When Assicurazioni Generali became the first European financial institution to sell a green bond in a subordinated format in September, it forced other financial institutions to sit up and take note.
The Italian insurance company was said to have benefited from huge savings with its new deal, suggesting that issuers stand to gain more when combining their green funding plans with traditional capital planning.
French insurer CNP Assurances swiftly followed Generali’s example, selling €750m of green tier two bonds in November. The issuer was also able to secure a stellar result for its socially responsible deal, benefiting from strong demand in a busy market.
But European banks are still lagging behind. Though there has been in a rise in the supply of green senior bonds counting towards their total loss-absorbing capacity (TLAC) targets or minimum requirements for own funds and eligible liabilities (MREL), they have yet to take the plunge and issue capital instruments in a green format. The explanation could all come down the question of where banks are putting their priorities.
The general focus for issuance from the region’s lenders has been meeting TLAC and MREL requirements with senior debt, rather than on bolstering their subordinated debt buffers to meet total capital requirements. Many institutions are also still labouring to put the necessary debt issuance frameworks in place to allow them to offer socially responsible investments in the primary capital markets.
Joop Hessels, head of green bonds at ABN Amro in Amsterdam, says that finding cost savings through green bond sales is not the greatest challenge facing borrowers at the moment.
“The issue is not so much the pricing, it’s more the availability of projects, lending and expenditures,” he says. “Sometimes these are difficult to measure and report from current systems as these were not designed with sustainability in mind.”
Taxonomy breakthrough
The problem of identifying eligible green assets for green bonds has been common to all issuers in the capital markets. The EU has been developing a classification system, or “taxonomy”, to help market participants identify sustainable economic activity. The taxonomy, which could be in place in 2020, is expected to help bolster green bond issuance.
“We need to see what the final EU taxonomy on Sustainable Finance will look like, but there also needs to be clarity about how it’s implemented and if more data is provided to support issuers to identify taxonomy-eligible assets,” says Hessels.
Many banks have also been thinking about what they can do on the asset side of their balance sheets to build up a great stock of green assets. Some firms, for example, have started offering favourable rates of financing for projects or clients they consider to be sustainable.
“A better pricing in green loans could trigger a higher demand for green financing instruments and therefore potential new green bond issuances from financial institutions for financing these green loans,” a Technical Expert Group noted in a July report on EU green bond standards.
Hessels says that it is “a matter of how banks can incentivise clients to engage in more sustainable activities such as increase the energy efficiency of their processes and buildings”.
“This could be increased significantly if there would be a differential in pricing, which could be passed on to the customers,” he adds.
Despite the challenges in structuring new deals, there is no doubt that there has been increasing momentum behind green issuance this year.
European banks have raised a record $26.8bn equivalent of green, social and sustainable bonds in 2019, through a mixture of senior bonds, covered bonds and even asset backed securities (ABS). They are expected to further diversify their choices of formats in the coming years.
“Issuers are interested to know if there will be a pricing benefit in comparison with non-sustainable bonds,” says Hessels.
Generali was said to have saved up to 10bp with its €750m tier two in September. This was much higher than the kind of “greenium” that borrowers have secured through ordinary green funding instruments — typically no more than handful of basis points.
European banks are close to realising that they could also save money by turning some of their most expensive issuances green.
“It’s just going to take one bank to get a green capital deal out the door and then there will be a rush,” says Sean Kidney, chief executive of the Climate Bonds Initiative. “We’ll see that in the next 12 months.”