In the broader climate-aligned market, meanwhile, there is now around $1.5tr of bonds outstanding, according to numbers published by the Climate Bonds Initiative (CBI).
In recent years, however, there has been a growing recognition that the market’s longer term growth potential may be limited by ambiguity over definitions. As the G20 Green Finance Synthesis Report explained in 2016: “In many countries and markets, the lack of clarity as to what constitutes green financial activities and products (such as green loans and green bonds) can be an obstacle for investors, companies and banks seeking to identify opportunities for green investment.”
Aldo Romani, head of sustainability funding at the EIB’s Luxembourg headquarters, says he is encouraged by the response of all market participants to the threats posed by this lack of clarity in the green capital market. “Policymakers, project specialists, lenders and capital market practitioners have all made progress in injecting more clarity into the market,” he says. “The result is that areas that were totally unintelligible two or three years ago are now more transparent.”
Further substantial progress on this path, says Romani, is expected to come from the European Commission, which in May 2018 presented a package of concrete measures as a follow-up to the Action Plan on Financing Sustainable Growth. Originally announced in March, this Action Plan was a response to recommendations from the High-Level Expert Group (HLEG) on Sustainable Finance submitted in January 2018.
Developing a broadly-recognised taxonomy
The proposals announced in May are a significant landmark for the Green capital market. As well as establishing a framework for a unified EU classification system – or “taxonomy” – of sustainable economic activities, they strengthen disclosure requirements on how institutional investors integrate environmental, social and governance (ESG) factors in their risk process. The Commission’s package also creates a new category of benchmarks designed to help investors compare the carbon footprint of their investments.
Romani says that a notable feature of the EC’s package is that it is intended to be based on highly pragmatic, market-driven proposals. He adds that the EIB itself has made a number of key recent initiatives dovetailing with the Commission’s measures to promote clarity in the global sustainable finance market. A striking recent example was the creation of his Sustainability Funding Team, which launched the bank’s first Sustainability Awareness Bond (SAB) in September.
Romani explains that this €500m eight year transaction, the proceeds of which are earmarked for investment in water projects with significant impact, is an important milestone because it extends the transparency embedded in the bank’s CABs to a range of environmental and social objectives beyond climate.
An open-ended approach
“It does this in a number of ways,” he says. “The first is that it links the use of proceeds to objectives rather than activities. The second is that it takes an open-ended approach to the eligibility of activities serving these objectives. The third is that eligibility is linked with the Commission’s agenda of establishing the EU sustainability taxonomy. The SAB thus provides a showcase.” This approach, Romani adds, will soon be applied also to EIB’s green bond issuance. “Next year, we will begin to test new documentation for our CABs using the open-ended approach that we apply to the SABs,” he says.
Another compelling example of EIB’s commitment to enhanced transparency and comparability in the green bond market is the initiative it has developed in partnership with China’s Green Finance Committee (GFC), which was set up in 2015 by the People’s Bank of China (PBoC). In 2017, the EIB and the GFC jointly authored a white paper mapping out common principles for climate mitigation finance which was a notable step towards reaching global consensus on a standard-neutral taxonomy for use of proceeds. An interim report has just been published in a second EIB-GFC white paper at COP 24 in Katowice. “Before we can co-ordinate action between the two superpowers of the environmental finance market, we need to agree on a common language or at least establish a translation mechanism for our two languages,” he says.
Strategic opportunities
Establishing a common taxonomy that is recognised by all participants active in sustainable finance, says Romani, will have measurable benefits for the bank and for the broader green capital market. “The EIB sees not just a tactical but also a strategic opportunity arising from greater clarity and comparability in the market,” he explains. “Considerable synergies will be generated internally, extending to project evaluation, lending and risk management, as well as capital markets.”
Additionally, Romani believes that the adoption of a common taxonomy will increase lending opportunities across the sustainable market, in turn helping to bolster the EIB’s total issuance of green bonds, which already exceeds €20bn. “We can only add to our issuance of CABs and SABs if we can demonstrate that our lending standards meet the requirements of investors,” he says. “A clarification of these standards with the help of the EU taxonomy will support our lending and therefore our funding because it will define what we can allocate on the asset side with a higher degree of precision and reliability.”
In the context of the wider sustainable finance arena, meanwhile, Romani is confident that progress towards a common language will increase capacity in the market, encouraging more issuers and investors to participate in green bonds, kick-starting a virtuous cycle by fuelling more diversity and liquidity in the sector. “My expectation is that more clarity will enlarge the market for green bonds because by reducing reputational risk it will attract more issuers and investors,” he says. “Irrespective of who those issuers and investors are, this will support performance in primary and secondary markets.”
Against this backdrop, it is small wonder that Romani is upbeat about the next step in the establishment of a unified classification system in the green capital market and the underlying green economy. “If the Commission is able to live up to expectations, the market will have made an enormous step forward,” he says.