Green Debt Products

Thursday, 4 June 2020

The concept of sustainability and environmental protection has also recently found its way into the financing sector. By issuing so-called Green Bonds or granting green/sustainable loans, the attractiveness of investments in environmental and climate protection measures shall be increased. The European Union has developed an action plan for this purpose, which is intended to mobilise more private capital to combat climate change or to achieve greater sustainability in the economy through both binding and non-binding legal acts.

The centerpiece of the action plan for sustainable finance presented by the European Commission in 2018 is the planned "Taxonomy Regulation", which is intended to establish a uniform classification system for sustainable investments. According to the proposed wording of the regulation, financial products are considered sustainable if they significantly promote at least one of the relevant environmental objectives (1) climate protection, (2) adaptation to climate change, (3) sustainable use and protection of water and marine resources, (4) transition to a closed loop economy, waste prevention and recycling, (5) prevention and reduction of pollution or (6) protection of healthy ecosystems and do not significantly harm any of the other objectives (e.g. significant emissions of pollutants to achieve the objective). More detailed provisions on the environmental objectives and their technical evaluation are to follow from delegated acts to be adopted gradually over the coming years. The establishment of a uniform and transparent "sustainability seal of approval" is also intended to counteract so-called greenwashing.

Sustainable forms of financing have also emerged in the financing sector in the recent past. In the following, the most important characteristics of so-called "green bonds" and sustainable loans will be described.

Green Bonds

A so-called green bond is basically a normal bond, but the proceeds of the bond are to be used for sustainable purposes. To date, there are no legally binding guidelines regarding Green Bonds, but the International Capital Markets Association (ICMA) has published its Green Bond Principles (GBP) for the first time in 2018 to promote the creation of an international standard for Green Bonds. The four pillars of the ICMA-GBP are (1) the use of funds for general sustainable environmental objectives or a specific sustainable project, with the ICMA GBP containing an indicative list, (2) investor information on the selection process of the environmental objective/project, whereas issuers typically publish a framework, which is updated on an ongoing basis, to comply, (3) transparent fund management, such as through sub-accounts, and (4) regular reporting on the use of proceeds and project development. In addition, the ICMA-GBP recommend the involvement of external auditors to enhance market confidence.

In June 2019, the EU Technical Expert Group on Sustainable Finance set up by the European Commission has published a proposal for the establishment of a separate EU Green Bond Standard (EU-GBS), which is to be essentially based on the ICMA-GBP described above. In addition, however, for the purpose of informing investors, issuers will be required to establish and publish a Green Bond framework and to have external reviews conducted by accredited auditors.

The presented guidelines are currently not binding. Classification as a Green Bond is therefore currently not dependent on compliance with these requirements. However, there are plans at EU level to adopt the Green Bond standard as part of a legal act.

Green credits / sustainable credits

Although no binding legal acts have been passed for loans, models have already been developed in the international lending market to include sustainability factors in loan documentations.

The Loan Market Association (LMA) has issued guidelines for sustainable lending in 2019. Although these are not legally binding and only have the character of recommendations, the financial sector usually bases its lloan documentations on the LMA's guidelines, for example when granting high volume international loans. The guidelines contain both so-called "Green Loan Principles" (GLP) and "Sustainability Linked Loan Principles" (SLLP).

- Green Loan Principles (GLP)

GLP are not limited to loans, but can in principle be implemented in any form of financing. The principles are essentially based on the six environmental objectives of the Taxonomy Regulation and stipulate that the funds received must be used to implement a project to promote the environmental objectives, that this must be evaluated by the borrower in advance and regularly during the term of the loan, and that a reporting system must be established to enable the lender to verify compliance with specified environmental objectives. The GLP are particularly suitable for project financings.

- Sustainability Linked Loan Principles (SLLP)

In contrast to GLP, which aim at promoting a specific purpose, the use of SLLP can promote the overall sustainability of an entire company. The focus here is not on the use of funds, but rather on improving the borrower's sustainability profile on the basis of concrete sustainability targets to be determined by the company, which are usually oriented towards the areas of ESG (E - Environment, S - Social and G - Governance). In most cases, the level of the interest margin is linked to the development of the sustainability targets. These are reviewed during the term of the loan as part of a reporting system to be set up or by external auditors. Financing with integration of SLLP is therefore suitable for financing of ongoing business operations.