A positive step towards the UK government’s net zero ambition
The UK government published on 30 June its framework outlining how it will finance environment-related expenditures through issuing gilts. The framework explains the “basis for identification, selection, verification and reporting of the green projects” eligible for financing from the proceeds of these new issues.1
- The new framework fully meets Insight’s expectations for new impact bond issuance, achieving a green rating according to our traffic-light system.Strengths include lists of eligible – and excluded – projects that focus on suitable uses of proceeds; clear alignment with several Sustainable Development Goals (SDGs); and best practice with regard to a maximum limit on using proceeds for refinancing.
- The UK performs well relative to global peers on both environmental, social and governance (ESG) risks and alignment with UN SDGs. The new green bond framework may help to address the UK’s performance on renewable energy metrics.
- Room for improvement remains on some aspects, including the definitions of some categories of eligible projects, and the inclusion of tax breaks for some green financing.
Insight’s view of the new UK green financing framework
Our traffic-light rating for impact bonds rates the new UK green financing framework as ‘green’ – meaning we believe that the framework meets our minimum expectations for sustainable issuance.
Joshua Kendall, Insight’s Head of Responsible Investment Research and Stewardship, explains the framework and the factors that influenced our rating, answering the following questions:
- How does the UK perform in terms of ESG factors relative to other countries?
- What is your assessment of the projects that might be funded by this issuance?
- How are projects selected?
- How will the bond proceeds be used to finance projects?
- How are these projects, and the use of proceeds, monitored?
The UK performs strongly across a range of ESG factors, both in terms of ESG risk management and alignment with the UN Sustainable Development Goals (SDGs). It has the best possible ratings (a score of 1; worst possible is 5) generated by Insight’s proprietary Prime risk and impact measures. In recent years, impact momentum has been trending positively, while risk momentum has trended towards the downside.2
In terms of ESG risks, the UK performs strongly thanks to strong policies to protect the environment and enhance social welfare. And in terms of ESG impact, the UK performs well relative to the majority of the UN SDGs, but poorly against some renewable energy metrics. We are pleased to note the new green bond framework targets renewable energy.
Eligible projects for the use of proceeds in the framework are broadly defined and aligned with the following categories in the ICMA Green Bond Principles:
- clean transportation,
- renewable energy,
- energy efficiency,
- pollution prevention and control,
- living and natural resources, and
- climate change adaptation.
These eligible project types also demonstrate clear alignment with, and will contribute to the development of, several SDGs:
2. Zero hunger
6. Clean water and sanitation
7. Affordable and clean energy
9. Industry, innovation and infrastructure
11. Sustainable cities and communities
12. Responsible consumption and production
13. Climate action
14. Life below water
15. Life on land
A list of excluded project types strengthens the framework by ensuring the bonds’ use of proceeds do not contribute to unsuitable projects, either because they do not contribute to a low carbon and environmentally sustainable economy, or because they are socially controversial.
The framework excludes projects related to nuclear energy, fossil-fuel powered vehicles or fossil-fuel exploration and exploitation, large scale hydroelectric projects, weapons, tobacco, gaming, palm oil industries, and direct manufacture of alcoholic beverages.
A key area of improvement would be stronger definitions for the use of proceeds categories, with minimum thresholds. For example, minimum energy efficiency improvement levels or the minimum energy intensity for energy projects. Investment in these areas will help to boost the ESG performance of the UK from both a risk and impact perspective.
A cross-government Inter-departmental Green Bond Board (known as the IDGBB) will be responsible for the process of project evaluation and selection, ensuring that projects fall into one of the use of proceeds categories highlighted above.
As well as aligning with the categories above, projects will be analysed for controversies and alignment with international standards. These include the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights. We note the use of international standards positively.
The framework is aligned with the UK government’s overall sustainability strategy and aims to align with the UK taxonomy currently in development. The taxonomy aims to create a standardised list of economic activities considered environmentally positive or additive. However, with the taxonomy not published, the strength this adds to the framework is uncertain.
The maximum amount of refinancing will be 50% and the maximum lookback period will be 12 months. We believe this strengthens the framework compared to other sovereign issuers.
Disclosing the maximum amount of refinancing is in line with best practice; our preference is for most proceeds to be used for new financing for projects to increase the potential impact of the bond.
However, the framework outlines that eligible green expenditures can include direct/indirect investment expenditures, subsidies and tax foregone on some but not all operational activities. The inclusion of tax breaks for use of proceeds weakens the framework, as the impact is likely to be less tangible and impactful than explicit capital expenditure.
Proceeds will be managed via a green register, which is preferred over a portfolio approach. Full allocation is expected within two budget years and, pending full allocation, proceeds will be managed according to HM Treasury cash management guidelines. This is in line with market practice.
The framework commits to annual verification allocation and impact reports, with relevant key performance indicators.
A strength of the framework is the focus of reporting on the co-social benefits of the green projects. The social benefits are likely to include green jobs creation, support small and medium-sized enterprise, and protecting people’s homes and livelihoods from the impacts of climate change. This emphasises the focus on creating a just transition to a low carbon economy and helps to distinguish the UK government framework from other sovereign green bonds.
To read our previous update on green gilts, focusing on the likely characteristics of green gilts and their potential suitability for investor portfolios, please click here.
1UK Government Green Financing, 30 June 2021, UK Government.
2Ratings and scores are subject to change, for information only and are not investment recommendations. To read more about the Prime sovereign ESG ratings, please click here.
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