Green AT1s: not as controversial as they might seem
If investors are comfortable with a bank’s green credentials and labelled bail-in debt — then why not AT1s?
Despite BBVA showing that such a deal could be done, questions were raised over how feasible a green labelled perpetual capital instrument really is, hampering follow on issuance. However, as more firms move towards a net zero balance sheet and investors become comfortable with green debt elsewhere in the capital stack, the argument for greening the lowest segments grows stronger.
An AT1 is the most deeply subordinated bond that a bank can issue, ranking just above its common equity layer. And as a result, in the event of a resolution, conversion or write-down event, it is second in the firing line.
There are concerns that the insolvency of this debt would sever its tie with the underlying green assets. Investors bound by green mandates are unlikely to be pleased with the green capital they put up bailing out brown assets.
But this is not just restricted to AT1 bonds, with bail-in senior and tier two bonds containing similar loss absorbing features. These asset classes are themselves already incredibly popular with green funders — bail-in or tier two deals accounted for 29 of the 43 ESG labelled bank bonds publicly issued in euros this year, according to GlobalCapital.
Labelled debt issued in these formats is already treated on par with conventional bonds when it comes to absorbing losses — so why not AT1s?
What De Volksbank is proposing is a normal AT1 that just happens to have its use of proceeds ear marked for green projects — perhaps including some projects it might have funded anyway with a conventional AT1 instrument.
As long as brown and green asset pools sit side by side, investors will raise concerns about the perpetual nature of a green labelled product. It is unlikely that any bank would have green assets on its balance sheet that would require financing in perpetuity.
However, even then the maturity of most green asset pools does not always match a bond’s maturity on a one-to-one basis, requiring the bank to either refinance with a new bond or refresh its asset pool. A bond’s tenor is often a careful balance between the asset and liability management needs of the issuer and the desires of the investor base.
Of course, there is always the risk with a perpetual instrument that the bond is not called, with the result of such an event extending the bank’s green financing commitment for eternity.
But the Dutch lender is committed to 100% green financing by 2030 — it is going to end up issuing green funding AT1 debt by then anyway. And other banks are on similar routes towards net zero targets of their own.
Over 110 banks globally have committed to aligning their balance sheets with a net zero emission targets by 2050, with many setting even earlier targets of their own.
For a firm like De Volksbank with its ambitious 2030 target, the stronger the commitment to net zero, the more credible a green labelled AT1 becomes: green mandates will not have to worry about any post-call proceeds not financing green assets.
Of course, there are still sticking points in what exactly is a green asset. What is green now might not still be considered so in a few years’ time.
This has already happened. The EU’s green taxonomy has ruled that financing formerly green low-emission vehicles will no longer be classed as a sustainable or appropriate investment after 2025, with only zero-emission vehicles allowed.
Although there are risks that other assets could follow suit, any change in their classification is unlikely to happen overnight.
Perhaps concerned investors could look towards what has happened with capital instruments issued before the EU agreed on the rigidly defined Capital Requirement Regulation (CRR) in 2013. These legacy deals were grandfathered for almost nine years, giving banks plenty of time to mop up their capital stacks.
De Volksbank’s roadshow has so far garnered solid interest from not just subordinated debt specialists, but also ESG focussed accounts. Aside from BBVA’s foray two year’s ago, these investors have had next to no opportunities to invest in lucrative AT1 debt, and instead have been restricted to tier two and senior bank paper.
But if these accounts are content to already take the risk with tier two or bail-in debt, and are comfortable with the green commitment, then it is time to push banks to take the next step and print green labelled AT1s.