Circular dated 18 July 2021 on sustainable finance

Dear Sir / Chairman of the Board, Greetings,

In light of the Central Bank of Egypt's direction towards establishing the concept of sustainable finance, which contributes to supporting financial and banking stability and achieving sustainable development goals, thereby achieving long-term stability for the economy, environment, and society as a whole, the Central Bank has previously issued several initiatives aimed at achieving sustainable development goals and enhancing sustainable finance, such as the Small and Medium Enterprises initiative, initiatives for the industrial, agricultural, tourism, and contracting sectors, the housing finance initiative, the initiative for replacing vehicles with dual-fuel engines, and the gas stations initiative.

It is worth noting that the banking sector is one of the most important sectors supporting development efforts, and thus active participation in achieving sustainable development goals, including environmental and social challenges, cannot be realized without banks playing a role by directing financing towards more sustainable economic activities. Furthermore, integrating environmental, social, and governance elements has a positive impact on company performance and reducing risk ratios, in addition to being an important factor in attracting foreign investments.

Given that sustainable finance has become one of the most prominent topics discussed in international forums and has attracted the interest of many central banks, a general framework for defining sustainable finance and its directions has been established. Accordingly, I have the honor to attach herewith the Central Bank’s guidelines regarding the requirements for its implementation in the Egyptian banking sector:

-1 Discussion paper on sustainable finance (Attachment 1).

-2 Guiding Principles for Sustainable Finance (Attachment 2).

Please kindly ensure attention to the directive to take necessary measures to study and provide all means required to implement the attached principles in your esteemed bank. Please accept our highest regards,

Gamal Naguib

Attachment (1) Discussion Paper on Sustainable Finance

The attached discussion paper serves as an introductory note addressing the concept of sustainable finance, which has become a primary goal for central banks by encouraging banks to integrate environmental, social, and governance elements into their credit granting processes and investment decisions.

It is worth noting that sustainable finance contributes to achieving sustainable development, which is considered a national responsibility falling upon the concerned ministries, where it was defined as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs" according to the United Nations General Assembly. Thus, sustainable development aims to achieve long-term stability for the economy, environment, and society as a whole.

The Central Bank of Egypt has directed support for the concept of sustainable development and taken steps to enhance and apply sustainable finance in the banking sector, as its application has become an important topic discussed internationally.

First: Concept of Sustainable Finance

Sustainable finance refers to financial or banking services that consider environmental, social, and governance elements in the bank's decisions when granting credit or making investment decisions, in order to achieve sustainable benefit for customers, stakeholders, and society as a whole.

Second: Elements of Sustainable Finance (ESG - Environmental-Social-Governance)

.1 Environmental Element: Factors related to the environment such as climate change, greenhouse gas and carbon emissions, air and water pollution, water scarcity, and global warming.

.2 Social Element: Factors with social impact, such as providing employment opportunities and improving working conditions, which include health and safety, workers' rights, and impact on surrounding communities of the projects concerned, etc.

.3 Governance Element: Factors related to how the institution is managed, such as the independence and composition of the board of directors, shareholders' rights, and transparency.

.1 At the level of the Central Bank:

a. Sustainable finance supports financial and banking stability, as studies have proven that integrating environmental, social, and governance elements has a positive impact on company performance and reducing risk ratios, thereby providing low-risk financing for those companies, which positively reflects on the stability of the financial system.

b. Enhancing investment opportunities and injecting foreign currency by attracting a new segment of investors targeting sustainable finance, in addition to direct foreign investment for the banking sector and the national economy.

c. Enhancing the issuance of green bonds amidst the growing spread of environmental and social investment.

d. Possibility of creating green banks in accordance with the provisions of the new Central Bank and Banking Authority Law, where a new type of specialized banks will be licensed, as green banks help secure low-cost capital financing for clean and renewable energy projects and projects generally aimed at improving environmental quality at suitable prices and terms.

e. Supporting the Central Bank's efforts towards the state's achievement of sustainable development goals, which sustainable finance contributes to directly.

Generally, sustainable finance contributes to maintaining long-term financial stability. It is worth noting that the Basel Committee on Banking Supervision recently announced the formation of a working group on financial risks related to climate change, and international institutions have pointed out the need for new strategies and partnerships to effectively and efficiently address environmental and social challenges.

.2 At the level of the banking sector:

The banking sector is one of the most important sectors supporting the economy; thus, sustainable development, including environmental and social challenges, cannot be achieved without banks playing an active role by directing financing towards more sustainable economic activities. Below are the importance of sustainable finance for banks:

a. Providing new and innovative financial solutions and banking products, and opening new fields and markets for financing, which contributes to achieving more profits.

b. Adopting sustainable finance concepts works to reduce default opportunities, thereby maintaining the quality of the bank's portfolio.

c. Sustainable finance allows banks to contribute positively to community development and preserving the surrounding environment, and improving the reputation of banks locally and internationally.

d. Reducing environmental and social risks.

It is also worth noting that applying sustainable finance in banks does not necessarily negatively affect bank profitability or stop financing specific projects or industries, but rather leads to providing innovative financial solutions and achieving more profits by opening new markets and fields and reducing environmental and social risks.

It is observed that there is confusion between the concept of sustainable finance and corporate social responsibility in banks. Therefore, it must be emphasized that sustainable finance is a specific and fixed banking approach applied according to international standards regarding the style and method of lending and investment and reducing related risks. In contrast, social responsibility differs from sustainable finance as it stems from each institution's vision of its societal role and changes according to the institution, and it is linked to efforts and initiatives implemented during specific periods and cannot be relied upon in the long term as plans to achieve desired development. However, it can be said that social responsibility efforts contribute in the short term to achieving some of the sustainable development goals.

Fourth: Efforts of the Central Bank and the Banking Sector

The Central Bank has issued several initiatives aimed at achieving economic development and enhancing sustainable finance by making specific amounts available to banks to use in granting credit facilities to their clients under the umbrella of these initiatives at low yield rates, as this type of financing plays a fundamental role in developing the national economy, providing job opportunities for youth, and reducing unemployment rates, which respects the social element of sustainable finance elements, in addition to focusing on sectors such as new and renewable energy, which respects the environmental element. Below are some relevant initiatives:

a. Small and Medium Enterprises Initiative b. Initiatives for the Industrial, Agricultural, and Contracting Sectors c. Housing Finance Initiative d. Initiative for Replacing Vehicles with Dual-Fuel Engines and Gas Stations Initiative

Furthermore, the following have been issued, which contribute to achieving sustainable development goals:

a. Instructions for Protecting Bank Customers' Rights b. All efforts made to achieve financial inclusion c. Issuance of rules and digital service systems such as using mobile phones and digital payment tools

Fifth: Risks Resulting from Not Considering Sustainable Finance Elements

a. Physical Risk Risks resulting from environmental hazards and climate change—which threaten many industries and can disrupt global supply chains, such as droughts, floods, hurricanes, and rising carbon levels—which may affect financial stability through its impact on other sectors such as agriculture, energy, tourism, etc., and may have a long-term impact, leading to increased food commodity prices, for example, due to reduced agricultural production, and consequently affecting macroeconomic sustainability and stability, thus requiring regulatory authority intervention.

b. Reputation Risk Risks resulting from banks focusing solely on profit realization, disregarding environmental or social risks associated with the bank's activity or financing customers or projects that do not meet sustainability elements, and having negative environmental or social effects.

c. Credit Risk Risks resulting from the possibility of customers failing to repay credit facilities due to the following reasons:

• Disregard for sustainable finance elements and exposure to related risks.
• Incurrence of fines or compensation to affected parties that suffered negative social or environmental impacts, which may subsequently affect the value of their collateral or assets.

Risks resulting from operations conducted by financial institutions that negatively affect the environment, such as energy use, paper consumption, fuel consumption, and waste disposal. Although the direct impact of energy, waste, and paper used by financial institutions on the environment is relatively lower compared to many other sectors, their overall impact on the environment cannot be ignored.

d. Social Risk Risks resulting from neglecting social dimensions. Therefore, efforts should be made to strengthen the culture of respecting and protecting human rights in general and workers' rights in projects intended to be financed, in addition to ensuring justice and fairness, providing equal opportunities among individuals, contributing to their growth and development, and ensuring the maintenance of a healthy and safe work environment.

e. Legal or Direct Risk Involves legal obligations that banks and/or companies may incur, for example, paying fines and compensation to affected parties that suffered negative social or environmental impacts.

Sixth: Challenges Associated with Applying Sustainable Finance

Applying sustainable finance generates transition risks resulting from the rapid shift to environmentally benign industries and economies, known as the "low-carbon economy." Although this transition contributes positively to the environment, it may result in the need to rapidly redirect investments away from industries and economies that do not respect the environmental dimension, known as the "carbon economy," which may affect entire sectors within the current economic system, thereby eliminating billions of potential investments.

Based on the above, international practices of several countries whose central banks have issued principles or guiding instructions in the field of sustainable finance were studied, such as Brazil, Ghana, Philippines, Morocco, Cambodia, Nigeria, Georgia, and Bangladesh. Practices and reports of the European Supervisory Authority, the European Union, the Bank of England, and the Sustainable Banking Network were also studied. This study resulted in the following:

-1 Role of Central Banks in the Field of Sustainable Finance

Central banks have recently begun focusing on sustainable finance elements as a means to achieve economic stability, given that environmental and social risks harm the performance of financial institutions. The role of central banks focuses on encouraging banks to finance projects with economic or social viability or having a positive impact on the environment, such as those aiming to transition to new and renewable energy. The most important steps taken by central banks in this regard include:

a. Encouraging banks to integrate sustainable finance elements into the bank's credit and investment activities and enhancing this concept to include all bank activities.

b. Directing banks towards financing projects that respect sustainable development goals, such as financing small, medium, and micro-enterprises, and seeking new sectors to achieve growth and profitability while increasing financing availability for projects requiring more funding at reduced yields.

c. Directing banks towards investing in or financing projects with low carbon emission rates, new and renewable energy projects, and labor-intensive projects, with banks developing new markets that respect sustainable finance elements.

d. Issuing low-yield initiatives to finance projects that respect sustainable finance elements, especially the environmental and social elements.

e. Encouraging and motivating banks to issue Green Bonds, amidst the growth of the global green bond market, with the possibility of significantly expanding the scope of global financing for projects with environmental and climate benefits.

f. Implementing training programs for employees in the banking sector to create knowledge and build the necessary capacities in the field of sustainable finance and sustainable development in general.

-2 Most Important International Specialized Entities in the Field of Sustainable Finance

a. International Finance Corporation (IFC) (A member of the World Bank Group) The largest global development institution focusing exclusively on supporting and developing developing countries, headquartered in Washington, USA.

b. European Organization for Sustainable Development (EOSD) Comprises 35 countries represented by financial sector regulatory bodies, banking unions, and entities concerned with sustainable development and the environmental field, headquartered in Karlsruhe, Germany. It was established according to EU laws to work on implementing the EU's sustainable development strategy. Its jurisdiction includes developing policies, preparing initiatives, designing training programs, and exchanging experiences between EU member states and other member countries. (The Central Bank of Egypt is a participating member since 2018).

c. Sustainable Banking Network (SBN) A network stemming from the International Finance Corporation (IFC), comprising 38 countries represented by financial sector regulatory bodies and banking unions in emerging markets committed to developing sustainable finance in line with international practices. It is the most important international entity concerned with preparing policies for sustainable finance. (The Central Bank is a member since 2019), headquartered in Washington, USA.

d. Network of Greening Financial Systems (NGFS) The network comprises 42 countries represented by financial sector regulatory bodies and banking unions. It facilitates the exchange of experiences and discussion of best international practices applied in environmental protection and combating climate change. The French Central Bank in Paris coordinates the network's work.

e. Alliance for Financial Inclusion (AFI) The world's leading organization in supporting financial inclusion, headquartered in Kuala Lumpur, Malaysia. It comprises financial inclusion policymakers from more than 95 countries with the aim of exchanging experiences and best international practices in enhancing financial inclusion. (The Central Bank is a member since 2013). Mr. Governor of the Central Bank of Egypt chairs the AFI Board of Directors in its current term. The Alliance also established a specialized Working Group on Green, Inclusive, and Sustainable Finance in 2019.

f. Center for Financial Inclusion (CFI) Established by Accion as an independent research center focusing on inclusive finance to enhance comprehensive financial systems for low-income individuals worldwide.

-3 Most Important International Standards Regarding Sustainable Finance

a. UNEP FI Principles for Responsible Banking: These are six principles issued by the United Nations Environment Programme Finance Initiative (UNEP FI) aimed at establishing a framework for creating a sustainable banking system. They were launched by 130 commercial banks from 49 countries. It is worth noting that Bank Misr, Alexandria Bank, Banque Misr, and the Arab African International Bank signed these six principles in the Arab Republic of Egypt. The banks commit to the following:

.1 Alignment: Aligning bank business strategies to meet societal needs and objectives in accordance with sustainable development goals and the Paris Agreement on climate change, and all relevant national and regional agreements.

.2 Impact and Targets: Increasing banks' positive impact on the environment and society and reducing any negative impact resulting from their activities, setting necessary targets, and innovating products and services aimed at achieving this principle.

.3 Client Engagement: Treating clients responsibly to encourage sustainability activities and stimulate economic activities that achieve prosperity for current and future generations in general.

.4 Stakeholder Engagement: Consulting and involving all stakeholders and forming partnerships to achieve societal goals.

.5 Governance: Committing banks to these principles through applying best governance practices.

.6 Transparency and Accountability: Banks periodically review their activities and ensure compliance with these principles and demonstrate transparency regarding the banks' positive and negative impacts and the extent of their contribution to achieving societal goals.

b. Equator Principles (EPs): These are ten principles issued by the International Finance Corporation (IFC) representing a framework for managing environmental and social risks that financial institutions adopt in project financing. Its primary purpose is to provide minimum standards to support responsible decision-making regarding risks. Below is an overview of these principles:

.1 Review and Classification: Classifying projects based on the size of risks and potential environmental and social impacts.

.2 Environmental and Social Assessment: The client conducts an assessment of potential environmental and social risks for the proposed project and the extent of impact of those risks.

.3 Applicable Environmental and Social Standards: Ensuring compliance with applicable laws, regulations, and permits in the environmental and social field within the country.

.4 Environmental and Social Management System (ESMS) and Implementation Plan: The bank's client develops an environmental and social management system to deal with any environmental or social risks identified in the project assessment process mentioned in Principle Two.

.5 Stakeholder Engagement: Ensuring the client coordinates with all internal and external stakeholders in continuously assessing potential environmental and social risks for proposed projects.

.6 Grievance Mechanism: Requiring the client to establish a grievance mechanism—within the Environmental and Social Management System (ESMS) mentioned in Principle Four—aimed at receiving and facilitating the resolution of complaints from parties affected by the environmental and social impacts of proposed projects.

.7 Independent Review: Conducting an independent review of the Environmental and Social Management System (ESMS) (mentioned in Principle Four) and stakeholder engagement process (mentioned in Principle Five) by an environmental and social consultant for all proposed projects.

.8 Commitments: The client commits to providing guarantees to banks to ensure compliance with all relevant environmental and social laws, regulations, and licenses.

.9 Independent Monitoring and Reporting: Appointing an independent environmental and social consultant to assess the project's compliance with the principles, monitor the project's environmental and social performance after financing, and prepare necessary reports to monitor this performance at least once.

.10 Reporting and Transparency: The client commits to making available all information regarding the results of the environmental and social assessment mentioned in Principle Two annually regarding greenhouse gas emission levels.

According to the aforementioned principles, several procedures and assessments are conducted before making a credit granting decision, and several other procedures are taken after the financing process ends to measure the actual environmental and social impact of projects after commissioning.

In addition to the aforementioned principles, it is worth noting the following related entities, initiatives, and international standards:

a. Task Force on Climate-related Financial Disclosures (TCFD): Established by the Financial Stability Board in 2015, consisting of 31 members issuing recommendations on how to disclose financial information related to climate change.

b. Green Bond Principles (GBP): Issued by the International Capital Market Association, these are principles and guidelines regarding the issuance of green bonds.

c. Global Reporting Initiative (GRI): An independent non-profit organization and the first to establish international standards for sustainability disclosure.

Based on the above, and with the aim of keeping pace with best international practices in establishing "sustainable finance" rules in the banking sector and supporting sustainable development efforts, the Central Bank deemed it appropriate to issue the Guiding Principles for Sustainable Finance (Attachment) as an important step towards beginning to establish the general framework for applying sustainable finance.

The "Guiding Principles for Sustainable Finance" aim to begin planning and establishing the general framework for applying sustainable finance, building capacity, and providing necessary resources to implement these principles.

Principle One: Building Necessary Capacity and Knowledge Work on building and developing the capacities of all bank employees, and putting forward training plans that contribute to building and enhancing their knowledge regarding concepts and methods of applying sustainable finance.

.1 Building capacity to put forward necessary policies according to best international practices.

.2 Cooperating with the Central Bank of Egypt, the Banking Institute, and other training entities internally and externally in preparing and implementing necessary programs to train all bank employees in the field of sustainable finance.

.3 Training employees on data collection and analysis methods and using information systems in preparation for preparing necessary reports.

.4 Encouraging bank employees to apply principles gradually and focusing on recommended practices and guidelines.

Principle Two: Enhancing Sustainable Finance Apply the concept of sustainable finance and work on integrating environmental, social, and governance elements into the bank's financing activities, as well as formulating a vision for managing environmental and social risks and taking them into consideration when measuring the bank's risks.

.1 Begin formulating a vision to modify existing bank policies and procedures to include sustainable finance elements, while considering setting clear goals for the bank under the umbrella of sustainable finance.

.2 Work to increase and encourage financing or investment in projects that respect sustainable finance elements and achieve sustainable development, for example, financing the creation of new and renewable energy generation stations, and financing waste recycling projects.

.3 Support financial inclusion in general and facilitate access to formal financial services, and work on innovating products and services for low and middle-income individuals and persons with disabilities.

.4 Integrate environmental and social risks and utilize technological solutions to measure them when preparing credit studies for customers to make decisions on granting or renewing credit facilities.

.5 Pay more attention to innovation and issuing green banking products such as green loans, green investment funds, and green bonds.

.6 Facilitate paper usage reduction and decrease unnecessary customer visits to branches by encouraging the use of digital financial services, aiming to reduce carbon impacts.

.7 Assign tasks related to sustainable finance to a designated manager in the bank's sectors, provided that these tasks do not fall under the umbrella of Corporate Social Responsibility (CSR) management.

Work to avoid negative environmental and social impacts resulting from the bank's activities, and enhance positive environmental and social impacts while applying best governance practices. Enhance cooperation with ministries, government entities, and all stakeholders at the national and international levels.

.1 Cooperate with government entities, ministries, non-governmental organizations, and international financial institutions.

.2 Utilize experts, environmental scientists, and academic circles in determining the environmental impact of projects intended to be financed, as well as keeping up with the latest technologies and practices in this field.

.3 Activate the role of the Egyptian Banks Union in involving all stakeholders.

Principle Four: Managing Climate Change Risks

.1 Work on identifying various risks related to climate change, classifying them, and working to mitigate them.

.2 Encourage financing projects aimed at mitigating climate change and global warming.

.3 Study climate change risks in projects intended to be financed and work on managing those risks.

.4 Increase awareness and develop bank employees' capacities in the field of managing risks resulting from climate change.

Principle Five: Applying Sustainability Principles to Bank Internal Activities and Operations

.1 Begin establishing systems and procedures to ensure the application of sustainability principles and consideration of environmental, social, and governance elements within all internal bank activities and operations.

.2 Work on identifying and reducing negative environmental impacts through the following: a. Measuring the carbon footprint resulting from buildings, branches, and equipment used. b. Improving waste management (reducing it and applying reuse and recycling principles). c. Adopting water and energy efficiency standards. d. Adopting environmentally friendly building standards (which reduce energy consumption) by increasing natural light, or one of the effective energy solutions, or otherwise. e. Encouraging electronic communication between internal departments of the bank and replacing it with the use of paper.

.3 Begin preparing an annual report detailing the bank's efforts in applying sustainability principles in internal bank activities.

Principle Six: Establishing Foundations for Identifying and Managing Climate Change Risks and Encouraging Financing Projects Contributing to Addressing the Issue of Climate Change

Begin preparing periodic reports on the bank's activities in the field of sustainable finance.

.1 Create and develop integrated information systems about sustainable finance in preparation for preparing necessary reports.

.2 Begin conducting gap analysis studies to determine future steps for applying sustainable finance.

.3 Begin measuring the impact of applying principles on the current portfolio and its reflection on the stability and performance of the bank.

.4 Begin preparing periodic reports on efforts made in sustainable finance, in addition to the challenges facing the bank in its application and proposed solutions.