ESG & Institutional Investment

Part 5

Henrique C. Martins

ICMA

ICMA: International Capital Market Association link.

  • The International Capital Market Association (ICMA) is a non-profit organization that represents the interests of the global financial market.

  • It provides a forum for financial institutions, investors, and other stakeholders to discuss and develop policies, practices, and guidelines for the global capital markets.

  • The mission of ICMA is to promote resilient well-functioning international and globally coherent cross-border debt securities markets, which are essential to fund sustainable economic growth and development.

  • The idea is to ensure that investors can trust the financial system while companies access capital at a reasonable cost.

ICMA

ICMA serves as Secretariat to the

  • Green Bond Principles (GBP),
  • the Social Bond Principles (SBP),
  • the Sustainability Bond Guidelines (SBG) and
  • the Sustainability-Linked Bond Principles (SLBP)

while also trying to lead the Climate Transition Finance Initiative

The Principles are a collection of voluntary frameworks with the stated mission and vision of promoting the role that global debt capital markets can play in financing progress towards environmental and social sustainability.

ICMA

Climate Transition Finance

In order to meet the global objectives enshrined within the Paris Agreement on Climate Change to keep the global temperature rise this century well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5°C, significant financing is needed.

The concept of climate transition focuses on the credibility of an issuer’s climate change-related commitments and practices.

Climate transition finance is the extent to which an issuer’s financing program supports the implementation of its climate change strategy. This strategy should clearly communicate how the issuer intends to adapt its business model to make a positive contribution to the transition to a low carbon economy.

Corporate climate change strategies should respond to stakeholder expectations by purposefully and explicitly seeking to play a positive role in achieving the Paris Agreement.

Climate Transition Finance

In Summary, Climate Transition Finance is about:

  1. Creating a corporate strategy,

  2. Acknowledge material risk factors

  3. Use science-based evidence

  4. Be transparent.

Climate Transition Finance

There are four key elements to these recommendations:

1. Issuer’s climate transition strategy and governance:

The financing purpose should be for enabling an issuer’s climate change strategy. A ‘transition’ label applied to a debt financing instrument should serve to communicate the implementation of an issuer’s corporate strategy to transform the business model in a way which effectively addresses climate-related risks and contributes to alignment with the goals of the Paris Agreement.

2. Business model environmental materiality:

The planned climate transition trajectory should be relevant to the environmentally-material parts of the issuer’s business model, taking into account potential future scenarios which may impact on current determinations concerning materiality

Climate Transition Finance

3. Climate transition strategy to be ‘science-based’ including targets and pathways:

  • The planned transition trajectory should:

    • be quantitatively measurable (based on a measurement methodology which is consistent over time);
    • be aligned with, benchmarked or otherwise referenced to recognized, science-based trajectories where such trajectories exist;
    • be publicly disclosed (ideally in mainstream financing filings), include interim milestones, and;
    • be supported by independent assurance or verification.

Climate Transition Finance

4. Implementation transparency.

Acknowledging the various pressures that issuers from hard-to-abate sectors are currently coming under, there is an obvious incentive to respond in the short term with announcements regarding strategy, targets and related commitments.

However, addressing the issue of financing of business operations and infrastructure to ensure the operational picture can deliver the announced response over extended time horizons is more challenging and time-consuming.

For this reason, it is recommended to provide transparency with regard to the planned capital and operational expenditure decisions which will deliver the proposed transition strategy.

Examples of Green Projects

  • Renewable energy
  • Energy efficiency (such as in new and refurbished buildings, energy storage, etc.);
  • Pollution prevention and control (including reduction of air emissions, greenhouse gas control, soil remediation, waste prevention, etc.);
  • Environmentally sustainable management of living natural resources and land use (including environmentally sustainable agriculture, etc.)
  • Terrestrial and aquatic biodiversity conservation
  • Clean transportation
  • Sustainable water and wastewater management
  • Climate change adaptation: (including efforts to make infrastructure more resilient to impacts of climate change)
  • Green Buildings

Types of Green Bonds

  • Standard Green Use of Proceeds Bond: an unsecured debt obligation with full recourse-to-the-issuer only and aligned with the GBP.
  • Green Revenue Bond: a non-recourse-to-the-issuer (i.e., with collateral) debt obligation aligned with the GBP in which the credit exposure in the bond is to the pledged cash flows of the revenue streams, fees, taxes etc., and whose use of proceeds go to related or unrelated Green Project(s).
  • Green Project Bond: a project bond for a single or multiple Green Project(s) for which the investor has direct exposure to the risk of the project(s) with or without potential recourse to the issuer, and that is aligned with the GBP.
  • Secured Green Bond: a secured bond

Green Bonds Principles

The four core components for alignment with the GBP are:

  • Use of Proceeds: describes the utilization of the proceeds of the bond for eligible Green Projects.
  • Process for Project Evaluation and Selection: communicate the goals of the project and how the project fits within GBP.
  • Management of Proceeds: create processes to make sure the proceeds are used in the project described.
  • Reporting: demand full transparency with up to date information.

Green Bonds Principles

The GBP also has two Key Recommendations

1) Green Bond Frameworks: It is recommended that issuers summarise in their Green Bond Framework relevant information within the context of the issuer’s overarching sustainability strategy

2) External Reviews: is recommended that issuers appoint (an) external review provider(s) to assess through a pre-issuance external review the alignment of their Green Bond or Green Bond programme and/or Framework with the four core components of the GBP

Green bonds principles

Social Bond Principles (SBP)

Examples

  • Affordable basic infrastructure (e.g. clean drinking water, sewers, sanitation, transport, energy)
  • Access to essential services (e.g. health, education and vocational training, healthcare, financing and financial services)
  • Affordable housing
  • Employment generation, and programs designed to prevent and/or alleviate unemployment stemming from socioeconomic crises
  • Food security and sustainable food systems
  • Socioeconomic advancement and empowerment

Social Bond Principles (SBP)

The four core components for alignment with the SBP are:

  • Use of Proceeds: describes the utilization of the proceeds of the bond .
  • Process for Project Evaluation and Selection: communicate the goals of the project and how the project fits within SBP.
  • Management of Proceeds: create processes to make sure the proceeds are used in the project described.
  • Reporting: demand full transparency with up to date information.

Social Bond Principles (SBP)

The GBP also has two Key Recommendations

1) Social Bond Frameworks: Issuers should explain the alignment of their Social Bond or Social Bond programme with the four core components of the SBP in a Social Bond Framework or in their legal documentation.

2) External Reviews: is recommended that issuers appoint (an) external review provider(s) to assess through a pre-issuance external review the alignment of their Social Bond or Social Bond programme and/or Framework with the four core components of the SBP.

Sustainability Bond Guidelines (SBG)

Sustainability bonds are bonds where the proceeds will be exclusively applied to finance or re-finance a combination of both green and social projects.

They must follow the GBP and SBP.

The common four core components of the Principles and their recommendations on the use of external reviews and impact reporting therefore also apply to sustainability bonds.

Sustainability-Linked Bond Principles

Sustainability-Linked Bonds (“SLBs”) are any type of bond instrument for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined Sustainability/ ESG objectives.

The objectives are (i) measured through predefined Key Performance Indicators (KPIs) and (ii) assessed against predefined Sustainability Performance Targets (SPTs).

Sustainability-Linked Bond Principles

The SLBP have five core components:

  1. Selection of Key Performance Indicators (KPIs): should be measurable, relevant, verifiable, etc.
  1. Calibration of Sustainability Performance Targets (SPTs): SPTs are the targets that the issuer wants to achieve.
  1. Bond characteristics: The cornerstone of a SLB is that the bond’s financial and/or structural characteristics can vary depending on whether the selected KPI(s) reach (or not) the predefined SPT(s), i.e. the SLB will need to include a financial and/or structural impact involving trigger event(s).
  1. Reporting: The issuer reports relevant information.
  1. Verification: Issuers should seek independent and external verification of their performance level against each SPT for each KPI by a qualified external reviewer with relevant expertise.

Sustainability-Linked Bond Principles

Finger et al 2018 JIFMIM Source

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