Big time for green and sustainable finance

Recent news from Lithuania and Europe reveal that we are ready to overcome the challenges posed by COVID-19 and start a new era of green and sustainable finance.

On 27 May 2020 the European Commission (EC) updated its seven-year EUR 1 trillion budget proposal and announced the biggest recovery plan in EU history – Next Generation EU – bringing to bear an additional EUR 750 billion of financial firepower. All funds will be filtered by reserving 25 % of spending for climate change expenditure, ensuring implementation of the European Green Deal initiative.

On 26 May 2020, the EC approved Lithuanian plans to set up a fund with a target size of up to EUR 1 billion, making it the first State Aid scheme for debt and equity instruments in the EU allowing private investments to be blended with State funds. One of the objectives of the fund is to focus on green and sustainable investments.

In addition to public initiatives, private financial market participants have also been active in the green and sustainable financing sector. However the full potential of financial instruments was limited by lack of regulation allowing an indication of what makes a financial product sustainable and green. For this reason the EC is preparing the Taxonomy Regulation; its final report was recently presented to the public.

Finally, we believe that all the above initiatives will greatly help Lithuania to become a regional hub for green and sustainable finance, however, opportunities for private financial market participants are already within hand reach.

Booming European public funding for climate change initiatives

As EC President Ursula von der Leyen said in her statement, the updated budget provides not only an opportunity to support the recovery of the EU economy from COVID-19 caused stagnation, but also to invest in our future – the European Green Deal and digitalisation. To ensure an effective response the investment will be channelled under three pillars:

• Supporting recovery of Member States. This pillar includes three key instruments:
  • European Recovery and Resilience Facility – EUR 310 billion for grants and EUR 250 billion in loans by implementing Member States’ national recovery and resilience plans, including in relation to green and digital transitions and the resilience of national economies.
  • REACT-EU – Recovery assistance for cohesion and the territories of Europe – EUR 55 billion between 2020-2022 for grants for municipalities, hospitals, and companies via Member States’ managing authorities.
  • Next Generation EU support – EUR 40 billion for the Just Transition Fund to assist Member States in accelerating transition towards climate neutrality and EUR 15 billion for the European Agricultural Fund for Rural Development to support rural areas in making the structural changes necessary in line with the European Green Deal.
• Kick-starting the economy and helping private investment, which includes a EUR 30.3 billion InvestEU Programme and Strategic Investment Facility, which will provide an EU budget guarantee for financing of investment projects via the European Investment Bank (EIB) and national promotional banks and a EUR 31 billion New Solvency Support Instrument providing an EU budget guarantee to the EIB in order to mobilise private capital.
• Learning lessons from the crisis – a EUR 9.4 billion new Health Programme to equip Europe against future health threats and EUR 3.1 billion reinforcing the EU’s Civil Protection Mechanism to respond to large-scale emergencies.

In order to raise funds needed for these investments, the EC will issue bonds on the financial markets and channel them via Next Generation EU. It is believed that EU efforts will create conditions for a recovery led by private investment in key sectors and technologies.

Lithuanian Super-fund for debt and equity investments

After two intensive months of work and debates, the Bank of Lithuania successfully pushed through the first and unprecedented scheme approved under the State aid Temporary Framework, which provides EU countries with the opportunity to recapitalise non-financial corporations facing difficulties due to the COVID-19 outbreak.

The Super-fund, which will be established and managed by the Ministry of the Economy and Innovation as well as the Lithuanian Ministry of Finance will unlock liquidity and capital support of up to EUR 1 billion for Lithuanian SMEs and large enterprises. According to the EC press release, the State will provide an initial investment of EUR 100 million in the fund, and will guarantee bonds up to EUR 400 million that will be issued to raise additional capital for the fund while the fund will also aim to attract private investments of up to an additional EUR 500 million.

It is expected that the fund, which will provide aid in the form of loans, debt securities, equity investment or hybrid capital instruments, will encourage Lithuanian companies to issue debt securities, thus contributing to the long-term development of Lithuania’s capital market.

EU taxonomy – ID of sustainable finance

A variety of sustainable financial products have been visible in the financial sector for some time now, but due to lack of regulation many financial market participants and other stakeholders are postponing their turn to sustainable finance products. Nevertheless, this is likely to change in the nearest future.

On 9 March 2020, the EC Technical Expert Group published its final report on EU taxonomy followed by (i) technical annex containing screening criteria for climate change mitigation and adaption activities and (ii) a special Excel tool to assist users of the Taxonomy to adopt their own activities.

The report revealed that upcoming Taxonomy Regulation, which should be established by the end of 2020, will help investors, companies, issuers and project promoters identify which activities are environmentally friendly and sent an important message – Taxonomy Regulation will introduce a new disclosure requirement for pension and asset management, insurance and corporate investment banking products marketed in the EU. More specifically, financial institutions will be required to disclose:

• how and to what extent the taxonomy has been used in order to determine the sustainability of the underlying investments;
• the environmental objectives to which the investments contribute; and
• the proportion of underlying investments that are taxonomy-aligned.

According to the report, individual financial instruments such as bonds or loans will not be directly included in the taxonomy disclosure obligation, though financial market participants may choose to use the taxonomy for other product types and it is most likely that they will.

Even before the announcement of the EU’s sustainability-related goals, European public and private, financial and non-financial institutions were actively using or developing sustainable financial products, and establishing specialised institutions. The financial market has been active in using green bonds (e.g. based on the International Capital Market Association’s Green Bond Principles), introducing new business lines (e.g. green loans and sustainability linked loans based on principles established by the Loan Market Association).

Finally, it is most important that more and more financial institutions declare their primary interest in contributing to the fight against climate change, whether it is an investment company having a special label (such as the French Label ISR or Luxembourg’s LuxFlag label) or licensed credit institutions strongly committing to sustainable finance (eg BBVA or Triodos Bank), so the question is not ‘if’ but rather ‘when’ the EU and Lithuanian financial markets will become fundamentally green and sustainable.

Lithuania – future centre of sustainable finance and existing opportunities

While Lithuania is still continuing its FinTech jurisdiction’s success story, by using its know-how and flexibility the country has set a new goal – to become a regional hub for green and sustainable finance. For this reason, Lithuania together with the EC and the EBRD launched a project for creating a national strategy and action plan on sustainable finance.

One of the most important targets of this project is to identify measures that would facilitate a favourable ecosystem for sustainable investment in Lithuania by increasing the supply of sustainable finance products and attracting foreign investment. Notably, it is inevitable that the respective ecosystem will need to develop three essential elements:

• public-private capital investment vehicles (blended capital funds);
• guidelines and principles for identification of sustainable finance products, and
• a network of local financial institutions oriented to green and sustainable financing.

Much has been done to unlock benefits from public and private sector cooperation, and implementing EU taxonomy is also underway, so the only question is whether financial market participants will be able to use the opportunities offered by Lithuania.

Investors can already find a suitable environment for the development of credit and investment services in Lithuania as it offers benefits such as:

• Gateway to the European market (passporting): banks, investment firms, asset management companies and insurance companies holding a licence in Lithuania may provide their services in all EEA countries.
• Low initial capital requirements: Lithuanian law foresees that initial capital for specialised banks (without investment services) will be only EUR 1 million (instead of EUR 5 million for full banking licence in Lithuania and other EU countries) and for investment firms from EUR 50 thousand to EUR 730 thousand depending on services to be provided.
• Nearby Eastern European market: the Baltic, Belarusian and Ukrainian markets are heavily underserved because of their geographical position, but their potential need for green and sustainable financing is unquestionable.
• Minibonds: a very recent but successful tool for borrowing up to EUR 8 million in capital markets is by issuing bonds. Minibonds fall outside EU prospectus regulation, so preparation is fast and easy.
• Technical services for banks: the Bank of Lithuania provides technical access for all payment service providers, enabling them to send and receive SEPA payments.
• Technical services for investment companies: Nasdaq Vilnius, the stock exchange operating in Lithuania, provides special screening and labelling for equity and debt issues related to ESG principles.
• Transparent legal system: Lithuania being a member of the EU has transposed EU directives (including CRD IV, MiFID II and UCITS directives) allowing market participants to understand EU market rules.
• Reputable, progressive and open regulator: the Bank of Lithuania has proved that is ready to be a leader in regional financial markets by providing technical services and organising eye-to-eye meetings with all newcomers and stakeholders. The latest success in creating a national Super-fund just proves that Lithuania is ready to welcome private companies willing to co-operate with public initiatives and provide their services from Lithuania.