ORGANISATION DETAILS  
Name Ostrum Asset Management
Signatory type  Investment manager
Region of operation Europe - France
Assets under management €254bn
COVERED IN THIS CASE STUDY 
Fund Green bond assets held by our client CNP Assurances across various portfolios, amounting to €1.4bn AuM.
Sector
Across all sectors, although most GBs are concentrated in a small number of mega-sectors (energy, transport, infrastructure). 
Geography Europe
Asset class Green bonds
Environmental objective Mitigation and adaptation
Economic activity All

Ostrum AM strongly believes that a taxonomy is essential to define whether ’green’ investments are detailed and coherent; a view shared by our main clients. Indeed, CNP Assurances asked us to develop this case study (taxonomy impact on Green Bonds (GB)). We applied the taxonomy framework to a large portfolio sample of CNP Assurances’ green bonds. Our objective was to ascertain how we could implement the taxonomy efficiently, while assessing the risks of non-compliance and ensuring a gradual convergence towards taxonomy criteria. A key feature of our strategy was the partnership we fostered with extra-financial data providers to capitalise on their existing data.

Our methodology and testing assessed whether CNP Assurance GBs were compliant with taxonomy criteria. Though we obtained reasonable short-term results, allowing us to make broad assumptions, despite the scarcity of data, the process was not sufficiently robust. We believe a ’deeper’ and more sophisticated project-by-project analysis is required, leveraging higher-quality issuer data and extra-financial providers. At present, these participants are still adjusting to taxonomy requirements.

Other aspect you would like to mention?

We set up a methodology and ran tests to assess whether Green bonds held by our client CNP Assurances were “compliant” with taxonomy criteria. Finding the right approach was key.

We obtained are encouraging results to start with. They are “good enough” for the short term, as they enable us to make rough assumptions despite data scarcity but they are not robust enough. To fulfil our mission we need to go “deeper” in the analysis project by project.

A more sophisticated approach requires more quality data from issuers and extra-financial providers. For now, both actors are in the process of adjusting to Taxonomy requirement. We are hopeful that this will be the case in the years to come.

Taxonomy implementation

Principles, criteria, thresholds

We adopted a two-step approach:

  1. Assessment of the activity’s eligibility:
    This was simple to determine with the explicit exclusion of solid fossil fuels/coal – and de facto of nuclear. We confirmed the assessment through a screening via a provider that excluded projects invested in non-eligible projects.
  2. Compliance with technical criteria:
    This proved to be more complex, due to either a lack of detail on the technical criteria or to a lack of data provided by issuers and extra-financial providers.

An efficient and simple way to test basic compliance to the taxonomy is to split activities into two groups, according to how proceeds are used:

  1. Simple compliance due to amenable requirements.
  2. Those less likely to achieve compliance.

Going forward we aim to implement a more qualitative and issue-by-issue approach. We will analyse each GBs project to assess its compliance with the most important criteria by activity. Carbon intensity is the most significant threshold. Graph C demonstrates a deep dive analysis for a specific project. Ultimately, outcomes depend on the ramping up of our provider’s capabilities and on the data provided by issuers.

Do no significant harm assessment

It was not possible to conduct a conclusive test on externalities.

  1. Extremely complex in the case of GBs: How can we assess negative externalities tied to a specific asset/project (and not to the issuer’s)?
  2. Do No Significant Harm (DNSH) criteria are at times vague and therefore subject to interpretation.
  3. This is a difficulty expressed by even the most seasoned GBs issuers.

In most cases, it makes sense to assess DNSH at the issuer level. However, in certain cases, such as GBs financing of a hydroelectric dam, it is important to run a complementary study of the (biodiversity) impact.

We noted that many DNSH criteria are qualitative and difficult to interpret. However, we believe clarity is highly likely to improve under the jurisprudence of EU GBs certification bodies.

Social safeguards assessment

We decided to use a third party provider to identify controversies and severe breaches against global norms. The outcomes were sufficiently robust, with the provider basing its assessment on United Nations SDGs (declined into Global Compact principles for businesses) and OECD and ILO guidelines.

We focused the analysis on the issuer, rather than the project financed. Our rationale was that projects are run by a specific company, and severe breaches of global norms usually result from poor governance associated with that company, rather than the asset/project financed.

Turnover/capex/opex alignment

GBs are very specific financial products. We analysed the project/asset financed, rather than the revenue/capex of the issuer. Therefore, to evaluate eligibility we focused on the percentage of ’use of proceeds’ dedicated to taxonomy-compliant activities.

Additional comments

We decided to capitalise on data from third party providers as it was quicker, consumed less resources and the large sample provided a more detailed analysis.

Our main provider retains significant information on key transition sectors and carbon threshold measures, and is developing new capabilities for other sectors, alongside more qualitative criteria.

Note 1: A very forward-looking approach.

  • The application of the taxonomy process depends on delegated actions being introduced by the end of 2021.
  • An important step for EU GBs, which may take some time, is in choosing certification bodies and regulators.

A gradual convergence of future GBs issues along TEG criteria is likely.

Note 2: Defining the compatibility of EU GBs in the existing portfolio remains a purely theoretical and inconclusive exercise.

  • EU GBs certification can only be achieved if three criteria are met. These comprise an identified and eligible green asset that corresponds to the impact criteria of the taxonomy; a EU ’GBs framework’ reporting, detailing alignment with EU GBs requirements; and certification by an organisation appointed by the regulator.

If one of these elements is missing, certification will be challenging, even if in theory the funded project aligns with the taxonomy criteria.

Alignment results

Step 1: Identify whether the asset is eligible for the taxonomy.

After screening of the portfolio (GBs) via a provider, we confirmed the activities financed were all eligible for investment. This was unsurprising as GB activities are more likely to be eligible than bonds of a random sample of issuers.

Step 2: Check whether the funded activities meet the taxonomy assessment criteria.

We conducted a test with an external provider to evaluate the alignment of the portfolio with the technical criteria, based on the share of proceeds allocated to a specific activity and the likelihood of this activity being compliant with the taxonomy. Our provider was able to evaluate 84% of the portfolio.

From the sample analysed, 49% of our GBs had a high probability of being compliant since they financed renewable energy: these assets benefit from very low requirements in terms of technical criteria (for example, photovoltaic solar energy is exempt from carrying out a Life Cycle Emission Assessment, so it is exempt from carbon threshold criteria). For the remaining 51% of GBs, projects had a moderate probability of being compliant. While they all demonstrated ’green’ use of proceeds, we cannot be sure that they will all meet the technical criteria. To be more accurate in future assessments of taxonomy compliance we need to dig deeper on a project-by-project basis. Our provider is in the process of acquiring relevant information (estimate late 2020/early 2021).

Step 3: Validate whether funded activities do not generate externalities incompatible with the taxonomy (DNSH & social safeguards).

Though we are currently unable to properly assess DNSH criteria, we screened the GBs portfolio using Global Norms services to detect severe violations. Only one GB appeared to be in breach of the UN Global Compact (UNGC) (Principle 10: Ethical Business Conduct), following a severe controversy regarding money laundering.

A. Three step methodology: compliance with taxonomy standards means a project is ’ticking’ the box at each step.

A. Three step methodology: compliance with taxonomy standards means a project is ’ticking’ the box at each step.

Source: Ostrum AM

B. Sample analysed: a high proportion can be analysed using third party provider

B. Sample analysed: a high proportion can be analysed using third party provider

Source: Ostrum AM

C. A more sophisticated approach means having higher quality project-by-project data (example of a carbon intensity threshold calculation for one of three projects financed by RATP GB)

Project no. 3 Modernisation of rolling stock

Carbon net benefit (tonnes C02e) = reduction in urban rail operational emissions + reduction in maintenance emissions - construction emissions   
Reduction in urban rail operational emissions (tonnes C02e) = total distance travelled per unti per year (km) * Number of trains financed 
NACE sectorManufacture of low carbon technologies 
Source: Trucost
 ValueSource no.
Investment cost per train (EURm) 15 12
Amount financed by the bond (EURm) 150 8
Number of trains financed 10 Calculated
Total distance travelled per unit per year (km) 155 172 Calculated using Trucost Green Transition Tool
Average occupancy (PAX) 114 Calculated using Trucost Green Transition Tool
Energy use (kWh per km passenger) 0.12 13
Carbon intensity (gC02 per km passenger) 4.91 Calculated
Country grid factor C02e/kWh) 0.04 Defra 216
Lifespan of project (years) 35 14
Energy savings (%) 20% 15
Reduction in urban rail operational emissions (tonnes C02e) 6 080 Calculated
     
Reduction in maintenance emissions (tonnes C02e) = maintenance emissions (Kg C02e/unit) * No. of trains * Lifetime (years) * % savings  
     
Maintenance emissions (Kg C02e/unit)  76 282 Ecoinvent
Maintenance savings (tonnes C02e) = construction emissions  (Kg C02e/unit) * No. of trains 20% 16
Reduction in maintenance emissions (tonnes C02e) 153 Calculated
     
Construction emissions (tonnes C02e) = construction emissions (Kg C02e/unit) * No. of trains  
     
Construction emissions (Kg C02e/unit) 599 920 Ecoinvent
Construction emissions (tonnes C02e) 5 999 Calculated 
     
Apportioned carbon net benefit (tonnes C02e) 234 Calculated 

Challenges and solutions

NO.CHALLENGESOLUTION
1

Limited resources for a single asset manager to perform the task internally

  • The number of projects to analyse is beyond any asset manager’s internal research capabilities within time constraints.
  • Execution difficult and a lack of detail likely unless a robust process is in place.
  • We worked with an extra- financial provider, building on its existing capabilities.
  • We took the decision to adopt a pragmatic approach based on existing data, only moving to a more sophisticated method when more data becomes available (for example, share of proceeds allocated to a given activity or a deep analysis of each project financed).
2

Inherent complexity of Green bonds and the challenge to evaluate the Taxonomy alignment of all project financed via a single bond.

  • A GBs issuance is not comparable to a corporate issuance, in which the activity can be measured and classified by revenues, opex or capex.
  • GBs are used to finance multiple projects, which often lack detailed reporting.
  • We evaluated the probability of a given activity to be taxonomy-compliant to technical criteria, according to the level of stringency. For example, renewable energies are likely to comply, while green transportations are less likely.
  • We used share of proceeds allocated to link a green bond to each activity and assessed its potential to be compliant (high/uncertain/low)
3

At this stage nearly impossible to run an assessment on harmful externalities (DNH)

  • DNSH criteria are often qualitative and subject to interpretation.
  • Lack of disclosure from issuers.
  • Difficulty in assessing the project’s DNSH.
  • We decided to use a third party provider specialised in assessing compliance with Global Norms.
  • We screened the portfolio at issuer level.

Recommendations

It is important to be realistic. At present, examination of the portfolio against the technical criteria for assessing taxonomy and externalities is theoretical and inconclusive. Limited data is available, and is subject to interpretation (externalities). EU GB certification can only proceed if issuers follow the full certification process (framework + verification). While theoretically you can take the test, you may never get the diploma. It is likely that certain issuers will not certify EU GBs, due to the complexity and cost. It makes sense to be cautious with findings, as it is difficult at this stage to determine portfolio taxonomy compliance - market authorities may be vigilant on this point.