Stockholm (NordSIP) – In its latest report on monitoring capital flows to sustainable investments, the EU Platform on Sustainable Finance, an advisory body to the EU institutions, proposed treating sustainability-linked bonds (SLBs) separately from the rest of sustainable finance instruments such as green or social bonds.
SLBs are one of the investment securities traditionally associated with sustainable finance. According to data from Nordea used in NordSIP’s 2023 annual review of sustainable fixed income markets, global and Nordic SLB issuance amounted to US$70.42 billion (7% of the global total) and US$6 billion (9.8% of the Nordic total) last year, respectively.
Asides from the appropriate methodology for monitoring SLBs, the report also discusses a number of other topics, including the size and distribution of the sustainable investment gap, the role of the EU Taxonomy and of the Corporate Sustainability Reporting Directive (CSRD), the relationship between green and transition financing, among others.
The Platform’s Proposal
The report seeks to propose a methodology for monitoring capital flows, so this is not a final decision. However, the Platform is seen as an expert and committed advisory group whose opinion carries a lot weight. In the past, it played key roles in the establishment of the EU Taxonomy and other EU sustainable legislative initiatives.
The reason for treating SLBs separately from Green Bonds has to do with transparency and accountability for the use of proceeds. “Integrating these instruments would require an in-depth assessment of the materiality and ambition of SLB targets, in light of criticism of some SLBs in the market. In the absence of this assessment, it is not possible to ascertain the share of SLBs that should be considered as supporting the transition,” the report explains. “In addition, SLBs often mix environmental and social KPIs which raises several data granularity issues to monitor these instruments,” the report continues.
Monitoring SLBs as General Purpose Bonds
As a result, the Platform decided to monitor SLBs as part of general purpose bonds.“SLBs are instead analysed like any general-purpose bond, as well as specifically for entities in transition. Given data availability it will not be possible to measure whether issued bonds are refinancing existing debt or financing new debt,” the report adds.
“Lastly, general-purpose bonds including SLBs will be monitored based on the entity characterisation as per the methodology outlined in the Real Economy section. This will generate a percentage matching of the bond towards Green Deal objectives,” the report adds. “This will not generate a figure which with confidence can be considered to represent the contribution of the instrument to the Green Deal investment gap. It does, however, inform the picture of general-purpose bond issuance depending on the underlying CapEx characteristics of the entity,” the report continues.
AFII Criticisms
The Platform’s decision was not welcomed by everyone. “The platform’s work is very focused on its own capital expenditure framework such as the EU Taxonomy and the EU Green Bond Standards – where a lot of time and effort has been invested – so it is perhaps not surprising that they struggle to warm to non-capex-focused transition financing solutions, such as sustainability-linked bonds,” Ulf Erlandsson, CEO of the Anthropocene Fixed Income Institute tells NordSIP.
“Building a wind-farm (green capex) does not help from an emissions perspective if you don’t shut down the coal plant next to it. In that sense, we find outcome-focused structures, like SLBs, which enable issuers to address their total emissions, to be very complementary to project-focused structures, like green bonds,” Erlandsson continues.
“If there is one number to take away from the report, it’s Figure 4, showing that the EU’s Industrial sector Scope 3 emissions are in excess of 5Gt per annum. As an investor, I would love to buy EU-issued bonds where the coupon is linked to a reduction of that Scope 3 emissions bombshell. It is unfortunate that the Platform on Sustainable Finance don’t think there should be a focus on such solutions,” Erlandsson adds.
“The mandate from the Commission was to develop a framework to monitor green capital flows against the investment gap, which means that monitoring capital flows to harmful activities is out of scope. Impact of capital flows is important, but not part of this iteration of the methodology,” Karl-Oskar Olming (Pictured), Head of Sustainability Strategy and Policy at SEB and one of the lead authors of the platform’s report told NordSIP in response to Erlandsson’s comments.
SLBs are Useful But not for Everyone
As a product, SLBs can be a bit awkward for investors because they seem to stand at the frontier of financial categories. In the past, we noted that SLBs may not be regulatorily very efficient for banks. As Maria Caneman, Head of Debt Investor Relations (IR) and Ratings at Nordea explained on that occasion, SLBs on the balance sheet may potentially not be useful for the application minimum requirement for own funds and eligible liabilities (MREL). MREL is set by resolution authorities to ensure that a bank maintains at all times sufficient eligible instruments to facilitate the implementation of the preferred resolution strategy, in case the bank faces financial hardship.
At the same time, while there is no regulatory ban on the inclusion of SLBs in sustainable investment funds reporting under Article 9 of the Sustainable Finance Disclosures Regulation (SFDR), some such fund managers have expressed unease about their inclusion, specifically due to the fact that they are general purpose bonds.
The Rest of the Report
Although the categorisation of SLBs by this report from the Platform on Sustainable Finance has attracted media attention, that is only one part of the report. “While the measurement of how sustainable investments are financed is an important part of this report, especially given the impact normally associated with primary market transactions, the main focus of the report is to consider what actual investments are being made in the real economy,” Olming says. According to the Platform, the purpose of the report is “to propose an architecture to measure the effective contribution of finance towards the objectives of the European Green Deal.”
“The report seeks to answer three important questions: First, given the present €620 billion financing needs, are there enough sustainable investment projects to bridge this gap?” Olming explains. According to the report, current investment levels are in the order of €940 billion, significantly short of the European Green Deal objectives of €1.6 trillion per annum until 2030.
“Second, the methodology aims to consider whether the companies carrying out sustainable investment projects in the real economy are receiving enough financing. Our understanding is that there are pockets of the market where there is not enough capital. This is more about the risk level connected to new green technologies Olming explains.
“Lastly, the Platform wants to know whether sustainable finance policy has been sufficiently mainstreamed in the financing and investment strategies of financial firms. Our aim is to create a framework that allows the EU to consider facts around these issues,” Olming adds.
Going Forward
The Platform will continue to develop its work on monitoring sustainable capital flows. Data is foremost on the agenda. “The next part is about populating the framework with data. At the moment we can get data from the EBA and ECB and ESG data vendors. Going forward, a lot more data will be coming with CSRD and more reporting from the Taxonomy,” Olming explains.
Another priority for the Platform is to ensure the capital flow monitoring framework is clear and user-friendly. “We need to develop a generic format for the report that can be hosted by some other EU institution outside of the Platform, once it becomes a regular annual publication,” Olming concludes.
