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Readying for a Russian surge in green debt

ESG is rising up the agenda of the country’s corporates. Supported by new regulatory initiatives, evolving financing structures and ever-greater investor demand, Mikhail Pichugin of VTB Capital outlines the growing potential for green and social debt in 2022 and beyond.

Commitments to the environment are gaining momentum in Russia. From projects aimed at reducing the negative impact on the natural world to increasing energy efficiency, ESG is a priority for many domestic businesses, as was showcased by debates on green transformation at the VTB Capital’s Investment Forum RUSSIA CALLING!.

This is increasingly translating into capital markets activity, for which issuers have a big incentive given the escalating costs of decarbonisation.

Estimates by VTB Capital, for example, suggest a 25% emission reduction will cost the Russian economy and also local industry – in the form of capital investments – RUB43 trillion ($583 billion). This compares with RUB86.6 trillion for a 50% reduction, and RUB479.8 trillion for full reduction by 2060, equivalent to 15% of GDP year-on-year.

At the same time, the analysis highlighted that the costs to combat emissions may lead to higher prices. The most significant increase is expected in the power industry (+28% to current end-user prices) and in the cement sector (+40%).

Such a wake-up call bodes well for the further development of social and green bonds, which have already seen a boost in investor appetite over the past 12 to 24 months.

“Investors are increasingly focused on ESG factors when making investment decisions in EM asset classes,” explained Mikhail Pichugin, head of international debt capital markets at VTB Capital.

This demand is shaping the plans of domestic borrowers. A growing number of them are now considering issuing debt obligations with an ESG agenda – including green and sustainability-linked bonds with key performance indicators.

  Building the ESG bond pipeline

  VTB Capital has placed five debt obligations with an ESG component in the Russian and foreign markets   in 2021, with a total volume of RUB137 billion:

  • The issue of perpetual ‘green’ eurobonds for Russian Railways, one of the largest ESG borrowers in the local market and the only corporate representing Russia in the green eurobond market
  • A tap issue of Russian Railways’ perpetual eurobonds
  • The issue of four-year social eurobonds by Sovcombank, the first Russian bank to issue this type of debt
  • The issue of seven-year ‘green’ bonds by the city of Moscow
  • The issue of five-year ‘green’ bonds by Sinara-Transport Machines

Fostering a greener culture

The next 12 months is expected to yield the results of intense work by Russian issuers on strengthening and improving the quality of ESG disclosure.

According to Pichugin, this will likely be reflected both in the number of green instruments and issues, as well as in the overall attractiveness of the Russian market to ESG investors.

In line with this, VTB plans to issue up to RUB20 billion of ESG loans in 2022 via a pilot lending programme to subsidise large corporate clients to finance green projects and sustainable development plans. These will support the improvement of environmental performance, reduce the consumption of natural resources and promote the use of renewable energy sources.

This transaction activity will mark an evolution of the bank’s existing portfolio of green-related financing initiatives. To date, VTB has completed a number of transactions totaling more than RUB45 billion to project finance solar and wind power plants.

“Interest among corporates in Russia in ESG loans, bonds and financing of various green initiatives on concessional terms continues to grow, and we are expanding our range of financial instruments and services with an ESG component,” added Pichugin.

A combination of regulatory incentives and government support measures should accelerate this further, especially in terms of the green lending market.

Today, banks are allocating the same amount of capital for “green” loans as they are for conventional loans. Taking into account the reduced rate at which ESG financing is issued, this often does not allow banks to achieve a sufficient level of return on capital. “However, regulatory changes to address this will have a positive effect on the development of the industry and on the volume of new ‘green’ projects,” explained Pichugin.

Taking the ESG evolution to new levels

The coming year also heralds the potential for greater maturity and sophistication of the market, including new opportunities for digitalisation and the emergence of new financing structures for large, environmentally and economically significant projects.

For example, VTB is launching a new business line that will focus on climate finance and carbon market operations, both in Russia and internationally. 

In short, this will give issuers from an array of sectors financially structured access to green funding by linking emissions commitments to voluntary carbon schemes.

It will include raising financing in the domestic and international markets for Russian companies to execute ESG projects aimed at reducing emissions, providing greenhouse gas capture and storage, introducing low-carbon technologies, promoting climate change adaptation and undertaking transactions in the carbon market.

“This approach will be relevant for issuers focused on enhancing efficiency in emissions, but which have not yet been able to achieve this in a predictable enough way to scale it,” explained Pichugin.

As a result, developing a larger range of products along with the infrastructure to launch operations in the carbon markets as soon as feasible appears to be a logical step for VTB to further integrate sustainable development principles into its strategy and operations.

Efforts to decarbonise the economy and society are certainly key driving forces. VTB believes it will be impossible to achieve these goals without a significant increase in the turnover of the global carbon markets.

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