The global market for green, social and sustainable investment is growing at an increasing rate. This is the result of considerable growth of both the demand for, and the supply of, capital for green, social and sustainable projects. Despite Switzerland having a highly developed and efficient capital market and being one of the world’s largest cross-border wealth management centres, the Swiss market for green, social and sustainability bonds is only just beginning to gain momentum. In view of this, the author expects this sector to significantly grow in the coming years.
By Andreas Josuran (Reference: CapLaw-2019-02)
The global market for green, social and sustainable investment is growing at an increasing rate. Back in 2007, the European Investment Bank issued the first green bond. Today, an aggregate amount of roughly USD 1.45 trillion climate-aligned bonds is outstanding according to a report by the Climate Bond Initiative (CBI) published in September 2018. For the full year 2018, CBI reports a total green bond issuance volume of USD 167.3 billion and for the year 2019, an increase to USD 250 billion is expected. The rapid growth of the global market for green, social and sustainable investment is the result of an increase of both the demand for, and the supply of, capital for green, social and sustainable projects:
– On one side (demand for capital), in particular in view of recent global endeavours to tackle climate change, there is an increasing demand for capital dedicated for green, social and sustainable purposes. According to an estimate by the European Council published in May 2018, around EUR 180 billion of additional investments in energy efficiency and renewable energy are needed per year in the EU area alone to achieve its 2030 climate targets. Against this background, the EU put in place an action plan with a view to adopt specific legislation in the near future that aims at mobilising private capital to fund sustainable investment. Other jurisdictions have launched similar campaigns or are offering subsidies to companies active in green, social or sustainable projects.
– On the other side (supply of capital), investors are increasingly seeking for sustainable investment opportunities, which has driven the creation of a considerable range of investment products in that sector over the past few years. Assets under management of green, social or sustainable funds as well as other investment vehicles are increasing at a remarkable rate.
Despite Switzerland being one of the world’s largest cross-border wealth management centres, the Swiss market for green, social and sustainability bonds is only just beginning to gain momentum. SIX Swiss Exchange currently reports 15 SIX-listed green bonds in an aggregate nominal amount of CHF 11.6 billion. Eight of these green bonds are denominated in Swiss francs. Globally, only about 1% of all outstanding green bonds are denominated in Swiss francs, while the most commonly used currencies are EUR, USD (each 26%) and CNY (22%) according to CBI. In view of this, it seems that there is still potential for significant growth in this sector in Switzerland. The combination of Switzerland’s highly developed and efficient capital markets and its large wealth management sector certainly offers ideal circumstances to facilitate such growth.
1) What is a Green, Social or Sustainable Bond?
There is no legal definition of what is a green bond, a social bond or a sustainable bond. Rather, these terms are sometimes used inconsistently and to describe different types of debt instruments. To increase integrity and transparency, the International Capital Market Association (ICMA) prepared principles and guidelines for each of these categories: the ICMA Green Bond Principles (GBP), the ICMA Social Bond Principles (SBP) and the ICMA Sustainability Bond Guidelines (SBG) (current versions all dated June 2018). These principles are (voluntarily) complied with by a rising number of issuers, thereby contributing to increased transparency by more standardized disclosure and reporting.
According to these principles:
– Green Bonds are any type of bond instrument (i) where the proceeds will be exclusively applied to finance or re-finance new or existing eligible Green Projects (see below) and (ii) that are aligned with the four core components of the ICMA GBP (see below).
– Social Bonds are any type of bond instrument (i) where the proceeds will be exclusively applied to finance or re-finance new or existing eligible Social Projects (see below) and (ii) that are aligned with the four core components of the ICMA SBP (see below).
– Sustainability Bonds are any type of bond instrument (i) where the proceeds will be exclusively applied to finance or re-finance a combination of both eligible Green Projects and Social Projects and (ii) that are aligned with the four core components of the ICMA GBP/SBP. Bonds that intentionally mix green and social projects are referred to as sustainability bonds, and specific guidance for these is provided separately in the Sustainability Bond Guidelines.
“Green Projects” are projects within the eligible green project categories identified by ICMA in the ICMA GBP. These categories currently include (without limitation): renewable energy, energy efficiency, pollution prevention and control, environmentally sustainable management of living natural resources and land use, terrestrial and aquatic biodiversity conservation, clean transportation, sustainable water and wastewater management, climate change adaption, eco-efficient and/or circular economy adapted products, production technologies and processes and green buildings.
“Social Projects” are projects within the eligible social project categories identified by ICMA in the ICMA SBP. These categories currently include (without limitation): affordable basic infrastructure (e.g. clean drinking water, sewers, sanitation and transport energy), access to essential services (e.g. health, education and vocational training, healthcare, financing and financial services), affordable housing, employment generation, food security, socioeconomic advancement and empowerment.
The four core components of the GBP/SBP that have to be met by any green, social or sustainability bond issued in compliance with the ICMA standards are the following:
1. Use of Proceeds: The cornerstone of a green, social or sustainable bond is that the proceeds of the bond issuance are used for Green Projects (green bond), Social Projects (social bond) or a combination of the two (sustainability bond).
2. Process for Project Evaluation and Selection: The issuer of a green, social or sustainable bond should clearly communicate to investors: (i) the environmental sustainability/social objectives, (ii) the process by which the issuer determines how the projects fit within the eligible green/social project categories and (iii) the specific eligibility criteria, e.g. the process applied to identify and manage potential risks associated with the projects.
3. Management of Proceeds: The net proceeds of the bond offering, or an amount equal to these net proceeds, should be credited to a sub-account, moved to a sub-portfolio or otherwise tracked by the issuer in an appropriate manner so as to be formally linked to the issuer’s lending and investment operations for green/social projects.
4. Reporting: Issuers should make and keep readily available up to date information on the use of proceeds to be renewed annually until full allocation and on a timely basis in case of material developments. The annual report should contain a list of projects and the amounts that have been allocated, as well as the expected impact. If non-disclosure requirements apply, the information should be presented generically.
2) Types of Green, Social or Sustainable Bonds
The variety of issuance structures used by green, social and sustainable bond issuers is wide and it seems fair to say that a large part of the capital market ABC is used in this respect: According to CBI’s market report published in September 2018, besides more traditional options such as senior bonds, available options include packaging and re-packaging green bonds/loans/leases by way of securitization (MBS, ABS etc.),
issuing green covered bonds, green hybrid bonds, green Schuldscheine, green sukuk (Sharia-compliant Islamic bonds) – just to name a few.
3) Requirements under Swiss law
As in most other jurisdictions, there are no specific legal rules or requirements under Swiss law for green, social or sustainability bonds. Rather, the general principles of law both under private law as well as under public law apply also to these types of bonds. Generally speaking, issuers are well advised to carefully manage investors’ expectations as to the investment of the proceeds and to avoid creating wrong expectations.
One important aspect of this is risk disclosure in the prospectus and potential other offering or marketing materials. Under Swiss law, this can be expected to become even more important in the future, given that the new Financial Services Act (FinSA) will specifically require that the prospectus contains information on the main risks related to the instrument (article 40(1)(a)(4) FinSA). Depending on the specific instrument, this may include information on risks related to the instrument being a “green”, “social” or “sustainable” investment. Similarly, for instruments that are listed on the SIX Swiss Exchange, the SIX listing rules already currently require that any special risks must be specifically mentioned (article 27(2) SIX Listing Rules).
Risk disclosure used in offering documentation of green bonds placed on the international capital markets varies, but seems to be gradually becoming more standardized. Some of the main risks flagged to investors typically include (among others):
– general uncertainty in many respects due to lack of a clear legal or regulatory definition of “green”, “social” or “sustainable”;
– use of proceeds may not meet expectations of the investors;
– high dependency on third party opinions (providers of evaluations) in respect of the status as “green”, “social” or “sustainable” investment;
– providers of green/social/sustainable evaluations are generally not regulated; and
– a negative change or a withdrawal of the designation as a “green”, “social” or “sustainable” investment may have adverse consequences for investors (such as green investment funds) with specific portfolio mandates to invest in green, social or sustainable assets.
Whether or not specific risk disclosure should be included in the prospectus and/or related documentation and, if so, what aspects should be specifically described therein, must be determined on a case by case basis, taking into account the specificities of the relevant instrument. As always with risk disclosure in capital market instruments, it is also important to carefully take risk disclosure in similar already outstanding instruments into consideration.
4) Requirements for a listing on the SIX Swiss Exchange
From a technical perspective, as far as requirements for a listing on the SIX Swiss Exchange are concerned, a green, social or sustainable bond is not treated differently from other debt instruments to be listed on the SIX Swiss Exchange. The listing prospectus has to meet the requirements set out in the listing rules as well as the additional implementing rules, directives and schemes. There are no separate rules or special requirements for green, social or sustainability bonds as far as the SIX listing process is concerned. That said, SIX relatively recently introduced a so-called “green bond flag” in order to increase visibility of green bonds and help investors to quickly identify green bonds listed on the SIX. For the purposes of verification, SIX collaborates with its partner CBI: Bonds that are listed on the SIX Swiss Exchange and that appear on the relevant CBI lists of green bonds will get the “green bond flag” from SIX.
Andreas Josuran (andreas.josuran@homburger.ch)