22 February 2019
The European Investment Bank's Head of Sustainability Funding, Aldo Romani, explains why the green bond pioneer is extending its capital market approach to sustainability and why he is optimistic about EU efforts to roll out sustainability taxonomies and standards.
Environmental Finance: Could you explain the relevance of the EU sustainable finance action plan for the green bond market?
Aldo Romani: The green bond market has provide d key inputs to the reflection of the European Commission since the creation of the High-level expert group on sustainable finance (HLEG) at the end of 2016. After HLEG’s final report was published in January 2018, the Commission announced the action plan, proposed a legislative framework and created the technical expert group (TEG).
The TEG is addressing HLEG’s recommendations very concretely, starting with a classification (taxonomy) of the economic activities that contribute substantially to EU sustainability objectives. This analysis should facilitate the identification of what can be considered eligible for investment seeking significant impact on sustainability, not only via bonds but also via loans and other financial instruments. Another objective is the definition of an EU green bond standard. Use-of-proceeds green bonds address the widest spectrum of potential investors in a very transparent and responsive market; they are therefore the financial instrument that so far creates the highest degree of accountability on the underlying activities of the issuer and an impulse for their ongoing improvement within the framework that the EC is putting in place.
Why is this action relevant? Because it addresses the lack of clarity that hampers sustainable finance. If there is no shared understanding of what is sustainability, you cannot orientate and accelerate mainstream capital market investments to support it. These markets need two things: certainty and comparability. This is exactly what the Commission is trying to deliver. It’s the only way to provide a reference for responsible investment decisions, reduce risks and costs, enhance efficient allocation of capital and foster market support to sustainability objectives. At the same time, the focus on economic activities goes to the essence of this challenge: to pursue sustainability seriously you need to measure the contribution of your activities to sustainable objectives in a reliable manner. It’s a very positive development.
At the same time, the discussions taking place in the HLEG and now in the TEG do not shy away from highlighting that developing taxonomies and standards is complex. Sustainability doesn’t just refer to climate but also to other sustainability objectives. It makes practical sense to provide a showcase in the area that is on everybody’s agenda, climate change mitigation, and then extend the approach consistently to other environmental and social objectives. Another important feature of the Commission’s approach is that objectives may not be considered separately: a substantial contribution to one objective may not significantly harm another.
Turning theory into practice is always the most difficult part and, given the complexity and pressure involved, I don’t envy those who work on the TEG sub-group on taxonomy. Their work is really very important, their efforts should be recognized and welcomed.
EF: Are you confident the taxonomies will be accessible and understandable to capital market participants who aren’t sustainability experts?
AR: I certainly hope so. The objective of DGFISMA isn’t perfection but to establish conditions to improve the way capital markets support sustainability. If the published classification of economic activities leads to an excessive degree of complexity, capital market participants will ask for more simplicity. A constructive dialogue between the market and policy makers is required to clarify what makes sense: what is needed to map reality with precision may be too complex for the market to digest. A balancing act is necessary and numerous market participants, including the EIB, are involved in the TEG to provide input and help develop solutions that serve the market pragmatically.
This is, in my view, also an important function of the Green Bond Principles (GBPs), equally represented on the TEG. EIB is one of the co-ordinators of the GBP working group on green projects eligibility and it’s clear from our discussions that you can’t bring in too much complexity into definitions and classifications because it will scare off market participants.
The move towards a green taxonomy
Efforts to establish a classification (taxonomy) of sustainable activities are at the heart of the EU action plan on financing sustainable growth. The EU’s 35-strong technical expert group (TEG) has been tasked with the mammoth job and in December published its draft taxonomy for climate mitigation activities as well as a suggested approach to climate adaptation activities.
TEG’s taxonomy sub working-group has asked financial market participants for feedback on the usability of the proposed mitigation taxonomy. The next step is to develop an overarching approach to adaptation activities. A first taxonomy for climate change mitigation activities is scheduled for delivery in June. The complete taxonomy, to be tackled at a later stage, is expected to address other environmental and social objectives and underpin delivery of the action plan.
TEG’s EU green bond standard sub working-group has undertaken targeted outreach consultations with corporate issuers, large investors, active underwriters, verifiers and supervisory agencies. It plans to open to a broader public consultation in February or March.
EF: The work on creating an EU green bond standard is attracting a lot of attention – can you explain what you hope the standard will achieve? And how can this work be applied outside the EU to help boost the global green bond market?
AR: There should not be any fear of standardisation because the standard will be applied on a voluntary basis. A standard in fact offers a benchmark off which it is easier to clarify one’s preferences and make more informed investment decisions; it provides guidance. Compliance with minimum requirements in terms of transparency and comparability are bound to enhance accountability and credibility. Essential will be the mediation between the taxonomy required to map economic activities and the market’s need for a practical tool based on a handful of primary impact indicators. The focus of the Commission on clearly defined objectives that are easy to operationalize is crucial in this regard. Even if the classification and standard aren’t perfect, the important thing is that they make core aspects of sustainability understood by capital market participants. This will drive sustainable investment in a more effective way than today.
It’s important that common objectives may be pursued on different paths depending on individual circumstances and priorities, and that different standards can co-exist. China took the initiative already in 2015 to create a catalogue of projects eligible for allocation from green bonds. The establishment of an EU taxonomy and an EU green bond standard will now provide a term of comparison. China and the EU of course need to develop an ongoing dialogue on their standards for their action to converge. EIB’ projects and capital markets experts have worked together with the China Green Finance Committee for over two years now in order to develop mutual understanding and a shared classification approach in the area of green finance. The goal is to foster cross-border flows of green capital seeking significant contributions to meaningful local objectives pursued within the framework of increasing international cooperation and monitoring.
For this purpose, we should also consider establishing a platform through which you can compare different standards – essentially a high-level comparison of primary objectives, activities, impact indicators and significance thresholds adopted by individual standards, e.g. the Chinese standard, the EU standard, the MDB-IDFC standard and those provided by influential players such as the Climate Bonds Initiative. This is an idea that we are presently discussing within the GBP working group on green projects eligibility.
EF: You mentioned the increasing importance of social objectives. What is the EIB’s role in supporting thematic bond growth beyond climate – for example social bonds?
AR: The EIB has recently decided to establish a dedicated sustainability funding team in its capital markets department. Sustainability funding will cover all areas of sustainability via the issuance, in all currencies, of Climate Awareness Bonds, with focus on climate change mitigation, and Sustainability Awareness Bonds, with focus on other sustainability objectives. This is expression of the strategic stance the bank is taking in this field.
The expansion the EIB is undertaking from climate to sustainability awareness bonds is partly a reflection of policy drivers. 11 years ago, we launched the first Climate Awareness Bonds (CABs), which focused only on renewable energy and energy efficiency. Why? Because these were two key areas of focus in the 2007 EU energy action plan to mitigate climate change. The EIB is a policy instrument of the EU and decided to increase its lending targets to these two areas.
The EIB’s Sustainability Awareness Bonds
The EIB issued a EUR 500 sustainability awareness bond (SAB) in September last year, marking its first capital market move into sustainable objectives beyond climate change mitigation. Investors were keen to back the new EIB product, with demand exceeding more than EUR 1bn.
The proceeds are meant for allocation to projects that ultimately contribute more broadly to UN Sustainable Development Goals, as the bank looks to highlight not just projects focused on climate change, but also other environmental and social objectives.
The first allocations have been to high-impact water projects, which the EIB said have robust performance impact indicators demonstrating strong contribution to key sustainability objectives (water conservation, pollution prevention and control, access to water and sanitation, natural disaster risks management). Over time, other sustainability objectives will be considered for SABs, with potential inclusion of projects in areas including health, education and sustainable and resilient cities.
Now, what’s happening is that the Action Plan on financing sustainable growth isn’t just limited to climate change mitigation. The EU is designing a policy framework for broader sustainable development. As a result, we started issuing Sustainability Awareness Bond (SAB) in September last year to shed light on EIB’s lending activities serving additional (environmental or social) objectives. The first to be allocated have been water projects with significant impact on water conservation and pollution prevention/ control (environmental objectives) as well as access to water and sanitation and natural disaster risk management (social objectives).
In the SAB documentation, we’ve included a clear reference stating that the bonds for the first time will focus on sustainability objectives beyond climate change, with an open-ended approach to the inclusion of additional objectives and project categories over time - once it is agreed how to measure the primary contribution to those objectives from a wider range of projects. As a matter of fact, EIB is using its technical expertise and capital market experience to provide a test case of how the EU-approach can be used to map and measure lending activities with significant impact on sustainability in a way that is easily understandable to capital markets.
But EIB’s climate bonds are not disappearing. We’ve decided to maintain the CAB brand for projects focused on climate change mitigation, with the idea to include additional project categories beyond RE&EE in the future.
In a nutshell, there is an enormous potential for market growth, as more and more areas of the balance sheet can be covered by green and social bond issuance.
EF: More broadly, what are your expectations for the green bond market and the wider sustainability bond market in 2019?
AR: I’d hope to see a greater awareness in the market that sustainability bonds, and now I’m referring to both green and social bonds, are not just a marketing instrument. They are an instrument we can use to shed light on what happens in the real economy, to rethink and reform its structure with the help of the accountability, not only the funds, secured by capital markets. There is an increasing incentive for financial players to contribute to environmental and social objectives and I hope the ongoing developments may help this course.
We need to create instruments to help people understand the environmental externalities of economic activity. Sustainability bonds are contributing to this endeavour and capital markets are turning into an important vehicle of social learning. In China, the awareness of the ecological impact of the economy is so high that the process of recognising externalities has become an absolute priority reflected in relevant legislation. It’s important this takes place in Europe too – the EU has highlighted in its action plan the necessity of stimulating economic actors to “measure the environmental costs of their business and profits derived from using environmental services”.
Of course, you can’t go from 0 to 100 in one day. We need strategic change and because of this it is important to clarify the impact of what you’re doing and how it can be improved overtime through changes in strategy. We can’t just point fingers at those not doing anything or not doing enough. We have to offer mechanisms and products through which one can address the problem concretely.
Green bonds offer a very concrete mechanism for quick and pragmatic capital markets to join the sustainability movement; bonds make visible the underlying activities, with knock-on effects. We have already witnessed a start to move beyond green bonds, with green loans that are labelled as such because they respond to capital market requirements and are eligible for green bond allocation. I expect more developments in these areas in 2019.
I also think it’s useful that finance experts are increasingly playing a role in the sustainability debate, since the objective is to increase market support. Who is responsible for coordinating the taxonomy and classification work at the European Commission? It’s the Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA). Here at the EIB we’re seeing a similar trend. The capital markets department is driving and co-ordinating discussions around sustainability alongside the project experts, helping them in simplification choices that are necessary to bring their stories to the markets, with ex-post reporting offering the opportunity of a more comprehensive description.