Internationally accepted guidelines such as the International Capital Markets Association’s Green Bond Principles have helped formalise the structure of a green bond. New issuers can now benefit from the experience of their structuring advisors who themselves have contributed to those guidelines.
Based on our proprietary green bond assessments, the average score at the time of issuance (‘the ex-ante score’) has risen over the years (see Exhibit 2). We believe this reflects that most issuers have indeed applied those guidelines in terms of structure and information disclosure.
However, those minimum standards do not yet cut out greenwashing. Tackling this is becoming a high-level regulatory issue in the EU where the EU Commission plans to protect customers against these practices.
In recent years, we have seen green bonds from issuers to finance solar PV projects, but these issuers are also expanding environmentally harmful activities elsewhere, such as new coal-fired power plants. On occasion, this is done on a larger scale than the environmentally beneficial activities. In essence then, the green bond is ‘greenwashing’ the issuer. In other words, the bond is not credibly green, no matter how well structured it is.
We believe it is now time for us to upgrade our methodology to formalise a new approach to assessing green bonds. We will be more discerning between bonds that do not just meet minimum market expectations, but also deliver credible environmental benefits at both the bond level and the issuer level.
Green bonds: green-ness, integrity, ambition
The concepts of ‘green-ness’, ‘integrity’, and ‘ambition’ should be distinguished when we assess green bonds.
- Green-ness should be about the extent of the environmental benefits that the use of proceeds generates, i.e. how green is this green bond?
- Integrity should be about the processes and management systems of governing the proceeds, mitigating potential negative risks from the associated projects, and measuring and reporting on the green bond project, i.e. how strong is the integrity of the green bond?
- Ambition concerns the issuer’s ambition, and the extent to which the bond contributes to it, i.e. how does the bond contribute to achieving the issuer’s decarbonisation efforts?
For a green bond to be credible, it must deliver on all concepts. No single concept is a sufficient condition by itself. To illustrate this, a green bond whose proceeds are used to finance utility-scale solar PV is considered green, but if the reporting fails to cover how the proceeds were allocated, tracked and reported on, the ‘integrity’ is weak. If the issuer has no deliberate renewable power targets as part of its power mix, the ‘ambition’ is weak.
Our upgraded green bond framework – an overview
BNPP AM’s Sustainability Research Team applies a two-step framework to assess each green bond:
- Ex-ante – at the time of issuance
- Ex-post – 1-2 years after issuance.
Source: BNPP AM, March 2021
Our assessment results in a score out of 100 points, and a corresponding rating of Positive, Neutral, or Negative. For our global green bond strategy, the investment universe is limited to bonds rated Neutral and Positive.
Our four components
- Issuer ESG decile & ambition – We exclude green bonds from issuers if they are in the bottom 10% of the peer group in terms of their ESG score. Issuers which are on our exclusion lists (in breach of our Responsible Business Conduct policy, and other sector policies) are in decile 10. This step includes assessing how the green bond helps the issuer transition towards a more sustainable model.
- Green-ness of use of proceeds – We have adopted the EU Taxonomy to assess green-ness of use of proceeds. This is the strictest taxonomy available. In some cases, we apply stricter criteria. We use alternative criteria in the event that data does not exist to verify the initial criteria. For the environmental objectives not yet covered by the taxonomy, we apply our own taxonomy. We score the use of proceeds on five levels (i.e., Aligned, Potentially Aligned, Partially Aligned, Not Aligned, Excluded) according to the extent to which they are aligned with the criteria of the taxonomy. We also check if the use of proceeds is certified against the Climate Bond Standard.
- Implementation integrity – There are two sub-elements.
1) How does the issuer respect the “Do No Significant Harm” principles? How does the issuer reduce the risk of negative externalities during the implementation of the projects/activities? Are there any negative controversies surrounding the issuer that may indicate future potential harmful externalities?
2) How does the issuer intend to allocate the proceeds within a timeframe and its share of refinancing? What is the issuer’s timeline for fully allocating the proceeds? What percentage of proceeds is used for refinancing and new financing?
- Allocation & Impact reporting integrity – Assessing the environmental impact. If the issuer does not report on this 12-24 months after issuance, we will exclude the green bond.
- For the post-issuance report, we check:
- How the proceeds are allocated (e.g. 40% of proceeds allocated to renewable energy)
- The output from the financing (e.g. pro-rated 35MW of renewable power project is financed by the proceeds)
- The impact associated (e.g. 100 000 tonnes of CO2 avoided from pro-rated output financed by the green bond).
We also check if the methodology used to estimate the impact is disclosed and explained (e.g. assumptions, baselines). Third-party verification of the report will boost its credibility. Finally, we assess how the bond contributes to the issuer’s sustainability ambition (e.g. % contribution to decarbonisation trajectory).
At the end of each step, we can choose to add either a bonus overlay or a penalty overlay to the overall score after assessing the various components to arrive at our final score and recommendation.
The overlay is informed by our conviction of the ambition of the issuer, for example, doubts over the credibility of the issuer’s sustainability strategy, a lack of clarity over planned eligible green projects/activities, incoherent future capital expenditures. Our conviction can also be based on elements that have not been formalised in our framework, e.g. unclear positive environmental benefits from eligible projects/activities.
Across the lifecycle of the bond, we monitor for negative controversies or high reputational risks related to the green bond. Sources include our portfolio managers who closely watch the issuers as well as rating agencies. If the negative controversy or reputational risk is substantial, we will not hesitate to sell the green bond to safeguard the reputation of our clients.
Our green bond assessment framework allows us to discern between green bonds by:
- Applying the strictest taxonomy to ‘green-ness’
- Assessing the implementation ‘integrity’ of the green bond
- Assessing the green bond’s contribution to the issuer’s ’ambition’.
- Benchmarking sustainability
- Positioning for a green recovery from COVID-19
- EU Climate Target Plan – A stepping-stone to climate neutrality
- Towards a sustainable finance system – Further yet to go
More on fixed income investing
 EU – New Consumer Agenda Plans : https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52020DC0696
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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