Bank & taxonomy: what’s the impact on a promotional bank and a development bank?

The EU Taxonomy is considered to be a key driver towards a sustainable economy. Financials and stakeholders are obliged to make their portfolio ‘green’ and to publicly report. What’s the impact of the taxonomy on NWB Bank and FMO - a promotional bank and a development bank? Wilke de Boer (NWB Bank) en Jim Bredemus (FMO) in part II of ‘Bank & taxonomy’.

Focusing on NWB bank and FMO: what makes your bank different compared to (commercial) banks?

NWB Bank is a ‘promotional bank’, meaning that we provide our clients with funding to enable them to meet their societal objectives”, says Wilke de Boer, Legal Counsel Sustainable Finance at NWB Bank. “This may sound a bit abstract, but we basically finance everything that Dutch society would benefit from. Our clients are public entities, such as water authorities, social housing associations, municipalities and health care institutions. By providing them with appropriate loans against relatively low costs, NWB Bank contributes to a smooth running and cost-effective public sector. We all take for granted that our municipality is emptying our waste container every week and that clean water runs from our tap. But behind the scenes this requires funding. Our bank has been fulfilling a vital role in this for many years now. Being a public sector bank, we limit our financing to clients that are somehow linked to the government. Hence, our client base looks quite different than that of a commercial bank.”  

Jim Bredemus is Sustainable Finance Regulations Specialist at FMO: “FMO provides financing and advisory services to the private sector in emerging markets to address climate change, reduce inequality, and support job creation. Different than other banks in the Netherlands, we only invest in low to middle income countries outside the EU. We are set up to take credit and country risks that commercial parties are unable or unwilling to take. As of 2021 we are active in 83 countries in Africa, Asia, Eastern European and Central Asia, and Latin America. At the same time, we are a fully licensed bank and subject to all European regulations and are required to apply the Taxonomy to our reporting just like all other European banks.”

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Wilke de Boer, Legal Counsel Sustainable Finance, NWB Bank
Wilke de Boer, Legal Counsel Sustainable Finance, NWB Bank

What can you tell about the impact of the taxonomy on your banks?

De Boer (NWB Bank): “Many organisations are now trying to integrate sustainability and ‘purpose’ into their existing business models. The good news is, our bank does not need to this this. Creating long term value for society is at the core of our promotional bank mandate. We are founded by the water authorities to help them raise the substantial investment needed to protect our country against the water. Sustainability is therefore in our DNA. Sustainability is also high on the agenda of our other client groups such as housing associations and healthcare institutions.  NWB Bank thus finances the sustainable transition of the Dutch public sector. So far, you could say that the impact of the EU Taxonomy is limited: we do not have to change our existing business model in order to be a ‘green’ or ‘sustainable’ bank. Therefore, we were quite eager to get going with the EU Taxonomy, even though we are not obliged to report under it. However, when we started to apply the EU Taxonomy for our eligibility reporting, we had to conclude that the current methodology does not work for our bank and client base.”

Bredemus (FMO): “At first glance FMO is well prepared for the Taxonomy as we have experience with ESG scoring and risk management, and also impact measurement. It’s also part of our ethos to be transparent about our investments and what impact we have achieved as well as how we measure it. But the devil is in the details. The impact of the Taxonomy is still uncertain, as the approach to its application to non-EU exposures is still under discussion.

The EU Taxonomy requires banks to report a Green Asset Ratio (GAR), simply speaking the result of their green investments (numerator) / their total investments (denominator). What are your specific challenges in applying the taxonomy?

De Boer (NWB Bank): The current methodology of the EU Taxonomy requires banks to exclude so called ‘non-NFRD exposures’ from the numerator. The vast majority of a promotional bank’s portfolio consists of public sector clients that are not required to report under the NFRD. This means that we will not be able to include these exposures in the numerator for our GAR calculation, resulting in a low GAR. We tend to think that the chosen focus on NFRD exposures better suits the business model of commercial banks. The EU Taxonomy does leave room for exposures to “public housing” and “other local government financing”. However, this does not provide any relief for our bank. Although roughly 1 in 3 social housing units in the Netherlands is financed by our bank and many sustainability investments are made in this sector, we cannot include these exposures in our GAR calculation. Because, under the current EU Taxonomy methodology, public housing loans need to go to municipalities. In the Netherlands however, social housing is not provided by municipalities but by specific social housing associations (woningcorporaties). Neither can we use the “other local government financing” category, since we mainly provide balance sheet financing to local governments. In this case it is not a specific activity that is financed but rather the generic financing needs of the client. In order to include those clients in our GAR calculation, we would need to provide them with project financing in which case the use of proceeds is known. This requires a separate so-called SPV structure and NWB Bank and its public sector clients are not equipped for this.

Bredemus (FMO): “The biggest difficulty for FMO is that since our activities are outside the EU (and thus all non-NFRD counterparties), we will not receive Taxonomy data from our clients and this data cannot be purchased from the market. The regulation is, understandably, EU centric which also presents challenges. Some of the Taxonomy standards, particularly regarding “Do No Significant Harm”, refer to European directives which legally do not apply in our markets. In some of our markets local Taxonomies are being developed and national pathways differ from those in Europe, but the current Taxonomy does not take this into account. Technically speaking there is still no way for activities outside the EU to be included as eligible or aligned since these must be based on actual data disclosed in line with the NFRD. We are in discussions with policymakers who acknowledge this shortcoming and intend to address this in the near future, and we are hoping that some flexibility is allowed to use estimates or proxies when primary data is not available.”

What are your concerns? Is there any impact on your clients?

De Boer (NWB Bank): “Our conclusion is that we finance many ‘green’ activities, but that these do not qualify as ‘green’ under the current regime of the EU Taxonomy. If the methodology of the EU Taxonomy does not change, NWB Bank will probably (voluntary) report a low GAR. We are a major issuer of Green Bonds, with great investor demand for e.g. our “Water Bonds”, the proceeds of which are used for climate related investments by the water authorities. If investor interest in our bonds decreases due to a low GAR, this could possibly lead to increased lending costs for the public sector. This would go against the role that we want to play as a promotional bank: enabling an affordable transition to a more sustainable public sector. We are eager to make the EU Taxonomy work for our type of bank. This could be done by bringing “balance sheet financing to local authorities” within the scope of the EU Taxonomy. This would enable us to continue to properly exercise our role as a promotional bank and channel funds to 'green' public sector activities.”

Bredemus (FMO): “Until the issue with non-EU exposures is resolved, FMO will report a very low Green Asset Ratio. This could have a negative impact on our reputation, ability to issue green bonds, and to mobilize commercial financing into emerging markets. More broadly, our biggest concern is that the Taxonomy could have the unintended consequence of discouraging sustainable or transition investment in low- and middle-income countries. If the EU standards and data requirements are difficult to apply, or the complexity and burden on clients is too high, it may be challenging to report investments as sustainable and would incentive investors to only fund larger companies operating in more developed markets where Taxonomy requirements are more easily met and verifiable.

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Jim Bredemus, Sustainable Finance Regulations Specialist, FMO

Jim Bredemus, Sustainable Finance Regulations Specialist, FMO

The taxonomy can be described as pretty complex. How does your bank turns it into a challenge in achieving a more sustainable economy?   

De Boer (NWB Bank): “There is a lot of expertise in the field of sustainable finance within our bank. The EU Taxonomy is complex, but I am quite confident that we, together with other European promotional banks, will be able to utilize this instrument to our benefit in the future. I find a lot of comfort in the thought: if promotional banks are not considered to be sustainable, what type of bank will?”

Bredemus (FMO): “It’s important to think of long run and the benefits the Taxonomy can bring to the financial sector and society, this is just the start of a journey. The Taxonomy can be a way emerging markets can better demonstrate the potential of sustainable finance in their countries, backed by common standards and data. Together with our peers we hope to serve as a bridge between the EU regulations and our clients’ sustainable practices. The Taxonomy regulation will drive harmonization and together with the ISSB this should come together to reduce the noise and complexity around sustainability reporting. Ideally the rest of the world will be inspired by the EU sustainable finance push and over time global standards will emerge.”