Benoît Theunissen: LuxSE was the first exchange in the world to specialise in green bonds. What is the your assessment of how things stand today?
Chiara Caprioli: The LuxSE universe is structured around fixed income products. Since 2016, we have had a platform, the Luxembourg Green Exchange, or LGX, which today hosts around 1,500 green, social, sustainable and sustainability-related bonds, with a total value equivalent of around €795bn.
In terms of issuers, what developments are you seeing?
In addition to the usual issuers such as multilateral development banks, governments, agencies and financial institutions, we have seen a significant entry of companies into the market since the codification of sustainability bonds. In this segment, we are seeing interest from companies that until two years ago were only marginally active in the green, social and sustainable bond market. These include companies active in greenhouse gas (GHG) intensive sectors such as shipping, aviation, fashion and steel. In the past, these companies did not participate in the green, social and sustainable bond market because they did not have enough eligible low-carbon projects to justify a bond. Now, these issuers can signal decarbonisation commitments to investors and integrate them into their bond product structure through sustainability bonds. The issuer then undertakes to pay a financial penalty in the form of a step-up coupon if it fails to meet its self-imposed targets relating to, for example, carbon reduction, energy intensity or water consumption of manufactured products. In this way, it sets a guideline that investors can trust.
These companies are therefore taking a certain risk by issuing bonds.
The difficulty for issuers of this type of bond product is to find a level of ambition that allows them to move out of their comfort zone and/or the sector average, but which is not completely unachievable. These targets must, of course, be approved by an external certifier. An issuer that fails to meet its commitments then runs the risk of losing its investors, a disadvantage that adds to the financial penalty.
LuxSE lists and displays, on its Luxembourg Green Exchange (LGX), four categories of labelled bonds: green, social, sustainable and sustainability bonds. What room is there for non-labelled products?
It is essential to make all products that can be investment solutions available online, displaying investors’ ESG mandates. The labelled universe does not cover everything. That is why we display unlabelled bonds issued by issuers that the Climate Bonds Initiative--an organisation that strives to mobilise global capital for climate action--considers to be ‘climate-aligned issuers’ on LGX. These are issuers that derive 75% to 100% of their revenues from sustainable activities, such as producers of solar panels or wind turbines. They are not necessarily required to structure their bonds according to a label, as this would incur subsequent costs that they do not need to justify, as their models are sustainable by default. Nevertheless, these issuers are not visible on the green bond market. That is why LuxSE displays them on LGX to make them visible to investors. This is an investment universe that is four to five times larger than that of labelled issues, and just as interesting in terms of impact.
We do not judge whether one product is greener than another, but whether the product offers sufficient transparency and incorporates international standards for investors to make their own analysis and investment decisions.
How does LuxSE select these non-labelled bonds?
We have the partnership with the Climate Bonds Initiative, which provides us with the methodology to identify climate-aligned issuers. Based on their analysis, we place the unlabelled bonds--and labelled ones if they have them, as is sometimes the case--on our platform. In short, the concept of LGX is to provide a platform with enhanced transparency criteria, which presents the market with investment opportunities that are robust to disclosure requirements. We do not judge whether one product is greener than another, but whether the product offers sufficient transparency and incorporates international standards for investors to make their own analysis and investment decisions, as well as to verify that issuers are financing projects that contribute to sustainable development.
Can we say that LuxSE compensates for a lack of regulation?
LuxSE anticipates regulation. Since 2007, the market has never really been regulated. The first wave of regulation is only recent and is still being developed. However, players federated within the [International Capital Market Association] had already introduced a set of rules applicable on a voluntary basis, which in practice became essential for any issuer wanting to be credible. There have been others. For our part, we have made these transparency and reporting standards mandatory for inclusion on the LGX .
Is the idea of focusing on green finance unique to LuxSE or has a form of competition developed?
We were the first to move in this direction back in 2016. Since then, other exchanges have tried to replicate our model. Some exchanges such as Nasdaq, Euronext, the London Stock Exchange and Tokyo Stock Exchange have developed a segment for the visibility of green bonds. However, they do not have a centralised depository service for all documentation, which is free and fully accessible to investors. These exchanges are limited to a certain extent to displaying a tag on the products that are eligible to signal them to the market, without making all the necessary information available to investors.
We have created a proprietary model with a unique granularity offering around 150 data points per bond and covering over 8,000 bonds.
So how important is data to you?
We have launched the LGX DataHub, which centralises ESG data on green, social, sustainability and sustainability-related bonds listed worldwide. We have created a proprietary model with a unique granularity offering around 150 data points per bond and covering over 8,000 bonds. This allows users to compare ESG indicators between one bond and another in order to make investment choices. It also helps investors access useful data for impact and regulatory reporting. It is a product that was originally developed for asset managers, but is also used by banks, research centres and even issuers.
Do you play a monitoring role with the LGX DataHub?
No. We only analyse public information, in this case that published by the issuers themselves. We check the primary source of this information, but we are not auditors, that is not our role. It is the responsibility of the issuer to appoint an auditor who can verify the information and make impact assessments. However, we will allow investors to know whether the reports have been verified by independent third parties.
How much automation and artificial intelligence is involved in the LGX DataHub?
At the very beginning, we started out purely manually, partly to deepen our knowledge of the data, before identifying the most relevant indicators. Now we work with a service provider who uses artificial intelligence. However, everything is checked by a double human control. Automation is mainly carried out when extracting part of the information, but a qualitative and manual review is systematic--a function that is not outsourced.
So how do you overcome the challenges of missing and incorrect data?
The proprietary structure of the LGX DataHub has fields that are predefined. So if a sender has missing data, then the fields will remain blank, empty fields do not contain a proxy. This creates positive pressure, as the less transparent issuers will be quickly identified. We cannot, however, assess data that does not exist.
The complexity of the data, the lack of standardisation and the absence of certain data are all challenges that will gradually be resolved by the force of regulation."
Read the original French version of this interview on the Paperjam site. This article was published for the Paperjam + Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link.