As KfW prepares to raise up to €13 billion ($14 billion) in green bonds in 2024, its head of capital markets Petra Wehlert explains the thinking behind its new green bond framework, and its approach to the EU Taxonomy and the EU Green Bond Standard.
Environmental Finance: KfW introduced a new green bond framework at the end of 2023, which applies to all green bond issuances from the start of this year. How has it been received by your investors?
Petra Wehlert: This is the third update of KfW's green bond framework since we first entered the market in 2014. The feedback we've received so far has been very positive. We have made several additions to the project categories that are eligible for refinancing with green bonds, but we have also made two technical changes that have come into immediate effect.
The first major change is that we are now able to start our green bond issuance earlier in the financial year, because we have created the possibility to also include disbursements from the last quarter of the previous year. This means we have already been able to issue two green bonds in early January 2024 – an A$1.5 billion ($970 million) five-year bond, and a NOK2 billion ($190 million) bond, also five year. The Aussie dollar green bond is the largest ever in this currency, with more than half of the issue sold to investors in Asia. Both transactions were very well received by investors.
The second change is that we are now able to tap bonds that we issue under the new framework even after we release any future versions of the framework. This will enable increased liquidity in our green bonds. Under the previous frameworks, we had to close each bond we issued, as it was too complicated to reopen them and find a way to report properly. This is a very important improvement for investors, as they prefer large and liquid benchmark bonds.
EF: The framework now includes a number of new categories of activity at KfW which can contribute to the pool of assets refinanced by your green bonds, including biodiversity. What types of biodiversity-related investments will be included?
PW: Biodiversity is gaining increased attention and our inclusion of it in our framework is thus very much welcomed by our investors, some of whom were calling for us to do so. We are taking a staged approach to including the category, as it needs a large amount of data to assess and monitor projects and to report their impact properly to investors.
In the first instance, our framework will therefore concentrate mainly on forestry – specifically forest restoration and forest protection projects that we finance internationally, particularly in Asia and other emerging markets. We are beginning to include those because we can handle them for investors, in terms of data and reporting. Given that, the volume we expect under this category in the first year is not particularly large – perhaps around €500 million or so.
At the same time, we are working on an internal roadmap that should give guidance on how we are going to approach the topic. How do we define biodiversity? How do we establish a portfolio approach? What kind of projects do we already have in our portfolio, and how can we support them? What are the positive and negative impacts we are having on biodiversity and how do we measure that? Finally, when we have all this data available, we will establish a steering process. This is a project that is underway, but we're still at an early stage.
Our investors know that biodiversity is an important future topic, but they are also aware of the challenges it poses, especially with regards to data availability and reporting.
EF: You have also added a new project category of corporate climate transition investments to the framework. Can you explain the approach here?
PW: The new project category, Corporate Investments for Climate Change Mitigation, allows us to refinance programmes aimed at supporting domestic German companies as they transform themselves in line with the EU Taxonomy. The programme supports specific measures that are in line with the Taxonomy's technical criteria for substantial contribution: it allows us, for example, to support a company that may not operate in a sustainable part of the economy, as defined by the EU Taxonomy, but that is making its processes more efficient in ways that are in line with the Taxonomy's substantial contribution criteria. This might, for example, include companies powering their manufacturing processes with renewables or investing in electric vehicles. We expect investments of around €2 billion this year, and we expect that figure to grow over time.
EF: You will also be including international financings within the framework. What motivated that decision, and what sort of assets will you be financing?
PW: When we first published our framework in 2014, we decided to follow a quite pragmatic approach. Consequently, we started with only one programme – the renewable energy programme, as this financed pure dark green assets. But this programme only covered around €3 billion of assets and was shrinking in size. In 2019, we thus extended our framework and included our domestic energy efficient housing programme, which was much larger and allowed us to increase the overall green bond issuance volume significantly.
Focusing on larger programmes enables us on the one hand to issue bonds in larger sizes, which investors like, and on the other hand it is also easier for us to calculate impact from long-running programmes. In a further step, in 2022, we included our clean transportation programme. Although this makes up a relatively small part of our green bond allocation, we see the investments in clean transportation as a relevant tool to reduce greenhouse gas emissions.
Until 2023, our green bond framework was very much focused on our core programmes in Germany – our home market. But, as many of our international investors have been asking us to also include international projects, we decided to open up our framework also for international financings. So, although we expect most of the proceeds from our green bonds still to be directed at domestic financing, with the new framework we have the opportunity to also include promotional loan programmes and financing provided by KfW in the context of international cooperation and project and export finance.
Looking forward, our green bonds can, for example, now also support a solar park in Morocco, or a new clean transportation system in an emerging market. At the end of the day, it's all about having assets that we can break down for investors. Transparency and proper reporting are key to us, so the availability of reliable data is essential.
Green bonds issued by KfW: Overview of net proceeds and reporting
EF: The framework also notes that KfW is in the process of gradually aligning its lending and project financing to the EU Taxonomy criteria. How is that process going? What challenges are you experiencing?
PW: The alignment with the EU Taxonomy is indeed a big challenge, not only for KfW but for every financial institution. As you know, we have to demonstrate that we meet the substantial contribution and the Do No Significant Harm (DNSH) criteria as well as the minimum safeguards. These criteria are not always clearly defined under the EU Taxonomy and market practice has to evolve, especially in terms of data availability.
We must also differentiate between KfW's activities on the capital markets and our overall lending activities. Taxonomy-compliant assets can only be generated via our lending activities. As the capital markets team, we are aiming to increase transparency regarding the alignment of our Green Bond Framework to the EU Taxonomy, therefore we are involved in the internal processes of our colleagues in the lending departments.
We have also been working with our second-party opinion (SPO) provider to look into that topic. Morningstar Sustainalytics has taken a first view in its SPO, however it's difficult to say at the moment to what extent our lending activities are fully Taxonomy-aligned.
Morningstar Sustainalytics is of the opinion that the activities and projects to be financed under the framework will be carried out in alignment with the EU Taxonomy's minimum safeguards. This assessment is based on KfW as an institution and its internal policies of assessments and directives. Morningstar Sustainalytics also states that 80% of the economic activities within the use-of-proceeds categories are aligned with the substantial contribution criteria. We always thoroughly assess our investments for possible negative environmental and social impacts or risks. Work is in progress to prepare the data basis for the Taxonomy's DNSH criteria. We will continue to work on that topic.
EF: Does KfW intend to align its green bond issuance with the EU Green Bond Standard?
PW: We still have some time to decide, given that the EU Green Bond Standard can only be used from 2025 onwards. However, our experience is that the green bond market is quite well established internationally. What investors are looking for are large, benchmark bonds from reliable issuers. And KfW is very well known in this market. According to the feedback we receive from our investors, transparency about the allocation of net proceeds and proper reporting are the most important investment criteria. Thus, our focus lies on providing the data that our investors need to get a broad view of us as an issuer. Alignment with the EU Taxonomy is one criterion, but it's not the only one – particularly for investors in Asia or the US.
In my opinion, EU Green Bond Standard-compliant bonds will represent kind of a niche market, particularly in its early days. They will for sure play a role in the core EU market and serve as a benchmark for green bond issuances. But, at the same time, I see continuous international demand for bonds issued in line with the Green Bond Principles. I don't see this part of the market going away.
If we meet the requirements to issue bonds in alignment with the EU Green Bond Standard, as a European issuer, we will certainly do so. But I also think that the standard could in its early days rather be used by corporates, given that they realise the underlying projects, whereas the financial sector always depends on data to be provided by third parties.
EF: Do you plan any other changes to the mix or types of sustainable finance instruments you issue in 2024 and beyond?
PW: We will continue to focus on green bond issuances. We are thus not planning any additions to our sustainable finance instruments, e.g. social bonds. This year, we will have a closer look at the US dollar market. One of the reasons I attended the Environmental Finance conference in the US last year was because I wasn't sure about investors' interest in our US dollar green bonds, and about how the US market will develop. But the feedback I got from US investors was very positive.
Last year, most of our green bond issuance was in euros, and we didn't issue any dollar-denominated paper. However, while the euro will continue to play the major role for KfW, we will have a closer look at other markets as well. We started the year with an Australian dollar and Norwegian krona issue, as I mentioned, and we will also focus more on the US dollar market again. My perception is, independently from the political discussions around ESG in the US, US investors are committed to the market, and they are willing to invest as long as they are convinced of the investment case. They don't wait for any regulation or political guidance.
Petra Wehlert is head of capital markets at KfW in Frankfurt.
For more information, see: www.kfw.de/About-KfW/Investor-Relations/KfW-Green-Bonds/index.html