As NRW.BANK celebrates the 10-year anniversary of its green bond programme Frank Richter and Christian Hardt outline what is next for the development bank as it deepens its ESG approach on both the funding and investment side of the business
Environmental Finance: How has NRW.BANK's green bond programme evolved over the last decade?
Frank Richter: We started our green bond programme in 2013. At the time, we were the first issuer from a German jurisdiction to do so. Our approach has always been not only to fund our green projects but to also develop market standards to broaden and deepen the green finance market.
Our milestones achieved over the last 10 years include:
- In 2014, we sourced a second party opinion (SPO) to confirm the environmental benefits of our green projects.
- The following year we joined the International Capital Market Association (ICMA) Green Bond Principles initiative.
- In the same year, our first impact report was published. Since then both SPOs and impact reports have become cornerstones of our green bond programme.
- Since 2021, we have issued our green bonds in line with the EU Taxonomy and Green Bond Principles, as defined by the Technical Expert Group (TEG) on Sustainable Finance.
NRW.BANK has not just evolved in the green bond market in qualitative terms either. Volume of issuance matters when working towards a 1.5°C target and NRW.BANK's green bond programme has grown substantially in the last couple of years. In 2022, we mobilised €1.5 billion ($1.6 billion) in green bonds – a record level for us.
All these efforts have paid off and we were one of the first issuers to be rewarded by the market for these high-quality bonds via a 'greenium'. As a non-profit-maximisation institute, we passed the greenium on to the lending side, thereby encouraging more borrowing to be used for green projects.
Since 2020, our taxonomy-aligned projects have enjoyed an additional interest advantage of between three and five basis points.
EF: What lessons have you learned over the last 10 years?
FR: Credible issuers who follow a coherent ESG strategy and set ambitious (climate) targets, while providing an open dialogue and transparent reporting, can enjoy a very warm reception from investors. Given the current pricing differential between green and conventional bonds, issuers are being compensated for their efforts.
To achieve maximum benefits, we have learned an issuer has to adapt to new market standards as quickly as possible. For example, once the EU finalises the new EU's green bond standard (GBS), we will issue green bonds In line with this standard.
EF: Your social bond programme has been running since 2020. What are the main priorities of the programme?
FR: The social bond market is an 'emerging' market in comparison to the more established green bond market. Efforts from (public sector) issuers to counter economically unintended consequences and manage the health issues resulting from the Covid-19 pandemic were a catalyst for growth in the social bond market. Market participants now acknowledge the importance of 'S' as well as the 'E' in the sustainability concept of ESG.
ESG-related management of the corporate portfolio
In contrast to the Covid-focused issuances, our social approach was broader. It combined pandemic recovery elements with other social issues. Our programme operates under the ICMA Social Bond Principles. In contrast with the green bond programme – where we make use of the loan-to-bond approach - we follow a pool-to-bond approach on the social side. There is no link between an individual loan and a single social bond.
In January 2022, the programme was upgraded as we published an updated framework. Since then, the social bond pool consists of loans for:
- Social cohesion via affordable home ownership – targeting young (lower) middle-class families;
- Labour market – targeting the demand side via SMEs and targeting the supply side via education facilities (kindergartens, schools, universities);
- Healthcare sector – targeting vulnerable groups via hospitals and care homes;
- Economically disadvantaged municipalities – targeting underserved citizens in order to equalise living conditions;
- Regional resilience via disaster management capacities.
EF: What have been the challenges in impact reporting on the social bond programme?
FR: Reporting on the social side is much fuzzier and more complex. Green reporting is focused on science-based CO2 savings. You can debate which benchmark suits you best. Impact reporting for our social bond programme is based on the Theory of Change (ToC) metrics. ToC metrics establish an outcome pathway and defined intermediate goals.
The availability of data is key if you want to measure the outcome of your inputs. Looking at our affordable home impact we see that we have reached approximately 1500 units for vulnerable groups and provided a financial relief of up to €450 a month per household.
Looking at our impact in the labour market, approximately 40,000 new jobs have been created annually from the loans to SMEs incorporated in the asset pool.
We still have to improve on the impact analysis for our lending to the education sector and municipalities. Nevertheless, we are walking along a path, and it is important to keep on moving as we try to improve year-on-year.
EF: On the investment side of the bank, you have been developing an ESG investment framework – can you outline the work that has been conducted there?
Christian Hardt: Sustainability is a central guiding principle and a key criterion for NRW.BANK's decisions on business policy. We are aware of our responsibility as an investor to support the transformation of society towards a climate-neutral economy.
The framework enables us to describe our current ESG approach in more detail. We had done this for many years in labelled funding with our green and social bond framework so, we thought, why not have a framework for the investment side as well? The framework enhances the transparency of the integration of ESG criteria in our investment portfolio – which is a fixed income portfolio investing mainly in sovereigns, supranationals and agencies (SSAs), financial institutions and corporates.
The framework provides information about our objectives regarding the six Principles for Responsible Investment (PRI) and the expectations of our stakeholders. It also outlines our approach to achieving a climate-neutral investment portfolio by no later than 2045.
We apply a mix of thematic investing, norm-based exclusions, best- and worst-in-class screening and forward-looking portfolio management. We also engage with the companies we invest in that fail to prevent or address social or environmental controversies in line with established expectations for Responsible Business Conduct.
The framework complements our green and social bond frameworks and enhances the sustainability integration of NRW.BANK's capital market activities.
CO2 savings calculated by Wuppertal Institut
EF: What have been the main challenges in the integration of sustainability criteria in the investment portfolio?
CH: Each component faces individual challenges. But the general challenge is to define a harmonised concept that considers all asset classes within a very dynamic environment. We face diverse stakeholder expectations and evolving regulatory and supervisory requirements while simultaneously facing a lack of international standards and heterogeneous data sources. It is a very tricky exercise.
In this environment, it is a major challenge to select the right parameters. For the time being, NRW.BANK is convinced that the consideration of established market standards – but also widely applied ESG ratings, scores and other services of renowned providers of ESG data – is the most sensible approach.
Selecting ESG scores and ratings involves thorough research to understand their individual strengths and weaknesses. While ESG rating provider offerings are far from harmonised, that does not mean that they do not add tremendous value. The research behind the ratings and scorings simply cannot be done ourselves.
Another challenge is the general harmonisation of ESG integration and expectations, not only in the portfolio management itself but also for our overall sustainability strategy, credit analysis and risk management. All business units must be involved to ensure a holistic approach. Even though we have integrated ESG aspects since 2017, this is still quite new terrain for all of us. Continuous exchange is necessary, and we have implemented a working group for that.
EF: How will the framework inform your investment process and strategy?
CH: The framework is designed for those stakeholders interested in details of our ESG investment approach and is a base for corresponding reporting requirements. In addition, it sheds light on methodologies of scorings and classifies them where necessary.
We are convinced that transparency is key. And we hope that the framework will receive feedback that can then be incorporated into the development of our ESG strategy. We have to learn from each other, and transparency is essential for that.
We think that the framework is the perfect way to outline our current approach and ideas. For instance, we selected a KPI [key performance indicator] that considers climate risks but also the transition efforts of companies. We think it has the potential to become a market standard. It is called an Implied Temperature Rise (ITR) Metric and is recommended by the Portfolio Alignment Team of the Task Force on Climate-Related Financial Disclosures (TCFD) and applied by MSCI ESG Research.
It is a forward-looking estimate. It is designed to help investors seeking an investment strategy aligned with the Paris Agreement, as it shows the temperature alignment of companies. The metric is used as a first step in managing our corporate portfolio in line with the Paris Agreement and we will apply it to other asset classes if possible. As pointed out before, market standards are still missing, thus transparency is key to correctly classifying our ESG integration approach.
Calculation basis of MSCI research's ITR indicator
EF: What can the funding side of the bank learn from the investment side and vice versa when thinking about NRW.BANK's ESG approach more broadly?
FR: Funding and investment are intrinsically linked. Both sides learn from each other. For instance, it is important that both issuers and investors have a clear strategy. If we are in an allocation process in the primary market, investors following a clear green mandate are very welcome. We try to green the entire supply chain from the projects to the issuer to the bond, to the investor.
CH: We started our ESG approach on the funding side and investors are material stakeholders in this. The feedback we receive informs our ESG investment strategy. The funding side also benefits from the investment side as we can outline what is important for ESG-focused investors. One example is ESG ratings. They are relevant for many investors and a fundamental component of our ESG investment approach. Thus, we are able to focus on the right information in investor meetings and presentations.
EF: What are your plans for 2023?
FR: Aside from aligning our green bond programme with the upcoming new gold standard – the EU GBS, investors can expect NRW.BANK to be a frequent issuer of EUR-denominated green and social bonds. If we have the opportunity to do more this year, we will.
CH: On the investment side, we are focusing on analysing ways to apply a Paris-aligned portfolio management approach to other asset classes. In addition, we will continue to evaluate the relevant ESG management parameters – which are based on MSCI ESG Research's scores – with other providers. The observation of market developments and regulatory and supervisory requirements remains a core task.
Christian Hardt is a senior specialist for sustainable finance & ESG at NRW.BANK.
Frank Richter is head of investor relations at NRW.BANK
For more information, see: www.nrwbank.de/en/about-us/sustainability/.