Responsible investment in green bonds

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Margaret Thompson
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1 Responsible investment in green bonds march 2016

2 Contents 1 Green bonds 3 2 Investing in themes Climate Land Water 4 3 Definition of green bonds 5 4 Conclusion 7 Appendix 1: CBI Standards 8 CONTENTS 2

3 1 Green bonds Climate change is one of the main challenges of the coming decades. Climate is a central theme of ACTIAM s investment policy. The changes that are necessary, such as a switch to a low-carbon economy, require huge investments. As the money generated by green bonds is specifically allocated to sustainable activities, these bonds are a means of actively helping to bring about the transition to a low-carbon economy and thus having a positive impact. Other means employed by ACTIAM for this purpose are the ESG score and active ownership. 1 This green bond market has grown in recent years, a process that is often considered to have started in 2007 with the issue of the Climate Awareness Bond by the European Investment Bank. Whereas ACTIAM initially concentrated mainly on green activities such as renewable energy, it has recently widened its focus to include social bonds and even blue bonds for water-related projects such as sustainable fisheries. ACTIAM is an active player in this bond market and is involved in various initiatives. For example, it sits on the Executive Committee of the Green Bond Principles (GBP), which draws up transparency guidelines for the issuance of green bonds. ACTIAM also supports the Climate Bonds Initiative (CBI) and helps to develop standards. Such standards make it easier for investors to gauge the greenness of a green bond. This policy paper describes the choices ACTIAM makes when buying green bonds designed to have a positive impact. Such choices are made by reference to the GBP and the standards of the CBI. ACTIAM s focus themes of climate, land and water are then addressed in greater detail. Besides green bonds, ACTIAM also wants to invest more in social bonds designed to provide access to housing, health services and an adequate income. At present, however, there is still no agreement between the relevant market players about the precise definition of social bonds and there are still major obstacles to measuring and reporting on their impact. Once standards similar to GBP and CBI have been formulated and adopted for social bonds, this policy paper will be modified. 1 The aim of engagement is to encourage companies to change their behaviour. ACTIAM will exclude companies from its portfolios if, despite engagement, they continue taking irresponsible risks with the generation of nuclear energy or the extraction and combustion of fossil fuels, or make an insufficient contribution to the energy transition. The aim of the ACTIAM ESG score is to compare companies and sovereigns in terms of their sustainability performance and to calculate an ESG score at portfolio level, which can then be used by ACTIAM to measure the portfolio's sustainability in comparison to its benchmark. A bonus of 10 or 20 points to a companies' ESG score increases the likelihood of investment in a green bond in those funds for which it is agreed that the ESG score should be at least higher than its benchmark. GREEN BONDS 3

4 2 Investing in themes ACTIAM has defined three focus themes, including some relevant activities and technologies, to which green bonds can make a positive contribution: climate, water and land. 2.1 CLIMATE 2.2 LAND Utility companies Fuel switch from coal to gas Renewable energy Solar and wind energy Tidal and wave energy Biofuels Grid management Smart electricity grids Energy storage Transformers at sea Financial institutions Green mortgages and (property) loans Industry Cogeneration Fuel switch options Reuse of residual heat Transport Urban electric railway Hydrogen-powered and electric cars Electric/hydrogen charging points Hybrid cars and cars powered by natural gas High speed trains Built environment Refurbishment of housing stock Afforestation and reforestation Sustainable forest management Prevention of deforestation Soil remediation Protection of biodiversity Promotion of animal welfare through organic farming 2.3 WATER (Waste) water management and more efficient waste water treatment Clean water projects Climate adaptation: water storage, climate buffers and river widening INVESTING IN THEMES 4

5 3 Definition of green bonds In ACTIAM s view, compliance with the GBP guidelines on process transparency does not provide a clear answer to the question of what makes a bond green. Unlike the CBI, GBP is not a standard for determining whether projects can be treated as green. The CBI has developed standards for a few activities and technologies so that investors can assess the impact of the bond concerned (see Appendix 1). This is important because once money has been lent and allocated to projects, it is locked in. This means that it can no longer be used - at least for the time being - for projects that might have had a more positive environmental impact. It follows that where projects involve the same type of activity or technology, the one with the most ambitious and credible climate targets should be chosen. However, only a few of the green bonds researched by ACTIAM have been certified in accordance with the CBI standards. Possible reasons for the lack of certification may be unwillingness on the part of issuers to pay for certification costs, the strictness of the green criteria applied by the CBI, and the inadequate pressure exerted by investors on issuers to comply with the CBI standards. Furthermore, green bonds often cover a number of activities, for some of which no criteria may yet have to be defined. For this reason, ACTIAM needs to continue carrying out its own research in order to be able to assess the greenness of bonds. This research into greenwashing has been summarised in Table 1 below. Steps Yes CONSEQUENCES OF ANSWERS No Before issuance of the green bond 1. Is the issuer of the green-designated bond excluded? 2. Is the issuer of the green-designated bond a worst offender or involved in controversial projects? 3. Do the financed projects appear on the CBI s exclusion list? 4. Does the bond meet ACTIAM s positive impact test and the GBP guidelines? 5. Does the issuer have a credible, broad and ambitious transition strategy for the themes of climate, water and land? After issuance of the green bond 6. Does the bond meet ACTIAM s positive impact test? ACTIAM cannot invest in the green bond. Go to step 2. ACTIAM can invest in the green bond provided that there is credible and robust ring-fencing. ACTIAM does not classify the bond as green and therefore does not allocate it a green label or increase the ESG score of the relevant issuer. Go to step 5. ACTIAM awards a green label and increases the issuer s ESG score by the permitted maximum of +20. Go to step 6. ACTIAM reports on the positive impact of the bond. Go to step 3. Go to step 4. ACTIAM does not classify the bond as green and therefore does not allocate it a green label or increase the ESG score of the relevant issuer. ACTIAM awards a green label, but the bond s ESG score is increased by only +10. Engagement is initiated only if the bond is purchased. Green label is maintained, but engagement is initiated if evidence of positive impact is not forthcoming. On the basis of step 1, ACTIAM checks first of all whether the issuer of the green bond complies with the Fundamental Investment Principles. If this minimum requirement has been fulfilled, ACTIAM will go through steps 2 to 5 for both worst offenders and non-worst offenders that wish to issue green bonds. Worst offenders are issuers of green bonds that have been involved in a relatively large number of behaviour-related controversies and/or controversies connected with water and energy-intensive activities. The non-green bonds of worst offenders are excluded from ACTIAM s actively managed bond funds. In step 3, ACTIAM makes a substantive assessment of green designated bonds. Bonds earmarked for financing activities, projects or technologies are rejected by ACTIAM if they occur on the list of exclusions of the Climate Bonds Taxonomy. 2 This means that all (energy-efficient) projects involving (clean) coal, gas and shale gas, oil and nuclear energy are excluded. In a number of cases, however, ACTIAM departs from the taxonomy and specifies additional requirements. ACTIAM considers the following cases are unsuitable for financing by means of green bonds (the list is not exhaustive): Construction of new or existing dams (> 20 MW), unless the project has been certified in accordance with the Clean Development Mechanism standards. 2 DEFINITION OF GREEN BONDS 5

6 Energy-efficiency upgrade of gas-fired power stations, unless the thermal efficiency exceeds 80%. Production of energy carriers from biomass, including fuel switch from coal to biomass co-firing, unless the project meets the CBI criteria for biofuels (see Appendix A). Agricultural activities, unless they meet the CBI criteria for agriculture, forestry and other land use (see Appendix A). Drilling (or test drilling) for deep geothermal energy, unless projects meets the CBI geothermal criteria (see Appendix A). Forestry projects for carbon offsetting, unless they meet the CBI criteria for agriculture, forestry and other land use. In step 4, ACTIAM verifies whether a green bond meets the four core components of the Green Bond Principles (GBP) for process transparency: (1) use of proceeds, (2) process for project evaluation and selection, (3) management of proceeds, and (4) reporting. 3 With the help of the CBI technology standards (see Appendix A), ACTIAM examines how ambitious the objectives are in relation to the starting position. These objectives may be the following: number of hectares of managed forest, reduction of water pollution, improvement of energy efficiency (avoidance of carbon emissions) and use of sustainable energy (installed power). ACTIAM does not classify a bond as green if there is insufficient evidence of process transparency and alleged positive impact. In step 5, ACTIAM focuses on the extent to which the possibly doubtful green image of issuers of green bonds is improved. This is clear in the case of worst offenders in the oil and gas, mining and energy industries. Moreover, banks can play an important role in the financing of these industries. At the same time, banks are increasingly issuing green bonds. Before a green-designated bond is issued, ACTIAM asks the issuer for transparency about its transit strategy so that ACTIAM can test whether the potential switch to low-carbon business practices and/or sustainable water and land use is credible and the level of ambition is high enough.depending on the response and the participation of these issuers in initiatives such as the Carbon Disclosure Project 4 and Voluntary Principles for Mainstreaming Climate Action within Financial Institutions 5, ACTIAM will increase the ESG rating of the green bonds by +10 or +20. ACTIAM awards an increase of +10 if doubt continues to exist about the current transition strategy and investments required for a transition to business practices that are less dependent on fossil fuels or water. After the relevant bond has been issued and purchased, ACTIAM will start an engagement process to ascertain whether the issuer is capable of dispelling any doubts ACTIAM may have about its transition strategy. If the issuer does indeed play an active role in the transition to more sustainable business practices, the issuer s rating will be increased by the maximum of +20. If no progress has been made, the increase in the ESG rating will remain at +10. Finally, in step 6, ACTIAM tests the reporting requirements from step 4, with the CBI standard version serving as a guideline for determining whether there has actually been a positive impact The Carbon Disclosure Project (CDP) is an independent not-for-profit organisation which seeks, on behalf of institutional investors, to convince companies to be open about their carbon emissions, land and water use, and the opportunities and threats they see in connection with climate change DEFINITION OF GREEN BONDS 6

7 4 Conclusion ACTIAM is positive about the opportunities and options for green bonds and wants to help develop this market further. That is why ACTIAM is actively searching for ways of increasing its investments in green bonds. The degree of success it will have is partly dependent on the wishes and requirements of its clients and market conditions. CONCLUSION 7

8 Appendix 1: CBI Standards Activities and technologies 1 STATUS Solar and wind energy Finalised Built environment (residential, commercial and refurbishment) Finalised Biofuels Available in 2016 Water Available in 2016 Agriculture, forestry and other land Available in 2016 Geothermal energy Finalised Transport Available in Source: APPENDIX 1: CBI STANDARDS 8

9 Disclaimer ACTIAM N.V. endeavours to supply accurate and up-to-date information from sources deemed to be reliable. However, ACTIAM N.V. cannot guarantee the accuracy and completeness of the information contained in this presentation and/or this document, referred to below as the Information. The Information may contain technical or editorial inaccuracies or typographical errors. ACTIAM N.V. gives no express or implied guarantees that the Information contained in this presentation and/or this document is accurate, complete or up to date. ACTIAM N.V. is not obliged to update or correct errors or inaccuracies in the Information. The Information is based on historical data and is not a reliable basis for predicting future values or equity prices. The Information is similar to, but possibly not identical to, the information used by ACTIAM N.V. for internal purposes. ACTIAM N.V. does not guarantee that the quantitative yields or other results from the Information will be the same as the potential yields and results according to ACTIAM N.V. s own price models. Comments about risks pertaining to any Information should not be regarded as a complete disclosure of all relevant risks. The Information should not be interpreted by the recipient as business, financial, investment, hedging, commercial, legal, regulatory, tax or accounting advice. The recipient of the Information is personally responsible for the way in which the Information is used. Decisions made on the basis of the Information are at the expense and risk of the recipient. Accordingly, the recipient cannot derive any legal rights from the Information. DISCLAIMER 9

ESG INTEGRATION IN GREEN AND SOCIAL BONDS. Assessment process. Public 1

ESG INTEGRATION IN GREEN AND SOCIAL BONDS Assessment process Public 1 Content 1. WHY ACTIAM INVESTS IN GREEN AND SOCIAL BONDS?... 3 2. ACTIAM GREEN AND SOCIAL BOND ASSESSMENT PROCESS... 4 Phase 1: ACTIAM