 2021.

NRW.BANK became an UN PRI signatory in 2020.

In 2020, NRW.BANK also became a member of the Green Asset Wallet (GAW) and the NASDAQ Sustainable Bond Network (NSBN). NRW.BANK supports transparency and welcomes all initiatives supporting market participants collecting information in an efficient manner.

With regards to external developments that are encouraging, on 1 January 2021 Germany's Federal Government kicked off the national emission trading system (nETS). Covering the transport and heating sector the nETS is complementary to the EU ETS, which covers the industry, power generating and air traffic. The nETS prices a tonne of CO2 initially at €25. In 2025, the price per tonne will be €55. Auctions are scheduled after this time.

Towards the end of 2020, the first 300 MW lignite power plants closed. On the hard coal side, 4785 MW – thereof 2830 MW in North Rhine-Westphalia – left the market as well.

All in all, there are many reasons to be cautiously optimistic.

NRW.BANK in a nutshell

NRW.BANK is a regional German development bank. The agency is owned and explicitly guaranteed by the Federal State of North Rhine-Westphalia. With total assets of €149 billion (2019) NRW.BANK is the second largest German development bank. NRW.BANK's mission is to support SMEs, municipalities, affordable housing and to fight climate change in the region. Since 2013 NRW.BANK issue green bonds to refinance environmentally friendly projects. Since January 2020, an (internal) green refinancing curve is in place. EU Taxonomy (drafted version by the TEG) aligned projects have access to additional interest subsidised loans.

Contact: Ophelia Percival-Thiery
Email: ophelia.percival-thiery@nrwbank.de