The European Covered Bond Council is working on a definition of green covered bonds aimed at reflecting the distinct characteristics of the instrument to ensure its appropriate treatment in incoming regulations, and following a Green Bond Principles update deemed contradictory to its core feature by some.
Trilogue negotiations on the EU Green Bond Standard (GBS) are just one of the legislative and regulatory developments underway that could affect the framework for green bond issuance, including covered bonds, while market initiatives critical to the sector are also progressing.
In the latest edition of the Green Bond Principles (GBP), published in June, two types of secured green bonds – which can take in securitisations and covered bonds – were delineated for the first time: “Secured Green Collateral Bonds” and “Secured Green Standard Bonds”. While the former encompasses the majority of green covered bonds that have been issued – with the proceeds linked to the collateral, i.e. the cover pool in the case of covered bonds – the latter, Secured Green Standard Bonds, may be used to refinance loans that are not necessarily securing the bond.
Some covered bond issuers who have kept the link between proceeds and collateral, as well as other market participants, have objected to the looser definition being applied to covered bonds, even if sympathetic to the overall aim of boosting green finance.
“A core feature of covered bonds is the fact that proceeds are used to refinance cover assets,” said Scope Ratings analysts. “The Secured Green Standard Bond breaks with this tradition and opens the door for potential mismatch risks.”
However, Doris Kramer, vice president, sustainable investment, at GBP executive committee member KfW, said the main aim of the update was to clarify that the proceeds of secured bonds have to go into green projects, i.e. to avoid green-washing. She indicated that in this context, whether or not the proceeds refinance a cover pool or other lending is of lesser importance, but that the Standard option might be helpful for some issuers away from more dedicated covered bond banks.
“You also have many other institutions issuing covered bonds that have very diversified business models and they are doing other green stuff,” said Kramer, “so we wanted to have more flexibility for them.”
The GBP update came after a European Banking Authority (EBA) official also flagged a potentially looser approach to green covered bonds.
In March, the regulator published a report for the European Commission on how sustainable securitisation might be best dealt with in respect of the EU GBS and related developments. The EBA said that during a transition phase, the most efficient and pragmatic approach appears to be to apply the GBS’s use of proceeds requirement at the originator level, thereby allowing green securitisations to be backed by non-green assets.
Speaking at an online event organised under the auspices of the Energy Efficient Mortgages Initiative (EEMI), Mira Lamriben, senior policy expert, ESG risk team, EBA, said this approach could also be relevant in the context of covered bonds.
“The focus at this stage is really about the use of proceeds,” she said, “and the regulators acknowledge this point. Although, in the medium term, maybe this could be reassessed once we have more green collateral available in the market.”
Despite challenges in identifying eligible assets, covered bond issuers have typically constrained their use of proceeds for green covered bonds to cover pool assets, even if a few issuers have not.
Both types have thus far been flagged as ESG covered bonds on the Covered Bond Label website, with a green leaf icon. And some market participants have argued that as long as investors are presented with transparent information regarding the use of proceeds and the strength of any link between the these and the collateral securing the bond, a broader definition of green covered bonds should prove problematic.
However, wary of any regulatory impact, the European Covered Bond Council is working on proposals for a definition of green covered bonds, Luca Bertalot, secretary general of the European Mortgage Federation-European Covered Bond Council, told Sustainabonds.
“The ECBC is very much committed to providing the market with the best practice on green covered bonds,” he said. “We have done this for years with the Covered Bond Label and now it’s time to be proactive and gather industry intelligence, and be ready to discuss and debate with the European institutions, and safeguard the covered bond product also in the ESG debate.
“It’s a different animal than a securitisation or other asset classes, so we have to make sure that whatever legislative framework emerges will fit the special nature of the covered bond.”
Photo: ESG panel at the Covered Bond Investor Conference on 30 June in Frankfurt, with KfW’s Kramer pictured centre; Credit: Wonge Bergmann