From brown to green: financing the sustainability transition

Channels: Green Bonds

Companies: UniCredit, MSCI ESG

People: Antonio Keglevich

There is much more to sustainable finance than helping companies issue green bonds, UniCredit's Antonio Keglevich tells Environmental Finance

Environmental Finance: UniCredit has a long pedigree in sustainable finance, but last year launched a Sustainable Finance Advisory team. What was the thinking behind the new approach?

Antonio Keglevich, global head of sustainable finance advisoryAntonio Keglevich, global head of sustainable finance advisory: This is an initiative designed to enhance the quality of our strategic dialogue with clients, mainly around sustainability-related topics.

The mission of the team is to advise on the development and execution of sustainability strategies and frameworks, as well as potential sustainability-related financing solutions.

The team helps our clients to define their current and near-term ESG-related challenges and opportunities, before leveraging our resources with a product-agnostic approach.

Our Equator Principles team is an integral part of the new set-up, as it brings deep experience in the key financial industry benchmark for determining, assessing and managing environmental and social risks in projects.

Both teams will work in alignment to define eligible project categories.

EF: You note that the approach is product agnostic – what is the range of solutions you offer clients?

AK: This is not only bond-related; we are happy to support our clients in defining, for instance, green, social or sustainability bond frameworks.

However, if the alternative is more suitable for the prospective client, we will advise them to go into the loan market with, say, either an ESG-linked or KPI-linked loan or even a green loan, which is basically the parallel to the green bond product.

We also consider all sorts of conceptual ideas around how we can integrate sustainability scopes within other products, such as hedging instruments, exchange-traded funds [ETFs] or investment products that the bank offers to its private clients.

This is really an ESG-wide approach to banking products.

EF: What advantages does this approach offer to the service you can offer to clients?

AK: I think it's important to understand that the DNA of green finance at UniCredit comes from the green bond market, given that that's where everything started and where our coverage was originally concentrated.

This new approach reflects that ESG conceptually is not only a question of bond financing, so we decided to transfer the activity from a product-driven approach into an overall advisory function.

This enables us to bring in the product experts whenever we deem them to be the right partner and to ensure that the ESG concept is embedded in the underlying product.

EF: UniCredit is involved in advising clients on 'brown to green' transition strategies. Can you give examples of this sort of work?

AK: As long as the use of proceeds from green bonds are exclusively applied to projects that are aligned with the four core components of the Green Bond Principles, then yes, brown issuers can raise green finance.

The last edition of the principles, in 2018, made a slight amendment in the second component, which deals with the selection process.

In that component, the principles state that issuers should communicate their process for project evaluation and selection, to put their use of proceeds definition into context with their overall environmental/sustainability objectives and strategies.

But, essentially, green bonds apply to companies who already have project categories or assets that qualify as green.

Now, for those who have the ambition to transition to green in the future, the green bond market is basically closed, and this is where the transition bond comes into play; we welcome initiatives that try to address rules of engagement to create credible instruments to help finance this transition.

It's important to understand that 'brown to green' has a higher positive environmental impact than financing companies that are by definition already green.

This is something that we really need to address because, if we are not able to deliver on that sort of solution, we will find it extremely difficult to achieve the goals of the Paris Agreement to hold the rise in average global temperatures to no more than two degrees above pre-industrial levels.

The challenge here is to avoid greenwashing and make sure that the integrity of the underlying instrument is being upheld

EF: UniCredit has been a leading player in the sustainability loans market. What are the relative advantages for borrowers of tapping this market rather than issuing green bonds?

AK: The vast majority of sustainability loans are linked to overall corporate KPIs or ESG indicators, rather than specific green projects, which enable the borrower to use the proceeds for general corporate purposes.

There is no need to define a framework or undertake an external review in the form of a second-party opinion. The issuer does not need to produce a yearly allocation

report, and there is more flexibility in defining KPIs – as they can cover not only environmental but also social and governance factors.

This instrument is basically aligned with the overall sustainability strategy of a company, bringing the client's needs into a sustainability context. We are seeing huge demand for the product.

The disadvantage is that, if the borrower fails to deliver on the KPIs, or if its ESG score goes down, it will have to pay a higher interest rate.

Such loans incentivise borrowers to work on their sustainability strategy through a connection to their financing.


EF: UniCredit was joint-bookrunner for the ENEL sustainability linked-bond, which represented a kind of migration of the sustainability loan approach into the bond market. How was the bond received by investors?

AK: The ENEL bond was extremely well-prepared and the company made sure that the market understood the concept before they offered it.

Talking to ESG investors, what they liked about the concept is that issuers are penalised if they do not deliver.In the green bond market, if you fail to deliver on the use of proceeds promise, then nothing happens.

The bond continues to exist and the harshest repercussion faced by the issuer is a reputational one. ENEL announced a meaningful and ambitious sustainability target, for instance the increase of renewable energy generation to 55% of the total within two years from 46%.

If it fails to deliver, it pays out a higher coupon. From the point of view of the investor, they are rewarded for the failure of the target, which is somewhat counterintuitive. Notwithstanding that potential contradiction, we found, when we analysed the order books that a great number of investors participated because of the ESG scope of that bond. Now, the big advantage of this type of bond, as in the sustainability loan market, is that the issuer doesn't need a green bond framework, or second-party opinion, etc.

The issuer just has to ensure that its auditor gives the correct information to the market. It is a slightly more straightforward product – we are discussing with other issuers about similar transactions.

EF: What are your thoughts on the EU Sustainable Finance Taxonomy? Do you think it will help to direct greater volumes of finance to the green economy?

AK: There is still a lot of misunderstanding around the Taxonomy. It does not define sustainable industries or sectors, but instead presents a list of economic activities that are regarded as sustainable.

That is extremely important to understand. The regulation has identified six environmental objectives for the purpose of this taxonomy and, to qualify as a sustainable activity, it has to address at least one of those six environmental objectives, whilst at the same time not do any harm to the remaining five.

This list of economic activities is not exhaustive and additional activities will be added in the future. Conceptually, the report that sets out the Taxonomy is really a masterpiece because it systematically describes sector classifications and activities, defines criteria in the form of principles, technical metrics and thresholds, and every activity is subject to this do-no-significant-harm assessment.

The potential caveat, however, is that it tries to be a one-paper-fixes-all concept and does not really take into account specific local situations in Europe.

For example, waste to energy is not regarded as a sustainable activity, mainly because the Commission concentrated on the incineration process.

This raises a number of questions around the alternatives, such as landfill, or the climate benefits that can be generated by waste-to-energy projects. Equally, some of the technical metrics are so strict that it is going to be very difficult to define some sustainable activities under the pure definition of the taxonomy.

Green, social and sustainability bonds in USD (bn)

Source: Climate Bonds Initiative, Bloomberg, UniCredit Research; as of 7 January 2020

EF: In terms of the buy-side, what patterns of demand are you seeing from investors?

AK: It's fair to say that demand is by far larger than supply. The Global Sustainable Investment Alliance, in its last report, found that almost every fourth dollar globally is being invested using some kind of ESG criteria.

The corresponding number is $31 trillion. The most commonly used ESG strategy is exclusionary screening (for sectors such as tobacco, alcohol or gambling).But what we see from investors who are focused on sustainability solutions is the call for a wider variety of use-of-proceeds categories: they don't want to concentrate only on renewable energy and energy efficiency which, in the green bond market, constitutes almost two-thirds of outstanding issuance.

They are calling out for opportunities in other areas: transportation, the circular economy, climate change adaptation and biodiversity, for example.

We also see many investors who are interested in the concept of transition bonds, because they realise that the impact of these investments is potentially higher from an environmental point of view compared to investing in companies that already have a considerable amount of green assets or projects. They are looking forward to rules of engagement emerging around transition bonds.

Sustainability linked and green loans in USD (bn)

Source: Climate Bonds Initiative, Bloomberg, UniCredit Research; as of 7 January 2020

EF: Is there an adequate range of products allowing investors to gain exposure to green and sustainability debt?

AK: We are certainly seeing continued innovation in this area.

For example, UniCredit worked with MSCI ESG to launch the world ́s first exchange-traded fund on European green bonds (ISIN:LU1899270539) at the end of 2018. The product offers all investor goups a low-cost means to access a broadly diversified range of liquid euro-denominated green bonds from European issuers.

Since its launch, it has attracted a lot of attention among investors and media and has shown a strong positive performance over the last year.

We are also expanding the range of opportunities for our private client base – we're seeing considerable interest from that part of the market in green and sustainability products.

Across the board, there is great and growing investor enthusiasm for solutions to the sustainability challenges we face and we are working hard to match the financing needs of solutions providers with the capital that our investor clients want to put to work.