Banks forced to design strategy for Europe’s green finance push

Sometimes the environment in which a speech is given is as telling as its content.

When Mark Carney said in April that “climate change is a tragedy of the horizon which imposes a cost on future generations that the current one has no direct incentive to fix,” he was repeating a message he first outlined back in September 2015.

Back then the governor of the Bank of England was accused of being alarmist and politically partisan.

But this time around his words were less remarkable. Carney could point to plenty of fresh initiatives pressing finance — and particularly the banking sector — to green up its act. The venue of the speech itself was one reminder of this: it was at a conference on climate risk in Amsterdam (the 2015 one was at Lloyd’s of London).

Carney believes that the clock is ticking: “Once climate change becomes a clear and present danger to financial stability it may already be too late to stabilise the atmosphere at two degrees,” he said. And it is not just him looking at his watch.

“Engaging with sustainability is increasingly seen as an essential form of stakeholder engagement,” says Navindu Katugampola, head of green and sustainability bonds at Morgan Stanley in London.

Three stakeholders in particular are pushing banks. The first is the customer, who factors sustainability into his or her decision-making. 

“It’s anomalous that you choose to drink fair-trade coffee, to buy organically sourced products, not to have a disposable cup, and yet with the single biggest decision you make — your finances — somehow you would not proactively choose a sustainability-focused organisation,” says Katugampola.

Secondly, investors are prodding banks to shape up, aware of the environmental, social and governance (ESG) risks posed to their holdings. 

The third stakeholder is the one who sets and monitors the rules for banks. And in Europe the regulators are driving ahead (see box-outs). 

The EU’s taxonomy, and its plan to use that to create a label for green financial products, will help turn recommendations from existing green initiatives into formal requirements. 

The taxonomy is starting with environmental objectives: these tend to have clearer indicators and objectives than social goals, making them easier to monitor and compare. 

And more momentum is behind them, meaning the Commission can at least get on with producing something now. But it does plan to incorporate social objectives later on. 

The taxonomy could have cast its net wider. Sabine Pex, senior manager of public affairs at ISS-oekom, a sustainability ratings agency, is disappointed that it only applies to products specifically earmarked as sustainable or environmentally friendly.

“Every sector and every producer has got to think about his or her impact on climate change,” Pex says. “It must not stay restricted to products that call themselves sustainable.”

But the taxonomy will boost the green market when combined with other aspects of the action plan, notably those relating to institutional investors’ duties. They will have to disclose information about ESG-related risks they are taking, as well as asking clients for their ESG preferences.

This is where the taxonomy and labelling come in handy — investors will need proof of their ESG strategy, and as a result will want the assets they buy to meet a certain standard.

Meanwhile, the work the Network for Greening the Financial System (NGFS) is doing is likely to raise the bar further for the banks.

“This is very important,” says Pex. “It’s very good and very important to see that those players in the market are now dealing with these challenges.”

In particular, it will examine how to push banks to integrate environmental risks into their decision-making and get them to disclose climate-related risk more thoroughly.

The NGFS has specifically said it will look at the risk differential between green and brown assets and the existing tools used by central banks and supervisors to reflect this difference.

This relates to the debate throughout Europe about whether banks’ capital regulations should be tweaked to promote or discourage certain types of lending.

A green supporting factor would give environmentally-friendly assets a lower risk-weighting, freeing capital for banks. But it now looks to be off the agenda, and a brown penalising factor appears more likely.

François Villeroy de Galhau, governor of the Bank of France, advocated for this in a speech in April. He said this could come in the form of either a dedicated Systemic Risk buffer or Pillar 2 requirements.

Banks are being ordered to think about sustainability across the organisation. One of the most popular statements they have been using to try to show they take the issue seriously has been to sell a green bond. But this must be linked to strategy as a whole. 

Five years ago, according to Katugampola, socially responsible buyers would focus primarily on the actual projects a green bond would finance.

But now investors are looking at the firm’s overall direction.

“Where we’ve seen some corporate green bonds struggle is where issuers have not been able to adequately explain what their long term strategy or objectives are,” Katugampola adds. “That’s why the conversations we’re having with financial institutions at the moment start with: ‘What is your strategy?’”

Axa Investment Managers shares this view. The first of four pillars in its own green bond framework relates to the overall ESG quality of the issuer.

“This pillar is the one that most differentiates Axa IM from the Green Bond Principles, where it is not currently considered a fully-fledged pillar,” the firm says. “But at Axa IM, we believe the quality of an issuer is crucial, when it comes to making a considered assessment.” 

It would like to see the asset volume for a green bond grow over time and a coherence between environmental strategy and issuance.

One bank aiming to link its sustainability bond framework to a wider strategy is Caja Rural de Navarra.

“The experience of issuing sustainable bonds has been key in deciding to devote more resources to define and also align our long term, sustainable objectives with our daily activities,” says Miguel García de Eulate, the Spanish lender’s head of treasury and capital markets in Pamplona. 

Creating its first corporate social responsibility annual report began with “a deep exercise of listening to our stakeholders — clients, employees, shareholders, suppliers — and then involving the whole organization in this exercise,” says de Eulate.

It has created a framework for sustainability lending aligning with the International Capital Markets Association’s Green and Social Bond Principles and the UN’s Sustainable Development Goals.

All banks are being pushed to develop their business model around sustainability, although it remains to be seen whether the pressure will be enough to prevent dangers such as the one to financial stability mentioned by Carney.

But one thing is clear: issuing a green bond on its own is not going to be good enough.