Integration of climate risks into investment decisions as a tool to ensure a climate resilient portfolio

Integration of climate risks into investment decisions as a tool to ensure a climate resilient portfolio

Integration of climate risks into investment decisions as a tool to ensure a climate resilient portfolio

21 April 2023

On 22 November 2022, the Chapter Zero Ukraine & Caucasus team held a webinar on creating a climate resilient portfolio and integrating climate risks into investment decision-making.

The speakers of the webinar were representatives of the EBRD and commercial banking sector – Raiffeisen Bank International (Austria) and TBC Bank (Georgia).
The meeting was moderated by Oksana Volchko, member of the Supervisory Boards of Ukrgasbank and Ukrposhta.
They discussed sustainable banking development strategies and implementation practices.
Read more in the summary of the speakers’ presentations.

Friso de Jong, Director, Green Finance System, EBRD:
The world will need at least US$67 trillion a year over the next 15 years to implement the Paris Climate Agreement to keep the average temperature rise at 2°C (ideally 1.5°C). At the same time, the global debt market and the global fixed income market amount to more than US$100 trillion. Therefore, the only way to attract the multibillion-dollar investments annually required to keep the average temperature rise is to mobilise the private sector to invest in green development.

Finding green assets is also a big challenge. And in this context, green sustainability bonds (SLBs) are an interesting tool, since there is no strict requirement for the issuer to have a sufficient amount of green assets. SLB bonds allow you to set specific targets that you can actually achieve while generating an income. You can simultaneously reduce the carbon footprint of your operations and achieve your social KPIs. This is especially true in areas of your business where green assets are difficult to combine. Or when it is clear to you that you should build up your specific green assets, even though your business model does not provide for such. For example, green energy facilities, green buildings, etc. SLB bonds will allow you to access the green bond market through clear, transparent, credible and ambitious key performance indicators (KPIs). Under this condition, investors can also achieve their specific objectives. But it is worth noting that green bonds, or more generally green capital markets, are not the answer to all issuer’s problems.

There are many unknowns surrounding the issue of asset certification. In my opinion, the first benefit immediately removes all concerns. The ability to identify and integrate climate risks into assessing business performance is well worth the time and resources involved.

The value of green bonds
Green bonds have become an important tool for increasing transparency in the financial sector. In fact, it helps to attract new investors and create an investment base that has not yet been available. This process is facilitated by the presence of ESG investors who have specific mandates to achieve certain goals in this area. This practice is currently widespread in Europe, where the EBRD has focused its activities. We also hope that this experience will soon spread to other markets.

In 2021, USD 1 trillion was invested in green bonds. We are currently seeing further growth in investment in green bonds, as well as in other instruments such as Green Social Sustainability+. A couple of years ago, such positions accounted for less than 1% of total investments. Currently, their share is up to 3-4-5% of the market. Over time, we expect this to grow exponentially.
However, to ensure the same prosperity of the market as in the United States, it is important to rethink the US Treasury’s bond market policy for the European context, especially for the EBRD’s region of operations. This is about recognising specific challenges and the relevant instruments that we need to develop. In addition, integration is already underway, as global rating agencies are increasingly focusing on the risks associated with climate disasters. We see this in the US municipal bond markets.

The EBRD’s investments
Frankly speaking, the EBRD was slow to invest in green bonds in the beginning. In 2017-2018, transactions were carried out mostly from a single issuer in one of the Baltic countries. The market really took off (in the EBRD’s region of operation) in 2021. Today, we have three types of institutions that are the three pillars of this market – financial institutions, the infrastructure group, which is part of the EBRD, and commercial and business groups. In 2021, the Systemic Infrastructure Group grew significantly in terms of the volume of green sustainability bonds and other products in our operations. Not to mention that the share of green bonds is 73%.
The market is showing great interest in environmental systemic bonds, such as green sustainability bonds (SLBs) in underserved regions combining green technology financing and social assets. This type of bond is a good fit for the development of the EBRD’s green energy transition policy, in addition to green technologies.

The first SLB bond we financed was issued by PPC, a utility company in Greece. This time, we supported the issuer to finance the decarbonisation of the grid, thereby adding more renewable electricity to the grid over time. Overall, institutional investors have shown interest in emerging market segments. For example, the subscription to the green bonds through Georgian railways was increased 8 times.

A few words about Ukrenergo on the issue of green sustainability bonds that we finance and цршср were issued before the war in Ukraine. It is important to emphasise that in early 2022, we restructured the initial loan to Ukrenergo, which was issued for critical assistance in 2019, to prevent blackouts at the beginning and throughout 2022. Later, emergency critical assistance packages were provided. Even later, it was supplemented by an additional €372 million, partially guaranteed by the United States, as well as €72 million in grants financed by the Dutch government, which is helping Ukrenergo meet its financial obligations. Of course, based on the example of the SLB regional bonds issued by Ukrenergo before the war, the guarantee mechanism most needs some improvements to the structure and support of the guarantees to give investors confidence in getting their money back.

We are also working with the EU to ensure further support for EFCD and EFCD+ and to be able to offer improved loan conditions and loan guarantee instruments based on the issuance of green bonds or SLBs.

Benefits and challenges of issuing green bonds
Green bonds unequivocally indicate the reliability of the issuer and transparently inform investors about the use of money. In addition, during the covid pandemic, green bonds proved to be a stronger instrument compared to conventional bonds, as their value on the secondary market was more expensive. Finally, reputational risks directly related to climate management are being reduced. After all, even listing on a stock exchange requires companies to openly provide a list of measures for the transition to sustainable development, as well as measures to reduce their carbon footprint and climate change.

Our most recent examples include two particularly optimistic green bond projects for the development of renewable energy in Georgia, which were issued and invested together with IFC. However, even with the good practices of our colleagues, some companies, banks and countries do not get it right. In such cases, the EBRD has made decisions not in favour of such investments and such emissions. Of course, this process takes place in emerging markets. Unfortunately, trust is lost even before the potential or ability to win the green market is manifested.

Let’s take a closer look at decision-making procedures. So, the ICMA Principles – the International Capital Market Association’s Green Bond Principles – are the basis, the platform on which the green dialogue is built. It begins, in fact, with the use of protocols. As you know, the EBRD works very closely with the EU, applying the EU classification. Similarly, the EBRD relies on the methodology or classification of the CBI – the Climate Bond Initiative. This is also a trend, with more and more clients and issuers using the CBI scheme as a more advanced scheme compared to the ICMA principles (which are actually incorporated and actively used in the CBI scheme).

Despite a thorough systematic analysis of the issue, the EBRD requires a third-party audit of green bonds in advance of the issue. The EBRD examines the structure of the green bonds (which is a financial structure) and also provides external supervision, which technically ensures an assessment of the other party. The EBRD has its own requirements for the issuer’s social policy, which must also be transparent. All this must be published on the issuing company’s website in advance. Usually, funding is placed for a period of about 2 years, namely 18-24 months. At the same time, there is an annual public reporting of actual expenditures on the issuer’s website.

The work we are doing is mostly just the first step. We are currently working directly with both issuers of green bonds and those who are just considering this opportunity. I can’t resist announcing that we are just now finalising a support programme for a bank in Armenia which will enable this bank to establish a systemic financing framework, as well as issue in the green capital market. In other words, we are working to help establish a systemic finance framework so that banks can then help issuers understand all their weaknesses and risks. In this way, they become fully prepared to enter the green capital markets and can make issues right now or in the future. And it is precisely this kind of preparation of market participants that is the real professional support of issuers, in particular, Ukrainian, Georgian and Armenian issuers within Chapter Zero Ukraine & Caucasus.

For reference:
The EBRD’s Energy Efficiency and Climate Change team began its work in the early 1990s, since the foundation of the bank. The EBRD’s green investments can be traced back to 2006, when the bank launched its Environmental Strategy Initiative or Sustainable Energy Initiative. Over time, this strategic initiative has been scaled up to include the Systematic Resource Development Initiative, launched in 2013. In 2015, the Green Financial Systems Initiative was launched to support the transition to a green economy.
The share of green investments in the EBRD’s total investments increased from 26% in 2006 to 46% in 2015. By the beginning of 2022, more than 50% of the EBRD’s investments could be classified as green. This was the target until 2025, but was achieved ahead of schedule. However, for the current period, despite the huge impact of the war in Ukraine, the EBRD is still striving to achieve a similar level of performance.

The green bond market actually started in 2007, when the EIB – the European Investment Bank – issued its first Climate Awareness Bond. Their experience was followed by other banks. The EBRD issued its first green bond in 2010. Since then, the EBRD has issued more than 120 green bonds, which include transition climate bonds, climate action bonds, and the full range of green bonds presented here. In total, they amount to €8 billion.
It is important to know that the global green discourse began with the EBRD’s approach and experience in green energy. Over time, this terminology became part of the green economy vocabulary. The EBRD has created its own GET guide on the transition to green energy, which is used by the entire market.
Representatives of Raiffeisen Bank and TBC Bank (Georgia) spoke about the practice of developing and implementing EGS strategies in the banking sector.

Christine Würfel, Head of ESG & Responsible Banking at Raiffeisen Bank International (RBI)

RBI’s sustainability strategy has been in place for a long time and includes the following areas:

1. Acting exclusively from the perspective of responsible banking, driving economic growth while taking into account the environmental and social aspects of our core business.
2. Honest partnership. Being honest and transparent with all relevant internal stakeholder groups and reducing our environmental impact.
3. Citizen engagement. Supporting the development of a sustainable society by promoting environmental sustainability and entrepreneurship.

Although the strategy itself has been in place for a long time, the content and importance of all three components has changed dramatically recently. In previous years, the formulation of corporate social responsibility focused on employee relations, reflecting management’s attitude towards employees. Attention was also paid to the company’s interaction with society and charitable projects. But today, especially now, with the launch of the European Commission’s Green Deal, the focus of EU Taxonomy has shifted towards climate protection.

The UNEP Finance Initiative’s Principles for Responsible Banking help us a lot on this path. These are six simple principles that guide our banking group on the path to sustainability. While we were analysing the possibility of working in accordance with these principles in 2019 and 2020, our clients asked us whether we had already signed the Principles for Responsible Banking. This was also a good sign that we should persevere in our research. So now, after signing, we should constantly work according to these principles.

The main advantage of the Principles is that they provide a single framework that truly helps to achieve results in all ESG activities that a banking group has to perform, regardless of its business model.

Another significant advantage of the Principles is that they are fully aligned with EU regulations and all other international standards.

Vera Economou, Head of ESG Group Competence Centre, Coordinator of ESG Experts in Network Banks in CEE region, Raiffeisen Bank International

Until 2018, we had an ESG area in the form of corporate social responsibility (CSR). In 2018, when we issued our first green bonds, the ESG took on new meanings. We saw that by issuing green bonds, we attracted fundamentally new investors. These were investors with defined green strategies who bought green bonds because they chose the green transition path. It was extremely important to them that we decided to act in this way.

In 2019, the bank made its second green bond issue and started issuing retail bonds. Today, we are the largest issuer of green bonds in Austria with almost EUR 2 billion outstanding. We plan to continue to maintain this leadership position.

We have realised that by influencing the development of the economy by issuing green bonds, we can stimulate the development of green industries while at the same time avoiding to stimulate, for example, the coal industry. So we can further contribute to this by going beyond the standard communication with clients when lending to them, asking additional questions, for example, do they have carbon emission reduction targets, what is their action plan to make their business more sustainable and move away from fossil fuels? We also launched a programme that would highlight the social component, as we noticed that the green component was almost always preferred by customers.

We transferred this experience to Central and Eastern Europe and the first thing we got was that this is not for us, it was better to leave this practice for Western Europe. And I am happy that we were able to change these views and demonstrate the growth opportunities for businesses that have embarked on the path of sustainability.

So, along with the green bond issue, RBI has several other priority areas of lending to clients with a social component – small business financing, financing women’s entrepreneurship, financing of public education and healthcare, which has become especially important due to the coronavirus pandemic.

In 2020, we created an international network of ESG professionals to share knowledge about the environment and sustainability. In 2021, the ESG Group Competence Centre, which I headed, was launched. We conduct many trainings to raise awareness among our employees.

According to the bank’s policies, we must completely stop financing the coal industry by 2030. Instead, we are focusing on financing renewable energy projects. In fact, this is a big challenge for the bank, because if we look back, we will see that such projects were not a priority for banks due to the high dependence on government policies and government programmes.

Maka Bochorishvili, ESG Coordinator at TBC Bank (Georgia)

Our bank’s EGS activities began even before the development and implementation of the EGS strategy. It consisted of assessing the environmental and social risks of lending, which is mostly present in Georgian banks, in accordance with the existing EBRD performance standards.

However, it quickly became clear that we needed to develop systematically, so we decided to develop an ESG strategy. Why is it important for everyone to have such a strategy? In this document, we have finally clearly defined the areas of activity and filled in the gaps in our ESG that we had at that time.

TBC Bank’s ESG strategy was approved by the Bank’s Board of Directors at the end of 2021. It is very important that it was adopted at the highest level because it is necessary to implement it successfully, integrate a certain direction into daily activities and think about its development within the framework of medium-term goals. It is very important that the initiative comes from both the executive management and the Board of Directors.

TVS Bank’s ESG strategy includes more than 50 different initiatives, the main ones being the following:

Strong ESG governance structure

In 2021, an ESG committee was established at TVS Bank at the executive level, and in 2022, the ESG committee and an ethics committee were established at the level of the Board of Directors. Among other things, the ESG committee is responsible for expanding the ESG culture in the company (introducing it to a wide range of employees and specialists in all areas), systematic training activities, including training for members of the Board of Directors, etc.

Focus on clear information about sustainable finance, services and products

We pay special attention to making our green products and services as clear and transparent as possible. Both businesses and bank employees who work with green finance programmes should understand the benefits of the banking product and its target audience.

Climate risks and opportunities

This is the area that poses the most challenges, not only in Georgia, but globally.

Green and sustainable finance

A focus on green and sustainable finance is very important as incentives and benefits can be passed on to clients. Green and sustainable finance is also accompanied by technical assistance, capacity building, and knowledge sharing, as this is essential for incorporating climate considerations into investment decisions and impact measurement systems.

Impact measurement and reporting system

Measuring impact is a prerequisite for achieving the goal. Transparency of sustainable finance is linked to reporting. For example, since 2019, we have been publishing a sustainability report in accordance with the Gr. This is not just reporting, it is a company’s commitment to report annually, as well as to improve it from year to year. The target volume of our sustainable loan portfolio has been set at GEL 750 million (EUR 261 million) for 2022 and GEL 1 billion (almost EUR 350 million) for 2023, respectively.

Solutions and trends that will be useful on the way to sustainable banking

Next year we will launch a two-year training programme for our clients and staff. We have named it Green Mindset because we plan to develop environmental thinking and environmental decision-making. We consider specialised training and courses to be one of the key levers to accelerate not only our work but also the sustainable development of the region’s economy.

Many partners, especially international financial institutions, support our aspirations. So, anyone who wants to move towards sustainable banking should seek help from financial institutions and ask all their partners for opportunities to help, as partners have a lot to offer, starting with the implementation of international standards. It is also worth joining various international initiatives, such as the Science based targets initiative, Paris agreement alignment and many others.

Public advocacy of green initiatives is important. Do not wait for the moment when you “know everything”, because it is extremely difficult to know everything, for example, about climate change. Start with small steps towards public advocacy, and then gradually increase.

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