Frameworks for Labeled Issuances
The sustainable finance market has evolved significantly within the last few years. One aspect of the market has been whether or not a framework is necessary for an ESG labeled bond. In the context of sustainable finance, most market participants (i.e., investment banks and fixed income investors) consider a framework to be a standalone document that details a Company’s criteria for identifying environmental and social expenditures. Recently, the market expects this separate document or ‘framework’ to be published versus listing eligible expenditures within a bond’s legal documentation. (Note: This article is primarily focused on the Americas or U.S. credit market)
Green bonds have historically dominated the sustainable finance market; the reason for that prevalence is environmental expenditures were fairly straightforward for those issuers. Corporates who accessed the sustainable finance market circa 2015/2016, for example, tended to be regulated utilities and real estate investment trusts that could point to their respective renewable energy assets or third-party certified green buildings. Fixed income investors had already covered or kept track of those business investment plans (i.e., knew of the acquisitions via earnings or press releases) so it was not necessary for green bond issuers to have a separate document that detailed the planned use of proceeds given that investment had already been publicized.
As the sustainable finance market grows, investors and other stakeholders now have started to encourage issuers looking to raise a green, social and/or sustainability bond to create and publish a standalone framework.
Breaking down a Green / Social / Sustainability Labeled Framework
Amongst frameworks, there may be a range of stylistic or branding differences depending on the corporate, but the high-level sections are largely consistent. The following goes over the aspects of a labelled framework and what is typically included within each element.
Introductory & Overarching Components
There are 3 sections that are included when creating and posting a standalone framework: Company Overview, Sustainability Overview and Rationale for Issuance. Regardless of whether or not the company is a household name, sustainable finance participants expect to see these sections as they often provide an introduction to the company for new and existing investors. Click for more details on each element.
Company Overview
This section comprises a general overview of the business. Information listed within can be sourced from existing reports, presentations and SEC filings. Typically, the company overview highlights its corporate’s mission, operations and ethos. If the corporate has gone through a transformational event such as an acquisition or divestiture, this section could be another opportunity, in addition to an 8K or press release on the investor relations webpage, to highlight anticipated structural, growth and organizational changes. (~1-2 pages)
Sustainability Overview
The sustainability overview builds upon the previous section and provides high-level information on the company’s ESG or corporate responsibility strategy. This portion of the framework most commonly details focus areas across the organization in relation to ESG, public commitments & goals (e.g., net zero greenhouse gas emissions target) as well as broad policies that the company considers best practices. Prior to accessing the sustainable finance market, many investors might not have a fulsome understanding of a company’s sustainability strategy so this section of the framework helps guide investors towards initiatives that the issuer is keen on highlighting. (~4-6 pages)
Rationale for Issuance
Finally, the last section of the introduction is called Rationale for Issuance. This connects the prior two components and explains why the issuer intends to pursue the ESG finance market and how issuing into the market ties to its broader corporate finance and sustainability strategy. (~1-2 paragraphs)
ICMA Specific Components
The ICMA Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines outline the best practices for those looking to issue ESG labeled bonds. This section is arguably the most important portion as investors and market participants look to this section to understand the process by which a company selects eligible projects as well as descriptions of those expenditures. Below is an overview of the four core components. Click for more details on each element.
Use of Proceeds
This element is most commonly laid out in a table format and is a description of example eligible green (environmental) and/or social expenditures. Typically, the table is broken out by category and followed by a list of basic projects that the issuer is contemplating. Though not a definitive rule, the span of the eligible expenditures most commonly is between 5-6 years or a look-back period as far as three years prior to issuance and two years post issuance. This retroactive and forward looking timeframe can vary from framework to framework but the market currently has settled on 3 years look-back as the lower bound.
Process for Project Evaluation and Selection
After detailing the criteria for which an issuer might categorize its expenditures, this section outlines the process by which the company determines which projects are eligible and what criteria the expenditure goes under. More often than not, existing working groups, business selection processes and/or committees would be described here as long as there is an added description of how the issuer accounts for this added ESG finance project selection process. (~1-2 paragraphs)
Management of Proceeds
The understanding within sustainable finance is that there is a virtual accounting of proceeds raised from an issuance. In other words, the dollars raised from a green bond issuance does not literally have to be the same dollars that are paid towards that issuer’s environmental projects. Investors would expect the amount equal to the net proceeds raised (so excluding legal costs etc.) to be invested within the timeframe that is detailed within the bond documentation or the framework (i.e., the 3 years look-back & 2 years look forward). Many frameworks will indicate that the proceeds will be tracked over time and pending full allocation of the proceeds, funds would be managed in-line with standard treasury liquidity practices. (~1-2 paragraphs)
Reporting
Post issuance, the company is expected to publish an annual report on the uses of proceeds until full allocation. If a company raises $1 billion, annual reporting would need to occur until all the dollars are accounted for and disbursed to eligible green or social projects. At minimum, reporting includes a list of project categories to which proceeds have been allocated, description of those projects and then the expected impact, where feasible. (~1-2 paragraphs plus a table of possible impact metrics)
Key Recommendations
Surprise! Though many might think Reporting is the final section, the actual final section or at least a ‘key recommendation’ of the ICMA principles or guidelines is Verification. Here, ICMA recommends – and the sustainable finance market expects – the issuer to get its framework reviewed by an external party prior to issuance. This pre-issuance external verification is done by a Second Party Opinion provider which opines on whether or not the framework is aligned with the core components of the ICMA principles or guidelines. This section also includes language around post-issuance verification whereby an independent and qualified external reviever (e.g., Big 4 auditor) is required to assure that proceeds have been disbursed to eligible project categories within an issuer's annual ESG bond report.
Framework Created!
With all the introductory, core and recommended components combined, a framework is created! There certainly would be nuances in the Use of Proceeds section between issuers of different credit profits, geographies and sectors, but this article gives you a good sense of what is expected within a framework for a green, social or sustainability issuance.
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