Green CSPP, digital banks and negative rates, UK finance after Brexit
This week in Keeping Tabs: how the European Central Bank could decarbonise its corporate bond book, how digital banks would suffer if the Bank of England goes negative, and what UK financial services policy could look like after Brexit.
As central banks talk about their responsibilities in the face of climate change, some observers would their quantitative easing programmes to be made more green. The ECB has made interesting noises on this front and others recently (more context on that here and here).
This week, the New Economics Foundation, a think-tank, published a paper on greening the central bank's corporate bonds programme.
The paper says that while the current QE programme may be based on an approach of neutrality towards the corporate bond market, it is not neutral when it comes to carbon emissions, as it has a bias towards carbon-intensive sectors.
The NEF looks at the sectoral breakdown of the outstanding volume of bonds that the ECB has purchased under the corporate sector purchase programme (CSPP) or the pandemic emergency purchase programme (PEPP). It says that sectors with a high contribution to greenhouse gas emissions are over-represented when compared with eurozone employment and with the metric of "gross value added".
The authors of the paper — Yannis Dafermos, Daniela Gabor, Maria Nikolaidi, Adam Pawloff and Frank van Lerven —propose two different selection criteria.
The first is to leave the universe of eligible bonds unchanged, but not buy those issued by fossil fuel companies, and firms with a relatively high carbon intensity that are in the energy-intensive, non-renewable utilities and carbon-intensive transportation sectors.
The second would be to exclude all bonds issued by carbon-intensive sectors aside from green bonds, and include bonds that were issued in the eurozone and are of eligible maturity, but not necessarily of investment grade.
"Although this scenario does not keep the investment grade criterion for the eligibility of bonds, it should be kept in mind that… the existing credit ratings do not reflect climate risks and this criterion should in any case be reconsidered from a climate risk perspective," the authors write. "In addition, if the ECB expands further the CSPP/PEPP programme, it might be unavoidable to include bonds that are not investment grade in the universe of eligible bonds."
Meanwhile, in the UK there is speculation that the central bank will copy the ECB in a different regard — by introducing negative rates. Beyond the considerations for what this would mean for the economy and for the banking sector on aggregate, it is also interesting to look at how it would affect different types of banks.
"The threat of negative interest rates looms large for digital banks that are in the early stages of building lending businesses — the bog standard way of making money as a bank," writes Ryan Weeks in Wired.
"Through a combination of app-based banking, low cost products and bells and whistles, neobanks have built empires on low margin retail customers. Any changes to their model, especially those that introduce higher costs, have the potential to threaten their very existence."
These banks often simply place customers' deposits at the Bank of England, and earn whatever the base rate is.
Any lowering of rates would come on top of other coronavirus-related challenges for them, such as the loss of revenue streams linked to people travelling.
Monzo in particular already appears to have endured a tough year, with its auditor warning that a slower than expected recovery could lead it to breach its capital requirements.
The business model of Monzo and its like is rightly a long way down the list of people's concerns right now. But if UK regulators do — rightly or wrongly — want to encourage competition in the banking industry, it might be worth considering the impact of negative rates on this sub-sector.
It would also be interesting to see how competition would be affected by a dual rate system: an idea Keeping Tabs has covered previously.
Finally, onto another think-tank with the word "New" in its title.
New Financial has come out with a report supported by Barclays on the future of UK banking and finance after Brexit. There's a summary here, but here is Keeping Tabs' own summary of the summary, with five of the most interesting recommendations or snippets from Panagiotis Asimakopoulos, Manuel Haymoz and William Wright (in their own words):
In some key areas — such as derivatives and FX trading, fintech and sustainable finance — the UK is a world leader and it will need to build on this position to help set global standards and drive international business.
While there are many areas of the EU framework that the UK government and market participants would like to recalibrate, it may make more sense to put in place a moratorium on any substantive change for a defined period (perhaps a year or two). This will increase trust with the EU and give firms and regulators time to adjust to life after Brexit without also having to deal with radical changes in rules and regulations.
Before diving into a fundamental review of its framework, the UK should develop a clear vision for UK banking and finance. A commission of government departments, regulators and different sectors of the industry could take their time to develop a clear financial services strategy for the UK for the next 20 years.
Brexit could be an opportunity for the UK to lead by example on some of the big common challenges facing different regulators around the world. These might include addressing the tax differential between debt and equity funding; providing carefully-managed public access to private capital; rethinking the obsession with daily liquidity investment funds; addressing the problems of closet-indexing; driving diversity in banking and finance; and the future of finance in the data economy.
The UK could explore the creation of a ‘third way’ between private and public markets. This could involve a formal market with regular but infrequent trading; a level of disclosure and governance requirements that is not as demanding as a fully-listed company; and tax incentives for issuers and investors. This could be a potential venue for private companies that need to raise forms of equity (such as preferential shares or convertible debt) in response to the Covid crisis but which are not ready or willing to do a full listing.