Although, continuing the ESG’s comparison to the train, its movement in the outgoing year, for obvious reasons, cannot be called speedy. It’s a good thing it was on the move in principle, didn’t change its route and didn’t stop forgotten at a half-stop. After all, the regulator had better things to do in this period — to preserve the viability of the entire national financial traffic system... All in all, it might not have been up to the ESG.
Outcome-22: six issues and three new types of development bonds
Perhaps the resilience that the Russian financial system showed in the face of unprecedented sanctions pressure is one of the most important positive outcomes of the past year. The Central Bank, together with the government, has kept an unbalanced system in check, prevented panic and stabilised most of the processes that fall within its area of responsibility.
In addition to containing the situation, the Bank of Russia has significantly expanded the conditions for the development of the ESG agenda in terms of financial instruments this year. At the end of November, Bank of Russia Order No. 6195-U of 04.07.2022 came into effect, which, among other things, formed the legal framework for issuing new types of bonds — “adaptation bonds”, “bonds linked to sustainable development goals”, “climate transition bonds” (more details here).
Companies can now raise money not only to finance projects, but also to develop their businesses — including with ESG transformation in mind.
It is encouraging that there has been no failure in the 2022 sustainability bond market. According to Infragrin news agency, development institutions VEB.RF and DOM.RF, as well as major corporate sector issuers, including JSC Atomenergoprom and PJSC Rostelecom, placed six bond issues for a total amount of about RUB 90bn. The result, of course, is inferior to the previous year, but not by much: in 2021, the total volume of sustainable development bonds issued amounted to 211 billion roubles.
There has been an increase in ESG lending in the banking segment-22, according to expert estimates, but there is no exact market data in the information space: loan transactions are generally not public.
Staying on track to avoid higher provisioning norms
Overall, the financial market has managed to fulfil some of the other points of the Central Bank’s previous plan to develop ESG and responsible financing. And what has not been fulfilled has gone into the new programme, in which the Bank of Russia confirms the need to incorporate international best practices in the areas of regulation and sustainable finance reporting standards. This, it believes, will help build relationships with friendly countries for whom such practices are understandable and proven approaches. It is good that continuity is maintained.
But it is not just about her.
The Central Bank is well aware (and explains it in its financial market development programme) that the inclusion of ESG risks in financial sector regulation by foreign countries (and these processes are already underway) could lead even from friendly countries to increased provisioning norms for transactions with Russian carbon-intensive companies and financial market participants financing “dirty” industries. What might that lead to? Clearly a decrease in the competitiveness of Russian companies.
The introduction of cross-border carbon regulation and the expansion of its perimeter (China, for example, has already started trading in carbon credits in 2021) will inevitably affect Russian exporters — producers of fuels, raw materials and supplies. In any turnaround, it is therefore necessary to continue moving towards the ESG and the climate agenda — as the Central Bank quite clearly states in its three-year ESG development programme.
Innovations on the near horizon: catastrophe bonds, green mortgages and a closer look at verifiers
In the draft guidelines for financial market development for 2023–2025, the Bank of Russia identifies three focuses of the sustainable development financing agenda — the development of instruments, and infrastructure, as well as the introduction of sustainability and ESG considerations into corporate governance.
In terms of instruments, the focus will be on developing financing instruments for new energy projects, decarbonisation and adaptation to climate change, environmental protection, and addressing social issues.
It is planned to improve standards for green and social bond issuance, and to develop climate transition and sustainable development goal-linked instruments. Conditions for green project finance and green mortgages will be created.
Incidentally, on the way to green mortgages, crucial methodological conditions were prepared this past year: DOM.RF, together with the Ministry of Construction, issued a green standard for apartment buildings, as well as a system for assessing and certifying facilities. Now green mortgage has no formal barriers, and judging by the pace of development of financial instruments by DOM.RF, in the coming year we may see the first green mortgage transactions.
Sanctions restrictions, which have led to the closure of Western reinsurance markets and a shortage of available reinsurance capacity for Russian insurers, have encouraged the financial regulator to develop reinsurance securitisation, i.e. the issue of so-called catastrophe bonds by insurers, whose payouts depend on realised losses in the insurance portfolio.
In other words, catastrophe bonds are bonds whose interest rate reflects the rate of occurrence of an insured event. If no incident occurs during the term of the bond, the amount of the guarantee provided by the bond is paid to the investor with interest. But if the risk is realised, the proceeds from the bonds placed will be used to cover the damage.
Catastrophe bonds are considered complex risky instruments on the global market, but they can offer increased returns for investors. It is likely that there will be a place for higher-risk instruments in the portfolios of professional investors in the Russian market as well — there is an appetite for such instruments even among individual investors.
To protect investors’ rights, the Bank of Russia plans to develop approaches to regulating the verification of sustainable development financing instruments, as well as to monitor ESG rating activities by Russian organisations. In fact, this indicates the beginning of soft regulation of the most important institutions of the national ESG infrastructure. The process is inevitable.
Exchange trading, market price of carbon and recognition of netting for exported products.
The first verified climate project in Russia was the construction by LLC DalEnergoInvest in the Sakhalin Region of a plant with 648 solar panels with installed capacity of 250 kW, which provides for the use of renewable energy sources at the connected facilities and in the region’s mini grids. And on 26 September, the National Commodity Exchange, which is part of the Moscow Exchange Group, held its first carbon unit trading. In the course of the commodity auction, two transactions were concluded and 20 carbon units were sold, with a weighted average price of RUB 1,000. In fact, this event marked the beginning of on-exchange trading in carbon units in Russia.
In the main directions of financial market development for the next three years, the Bank of Russia, together with the Russian Government, plans to further fine-tune the national carbon regulation system and the system of exchange-traded carbon units with the involvement of clearing infrastructure to ensure settlements on a “delivery versus payment” model. This will not only allow the domestic market to form the carbon price, but also to move further towards the recognition of such netting of the carbon footprint for exported products abroad through the integration of greenhouse gas emission trading systems or mutual recognition of carbon regulation by markets of friendly countries.
Thus, the creation of a national carbon exchange system will contribute to making climate projects more economically attractive for Russian organisations, as it will help them to effectively integrate into new business chains that are based on carbon footprint reduction commitments. And such requirements are now taking shape at the national level and are already well developed internationally.
Outlook on: ESG regulation and supervision left for the medium term horizon
On the medium-term horizon, the Bank of Russia will work on the possibility of integrating ESG risks into prudential regulation and supervision. But the Central Bank plans to implement the regulations under development over a longer period of time than previously envisaged. The financial and real sectors need time to build up capital and rebuild their resilience after suffering losses due to sanctions.
Cover photo: Unsplash / Noah Busher
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