EIB, sustainable finance, and the role of green bonds, interview with Aldo Romani

This year, the European Investment Bank (EIB) celebrates the 15th anniversary of its Climate Awareness Bond (CAB), the world’s first green bond. What exactly is a green bond? What makes it green? And how can such bonds help enable capital markets to drive the sustainable transformation of our economies? Aldo M. Romani, head of sustainable finance in the finance directorate at the EIB, developed the inaugural transaction and has steered EIB’s sustainability funding programme to a share of 45% of its total funding in 2022. He will help us answer these questions.

Mr. Romani, what is the role of the EIB in the European institutional set-up and how does sustainability funding contribute to the fight against climate change?

“The European Investment Bank was established in 1958 by the Treaty of Rome. It is the investment arm of the European Union and is owned and governed by the member states. Article 309 of the Treaty on the Functioning of the European Union specifies that: “The task of the European Investment Bank shall be to contribute, by having recourse to the capital market and utilising its own resources, to the balanced and steady development of the internal market in the interest of the Union”. 

In plain words, the Bank raises funds in the international capital markets via the issuance of bonds (EUR 55bn in 2021); it then invests these funds in projects that contribute to sustainable development, mostly within but also beyond the EU’s borders. We support these projects with both financial and technical expertise, providing a seal of approval on their quality. This in turn facilitates the provision of capital from other sources. At the end of last year, the volume of EIB’s outstanding loans amounted to EUR 415bn.

Sustainability funding entails the issuance and product-development of Climate- and Sustainability Awareness Bonds (CABs and SABs). The funds raised with these bonds are allocated exclusively to investments that contribute substantially to the sustainability objectives of the EU, in a way that is gradually aligning with evolving EU legislation on sustainable finance. This activity is part of EIB’s strategic business development plan within the framework of its Climate Bank Roadmap 2021-2025. This document describes how the Bank intends to operationalize its goal of supporting the European Green Deal as the EU Climate Bank. 

Important objectives of this plan are:  the halt to energy projects reliant on unabated fossil fuels from the start of 2022; the increase of EIB’s green finance to at least 50% of the total loans signed in a year by 2025;  the alignment of the tracking methodology for green finance with the framework established by the EU Taxonomy Regulation; and the gradual alignment of CABs and SABs with a proposed EU Green Bond standard.  

This standard, presently under discussion among the EU co-legislators, requires alignment of the bonds’ use-of-proceeds with core classification criteria (the taxonomy). The European Commission is developing these criteria with the help of all relevant constituencies. Their uniform application across jurisdictions and along the investment chain aims to facilitate sustainable investment by improving market efficiency in the selection of sustainable projects. The taxonomy for climate is the first of its kind and entered into force in January this year.”

Bond, green bond, social bond, sustainability bond, Climate Awareness Bond, and Sustainability Awareness Bond (“SAB”)… Mr. Romani, could you please define these terms for our readers?

“In its simplest form, a bond is a debt security that the issuer sells to investors to borrow money from them; the issuer commits to repay the amount borrowed at maturity and to pay an interest that remunerates the investor for the use of its money and the risk that the money is not paid back.  The global bond market is estimated to be around €120 trillion in size. 

The EIB is not funded by taxpayer money, nor can individuals open accounts to store their savings with us. The Bank refinances itself through the issuance of bonds in the international capital markets with annual issuance volumes ranging between €45-65 billion, depending on the balance of disbursement and repayment flows. This makes it a reference issuer within the multilateral development bank community.

The fundamental difference between a “green” bond and a conventional bond lies in the “use of proceeds”. With a conventional bond, the issuer is free to use the funds for general corporate purposes. With a green bond, the issuer promises to allocate the funds to projects that contribute to an environmental objective and commits to publishing regular reports allowing investors to track the flow and impact of their money on the ground. This commitment entails a greater degree of transparency and accountability with regard to the issuer’s environmental activities, notably when an independent party, for example an auditor, verifies and assures the issuer’s statements and reports by reference to objective criteria. 

Social bonds apply the same approach to activities with a social sustainability objective. Sustainability bonds focus on both environmental and social sustainability objectives.

CABs have a focus on climate change mitigation and can therefore be classified as green bonds. SABs address other environmental and social objectives, i.e. they are sustainability bonds.  Together, CABs and SABs span the full spectrum of sustainability.”

What was the core idea behind the first CAB in 2007?

“On the occasion of the 50th anniversary of the Treaty of Rome, the European Commission, the European Parliament and the Council of the European Union highlighted the importance of sustainable energy policy and climate action in their “Berlin Declaration” of March 2007. The EU went on to announce an ambitious energy action plan and called on the EIB to scale up its support to renewable energy and energy efficiency projects.  

We therefore expected a major increase in refinancing needs in these areas and anticipated that capital markets would develop a particular interest in financial products with this focus. Crucial to our initiative was the idea that clarity and reliability with regard to the use of proceeds would entice investors with the confidence that their investment would help identify and support projects beneficial to climate change mitigation. We then developed the necessary infrastructure for this purpose.

The request for approval for the first Climate Awareness Bond encapsulates this with the following leitmotiv: “Accountability in the future disbursement in the fields of renewable energy and energy efficiency and precise definition of the types of projects to be included in this category.” 

How has the market developed over the last 15 years and how can financial instruments like green bonds spearhead the drive towards sustainability?

“The market’s early years were overshadowed by the global financial crisis until 2012, yet the segment has undergone significant developments, both quantitatively and qualitatively ever since. 

A recent PwC report estimates that around 14% of all new European bonds issued in 2021 were in green, social or sustainability format. In 2015, this was true of just 1% of the bonds. By 2026, these bonds are expected to represent more than 40% of total issue volumes in Europe. The EIB is already there, with around a 45% share of its total funding programme in 2022. Today, with more than €2 trillion in green bond issuance, we are witnessing a structural shift towards this bond segment. 

The variety of issuers has expanded, too. While the market was driven by multilateral development banks in its early years, corporate and financial issuers increasingly joined the ranks in 2015/6. Today, Sovereigns and the European Union are among the largest issuers.

Essential to this development has been the market-driven definition of shared rules of the game. Already in 2015, the first edition of the Green Bond Principles of the International Capital Market Association established the essential characteristics of these bonds, subsequently complemented by Social Bond Principles and Sustainability Bond Guidelines. 

A major challenge remains the absence of generally accepted technical screening criteria for the assessment of the relative contributions of investments to sustainability objectives, which generates confusion and hampers investment decisions. Without an agreement on core comparable indicators, policy signals are unclear and issuer and investor preferences cannot match in an efficient manner. 

Increasingly, markets, policymakers and civil society have come to recognise that bonds with clearly defined use of proceeds and reliable reporting can increase accountability and kick-start a clarification process, helping the mapping of the status quo in the real economy, the consequent definition of action plans and the monitoring of incremental results. Public and private spending programmes can be organised in a more concrete and reliable manner on this basis.  

Legislators, not only in the EU, are therefore now focusing on making screening criteria more specific and more comparable. On this basis, green, social and sustainability bonds can turn into a lever that fosters the transparent interaction between policy and markets and their convergence for the delivery of tangible results.”

The European Union is a leader in the field of sustainable finance legislation. What is the exact role of this legislation, notably the EU Taxonomy Regulation and the proposed EU Regulation on European Green Bonds?

“The European Commission recognised the necessity for more clarity in sustainable finance as the first priority of its Action Plan for Financing Sustainable Growth of March 2018. The cornerstone of this plan is the EU Taxonomy Regulation.

Art. 1 of this regulation states that the sustainability of activities in the real economy shall determine the sustainability of any financial products used to finance them. For this purpose, there is a need to, firstly, develop technical screening criteria that define the substantial contribution of such activities to six environmental objectives, which operationalize the Sustainable Development Goals of the UN. Those shall be easy to use and easy to verify. At the same time, the Taxonomy establishes the principle that any such activity must not do significant harm to the remaining objectives. For example: if you build a solar plant which supports climate change mitigation, the activity must not harm the objective of transitioning to a circular economy by ensuring that equipment and components are highly durable, recyclable, easy to dismantle and to refurbish.

Secondly, there is a need to ensure the uniform application of these criteria for all market participants across jurisdictions, to secure the conditions for fair competition, and along the investment chain, to foster effective scrutiny of the economy by financial markets. The key is to have comparability between investment alternatives. Different regulatory frameworks are being implemented that take the EU Taxonomy Regulation as common reference for non-financial disclosures of both investors, borrowers, and intermediaries.

Given the forward-looking focus and speed of capital markets, the European Commission has devoted special attention to the green bond segment with a regulation proposal that is bound to establish an “EU Green Bond Standard”. This standard builds on existing market practice with an additional core requirement: the alignment of the bond’s use of proceeds with the Taxonomy criteria.”

Is this alignment a straightforward process? What are the EIB’s commitments and what role do CABs and SABs play in this context?

“It is important to underline that EIB’s sustainability funding relies on the application of the EU Taxonomy to its lending activities. The Climate Bank Roadmap commits the Bank to progressively extending the CAB-SAB eligibility in tandem with this ongoing adjustment process. The plan is therefore to also gradually align with the EU Green Bond Standard.   The capital markets can thereby monitor EIB’s progressive adjustment process in full transparency.

This process can only be gradual, essentially on two grounds: firstly, the Taxonomy is still to be tested on the ground, and not yet complete; secondly the different pieces of the EU sustainable finance legislation are not yet perfectly coordinated and at the same time evolving with different timelines for different constituencies. Market practitioners are confronted with a number of usability issues that it will take time to even out. 

With our CABs and SABs, we aim to demonstrate how issuers can adapt to incremental changes in official criteria and disclosure requirements in a credible, stepwise manner. We aim to demonstrate that issuers and investors can already start applying the logic of the EU Taxonomy to improve the collection, reporting and assessment of core information. This will facilitate the unfolding of an organic discovery process, bearing incremental results via a pragmatic, therefore constructive dialogue between issuers, investors, policymakers and supervisors.” 

Where do you see the green and sustainability bond markets 15 years from today?

“Time is running against us. In 15 years, sustainability will have to be consistently mainstreamed in the whole set of financing instruments, not only bonds. The entire economy should be mapped by reference to sustainability objectives and we should have criteria in place that measure the contribution of all economic activities to those objectives, substantial or not. Green, social and sustainability bonds with focus on activities making substantial contributions will however continue to be the pivot of this process, hopefully with the major share of the total bonds issued by then, both in flow and stock terms.” 

This article was first published in the issue 37 of the magazine