Close panel

Close panel

Close panel

Close panel

Debt issuance 14 Jul 2020

How does a bank's green bond contribute to protect the environment?

A bond is a debt instrument that companies issue in capital markets to attract financing from institutional investors (for example, investment funds). Banks also issue debt: it is a way of obtaining funds that they later use to grant loans to their clients. Along with customer deposits, issuances are, for banks, an additional source of financing to carry out their activity.

In increasing order of risk for the investor, the instruments a bank can issue are: mortgage bonds, senior preferred debt, senior non-preferred debt, subordinated debt (Tier 2) and CoCos (additional Tier 1 – AT1-) These last three debt types are necessary to meet the capital requirements established by the regulator and are capable of absorbing losses when an entity has a solvency problem or enters resolution.

A green bond aims to raise funds and use them to finance projects that help protect the environment. For a bond to be labeled green it must comply with a set of principles ( ‘Green Bond Principles’ in English), which establish a series of transparency and reporting requirements regarding the destination of the bond proceeds.

In the case of BBVA, the bank has already issued three green bonds. In 2018, it became the first Spanish bank to issue a green bond, which also was, at €1 billion, largest green bond issued within the euro area at the time. It was a non-preferred senior debt issue, with a 7-year maturity period. With this bond, the bank managed to reduce the carbon footprint by nearly 275,000 tons, by allocating the bond proceeds to finance renewable energy and sustainable transport projects. A year later, it issued its second green bond, also worth €1 billion and maturing in 7 years, which was almost three times oversubscribed, after the issuance was met with strong investor interest. The projects financed with BBVA’s green bonds issues in 2018 and 2019 have avoided 724,000 tons of atmospheric carbon emissions, about the same emissions produced by 285,000 cars, have treated a volume of water equivalent to the annual consumption of more than 140,000 people; and have managed a volume of waste equivalent to the waste production of nearly 600,000 people.

The third – and most recent – green bond was successfully launched in July 7, 2020. This time BBVA became the first bank in the world to issue a green CoCo.

Why can a CoCo be green?

Depending on their particularities, these issues more or less resemble bond or stock issues, in the sense that they also have priority when it comes to assuming losses in the event of bankruptcy.

Convertible contingent bonds, or CoCos (‘Additional Tier 1’), are hybrid issues that combine debt and equity elements. Their defining characteristic is that they can be converted into stock if the CET1 capital ratio (the minimum quality capital of a financial institution) drops below a certain level.

They are perpetual instruments (i.e. they have no set maturity date), although the issuer can exercise an option to redeem the bond after a specific period of time since launch (typically five years).

In the specific case of a green CoCo, as the one BBVA issued, the novelty is that the funds raised in the wholesale market are used to finance or refinance sustainable projects, like any other green bond. However, being perpetual instruments, there is no preset maturity date for this financing, but there is a commitment to reinvest and preserve that reinvestment in green projects throughout the life of the bond.

How can a green bond be perpetual if there are no perpetual green assets?

The financing of green projects does not need to match the term of the bond with the maturity of the underlying assets. The commitment is to find eligible (green) assets to finance throughout the bond’s life. In the specific case of BBVA’s CoCo, this commitment includes:

  • Building a solid portfolio of eligible assets that proves the bond’s reinvestment capability. BBVA obtains an independent opinion from DNV GL, a firm that certifies that the assets on which bond proceeds are invested are aligned with BBVA’s framework and that the bank carries out its asset selection processes in compliance with the governance criteria established in its framework.
  • Having a reliable and robust capacity to generate eligible assets. In April 2018, BBVA published its Pledge 2025, whereby it pledged to mobilize €100 billion through 2025 in green financing, sustainable infrastructure, social entrepreneurship and financial inclusion. By December 2019, the bank had mobilized €30 million, an amount that evidenced its commitment. In addition, BBVA’s portfolio of eligible assets amounted to €2.9 billion at the end of March, compared to €1.8 billion in December 2018, and despite the expected amortization of €500 million.
  • Having a solid governance model. On June 22, BBVA published its 2019 Green Bond Report, summarizing the environmental impact of the projects financed by means of its 2018 and 2019 green bonds issues. PWC verified that the selection of assets met the eligibility criteria and also certified the environmental impact of the projects. In addition, a different certifying agency has been involved in the process to ensure independence between the Initial Assessment (DNV GL) and the Reinvestment Certification (PWC). In addition, BBVA set up more than two years ago the committees and internal structure required to identify, determine the eligibility and ensure the traceability of the assets.
  • Having a proven track record. In this case, BBVA is the most active Spanish bank in the issuing of green bonds

How does the CoCo combine green financing with its function as the bank’s capital buffer?

It is necessary to dissociate the nature of the instrument issued, the CoCo – which contributes to meeting regulatory capital requirements -, with the commitment to devote the proceeds from financing projects to fund new eligible sustainable projects. They are independent elements.

It is also necessary to differentiate between the green target of the bond and the financial rationale of the operation, which in the case of the CoCo issued in July, is the early refinancing of an issue completed in 2016, if the bank decides to redeem it in its first amortization date (April 2021).

Other interesting stories