Governments, with the guidance of the financial industry, will play a critical role in accomplishing this shift. As regulation tightens, improvements in data collection and transparency will show how each institution is alleviating climate change. Europe may start by implementing the approach to funding green mortgages that is already happening in the US, where discounted mortgage rates given by Fannie Mae on loans financing energy-efficient blocks of flats has boosted annual origination to $28bn.
The EU’s much-lauded Sustainable Finance Action Plan is a step in the right direction, but it lacks the urgency needed to cut CO₂ emissions in the timeframe envisioned under the Paris Agreement. With time running out, governments will be compelled to do much more to tilt the pricing balance between dirty and clean energy. The Norwegian oil fund has already proposed withdrawing from all investments in oil and coal, yet quantitative easing continues to reward the fossil fuel industry, which pays a tiny risk premium for its long term funding.
Financial institution issuers, investors and bankers gathered in June to discuss the opportunities and challenges that climate change and the emerging green economy poses for the financial industry.
Claudia Bärdges-Koch, deputy head of treasury, Münchener Hypothekenbank
Luca Bertalot, secretary general, European Mortgage Federation and European Covered Bond Council
Hans Biemans, head of sustainable markets, ING
Frank Damerow, director of treasury, sustainable finance and strategy, LBBW
Ulf Erlandsson, chief investment officer, Glacier Impact, Strukturinvest
Miguel Garcia de Eulate, director of treasury and capital markets, Caja Rural de Navarra
Arnold Fohler, head of debt capital markets, DZ Bank
Arnaud-Guilhem Lamy, co-head of aggregate and SRI fixed income, BNP Paribas Asset Management
Eivind Hegelstad, chief financial officer and director of finance, Sparebank 1 Boligkreditt
Dick Ligthart, director of social and sustainability bonds, debt and capital markets, ABN Amro
Bill Thornhill, moderator, GlobalCapital
Having a plan
GlobalCapital: Why might it make sense for a bank that has never issued a sustainable or green bond to have a sustainability or green action plan?
Ulf Erlandsson, Strukturinvest: If we’re heading into the projected three to four degree base case temperature rise scenario that scientists now predict, I’m quite convinced there will be very large economic ramifications that people are not prepared for, and for which we’ll suffer. We’re nowhere near to being sufficiently far progressed in our green and sustainability plans to actually counter these climate change moves, so it makes sense from an economic standpoint for people to prepare for that. I generally dislike any governance which suggests organisations should not care about the world they will be leave 25-30 years from now. That’s not a good long-term investment strategy and it’s something we certainly do not welcome from issuers.
Eivind Hegelstad, Sparebank 1 Boligkreditt: Having a sustainability plan, has been a learning experience within our company and has helped to define what we are doing and how we can perhaps do it better. It’s a question of how we can best align ourselves with various environmental and social governance goals in general, but also in particular, to set specific green goals that mitigate the risk of climate change that Ulf talked about.
Luca Bertalot, European Covered Bond Council and European Mortgage Federation: It’s very important that we link the green effort of every single bank to build something that fits the policy box and which is aligned with the energy agenda of the European Commission.
Refurbishing housing stock in Europe is a fantastic growth opportunity and when you don’t seize such an opportunity you create a cost. And when we look at how much borrowers in Europe are exposed to energy costs, there is a direct link back to their financial stability and the stability of the system.
We are not saying that the Norwegian solution should be exactly the same as the Dutch solution or the Spanish one. What we are saying is that they should all work within the same overarching framework, one that is able to gauge the PD and LGD of a green mortgage to better understand the appropriate risk weight.
I believe consumer behaviour could change completely as new policy frameworks are introduced. For example, in Flanders there is a new law that forbids any landlord from renting his property without a minimum level of insulation. So, if you are not making that investment your house will be out of the market.
Frank Damerow, LBBW: Having a green/SRI action plan should tie in with the requirements of the Task Force on Climate-related Financial Disclosures, which has a lot of momentum also among regulators such as the Financial Stability Board. The very simple fact is that, in future, for every single line of your business, you have to come up with metrics and a scenario analysis on what your climate risk is. Of course, that’s not the same as having a green bond programme where you’re specifically reporting on the impact. But obviously, that’s driving change among capital markets participants and should be taken seriously.
Dick Ligthart, ABN: The world is in a transition towards a low-carbon economy, whilst there are also many societal challenges that need to be addressed. As a bank, sustainability and environmental and social responsibility needs to be a core part of your strategy to remain relevant in society and successful in the long-term. To me, a green or social bond framework should always follow such a strategic focus and is part of implementing a sustainability strategy. This makes green and social bond frameworks much more credible.
Hans Biemans, ING: Investment sustainability has become the new normal so it makes sense for companies to be occupying that space. This is also part of a broader movement to improve transparency which means getting the right data is important, and the sooner you start the better.
Miguel Garcia de Eulate, Caja Rural: Sustainability is not simply about how capital markets people set about issuing a green or a social bond. It starts with taking a decision on how to respond to the need for transparency on your strategy and communicating this to your stakeholders. For us it began as a pure capital markets exercise to diversify our investor base, but now we are printing our first corporate social responsibility annual report.
Damerow, LBBW: We know within a very short period of time this market is going to be regulated, and within that, banks should have a strategy that essentially illustrates their provision of capital for a decarbonised economy, with climate mitigation basically being the immediate priority.
Arnold Fohler, DZ Bank: It’s important to have consistency in the overall approach of a bank towards the topic of sustainability. While we all have our frameworks and claim to be sustainable, issuing a sustainable bond is so far the most visible signal to the market that the company is committed to this topic. However, social and regulatory pressure has to take the topic to a new level.
Erlandsson, Strukturinvest: What I recently saw in the market was very telling, in terms of having a plan or not having one. The fossil fuel extraction company in question published their investor presentation, but failed to mention the risk of carbon tax or climate change. I did find a slide where they talked about clean CCS, which sounded terrific until I realised it’s an accounting method for clean cost of supply which measures the average cost of oil rather than carbon capture storage.
It tells me that this issuer has no plan with regard to potential tail risk and with regard to carbon taxation, for example. I’m not even putting a green perspective on this. It’s just very obvious for me, as an investor, that there will be a case at some point for policymakers to start out with a proper carbon taxation scheme, and some companies are not even considering that in terms of their business strategy. That’s a credit risk.
Sustainability versus green
GlobalCapital:: Should borrowers issue green bonds given that, arguably, the broader sustainability challenges are more important?
Hegelstad, Sparebank 1: I believe the green factor is actually fundamental. You can’t fix the broader aspects of ESG unless you have a good control on climate change risk.
GlobalCapital: Miguel, you kept green and SRI together under one framework, but you modified it recently by having more focus on green. Why is that?
Garcia de Eulate, Rural: We didn’t have so much green in our sustainability framework from the beginning due to data collection issues. Social aspects were easier to obtain from our systems while green loans were less easy to identify, also due to their granularity. Impact reporting and data provision for investors is more difficult to provide on tens of thousands of green mortgage loans, compared to a utility with five big projects. In my view, that’s the reason why some retail banks have been bit more reluctant to jump on to the green wave.
Some investors are more focused on green assets, but we have seen more and more looking at our framework through the eyes of the United Nations Sustainable Development Goals (SDGs).
Of course social housing and green housing can be separate and, following our involvement in the energy efficient mortgage action plan (EeMAP) initiative, we are still having thoughts on whether it would make sense to have a green framework. But for the time being, we are sticking with the one holistic framework.
GlobalCapital: Claudia, MüHyp has two frameworks, one for SRI and one for green bonds. Can you tell me how you came to that?
Claudia Bärdges-Koch, Muenchener Hypothekenbank: We first started work with a sustainable bond by looking at our existing mortgage cover pool. We soon realised that it made sense to design a new green mortgage product for our retail customers. So we have a green loan which became available to our customers on November 2015, and we also have now a family loan, which has a social aspect.
The feedback we got from investors was more or less “please, don’t mix SRI social with green”. Some have won newer green mandates but others have a pure social mandate and they don’t want to mix the assets. By law German banks are not allowed to separate these loans from the rest of the cover pool. But, just for any analysis, it’s become much easier to have two separate product sub-groups within the overall pool.
GlobalCapital: You’re getting investor diversification by bringing more people to the table and presumably you’re getting better price tension in your deals?
Hegelstad, Sparebank 1: Investor diversification was certainly an important factor behind our decision to debut the first Norwegian green covered bond because we saw that there was good demand. But what happened is that the organisation then decided that, actually, this is a very interesting way of becoming a leader in green finance in Norway. So the green bond deal was very quickly followed by a green mortgage product from some of SpareBank 1’s constituent banks which allowed customers to get a sizeable green discount.
GlobalCapital: From an investor’s perspective, do you believe it is now starting to make more sense for issuers to improve their product offering with green investments?
Arnaud-Guilhem Lamy, BNP Paribas Asset
Management: Last September we launched a green bond fund, so we welcome any initiative towards green bond issuance. We see green bond issuance as the link needed to fund the energy transition to a low carbon future. The green bond market should keep growing but supply has at times been insufficient and we’d definitely prefer to see more. For diversification purposes, the fund can invest in social bonds, but its main focus remains on green bonds. The first minimum requirement is that the issuer can flag that the proceeds are genuinely for green projects. We have put resources into this with SRI research to be sure that we’re able to analyse every single deal that’s coming to the market.
GlobalCapital: Green bonds are providing financing that would have been needed anyway, so in that sense they offer nothing additional in the way of net new supply do they?
Biemans, ING: Of course these deals would have been done anyway without green finance. The real additionality is that people are becoming more aware of the climate change problem and, for the first time, we are seeing that organisations, including the people around this table, can contribute to climate change mitigation via financing. It’s all about raising awareness.
Fohler, DZ Bank: There is additionality. The boost which comes from the political action that’s going to be undertaken. You have to be prepared for that kind of “event” risk, which is ultimately a credit risk. At some point there’s going to be a big transformation which needs to be in the hearts and minds of investors, intermediaries, issuers. Or, in other words the whole of society.
Hegelstad, Sparebank 1: I see additionality in two ways. One is that we are starting out on this path of creating a green bond market by building a good volume of outstanding green bonds. It’s important to get that right from the start so you really have the purest view of green bonds. Additionality has also been created because we are now actively getting people to refurbish their properties to make them more energy efficient.
Erlandsson, Strukturinvest: The bond market by nature is a tool for refinancing, and refinancing rarely meets the requirements for true additionality. If you, as an investor, want to achieve that, you are much better off supplying equity to projects in the development stage. But that is quite a different trade compared to what traditional bond investors want to do. So I think one should be careful to ask for a very high degree of additionality in green bonds.
Garcia de Eulate, Caja Rural: I see additionality in a strategic sense. How is your strategy aligned with what you’re saying and what you are doing? In this year’s impact report we have looked back to when we set up the sustainability framework and we have assessed how the sustainability pool has behaved and evolved. I think it’s the big question for issuers to see how their bank’s strategy has aligned with their sustainability framework.
Catalysing green supply
GlobalCapital: Luca, could you tell us a little about what the EeMAP (Energy efficient Mortgages Action Plan) is trying to do and how you think it might help catalyse supply for green issuance?
Bertalot, ECBC/EMF: The key here is about how we can reach a substantial critical mass that can help develop the market. We need an investor base, supply and consumers, so we have three big blocks of stakeholders. We have created a think tank including 37 European banks that have decided to work together to analyse the value chain step-by-step in terms of origination, risk management, marketing, funding and IT. And, we have tried to agree on a common set of best practices.
The idea is to collect data and create this common framework; that’s the purpose of EeMAP, where we can create this kind of green box where a large group of the market will be responding to the same kind of input. We think also that banks have a job to convince consumers to renew or refurbish their own house. There are two ways of doing this kind of exercise. With subsidies, which may not work so well as fiscal budgets in some countries are more constrained than others. Or with a capital market solution which we believe is the most appropriate.
Biemans, ING: Your assumption is now that refurbishing is partly a financial problem, but of course, people also need to be motivated to refurbish their house, and money is not the only thing.
GlobalCapital: So what’s needed to actually motivate people to invest?
Garcia de Eulate, Rural: I believe regulators need to play a role in setting incentives and deterrents. Subsidies are great carrots, but I also think the sticks are needed to goad us all in the right direction. At some point I expect to see some kind of regulatory and legal pressure on house finance and on everything. This carrot and stick approach should not just be aimed at companies but consumers too. Then you will see the green mortgage has a clear avenue for growth.
Hegelstad, Sparebank 1: I agree with that view very much. I think just for the reason of timing we need to see a relatively quick shift of pace right now. For example by the end of March Germany was already above its CO2 quota for the year, so you can see they’re already into overtime. Taxing and subsidising is going to work much more quickly and all of society should contribute to the shift, rather than just the investors or the banks.
GlobalCapital: Where does state intervention start?
Bärdges-Koch, MüHyp: As Luca mentioned with what’s happened in Flanders, the landlord has to make the investment, otherwise their flat or their house is no longer rentable.
Ligthart, ABN: The Dutch regulation for commercial real estate indeed expects that commercial buildings have a minimum energy label of ‘C’ by 2023. Other governments and/or municipalities also apply regulation in this direction, so this definitely shows that regulatory measures are adopted to reach CO2 reduction goals.
Bärdges-Koch, MüHyp: It’s the same in Germany. Every house owner needs to have an energy performance certificate. But there also needs to be some kind of regulatory pressure. If a bank grants a loan and asks about the borrower’s energy consumption, they would not be in a position to deliver the loan without getting an EPC.
Ligthart, ABN: To promote energy efficiency it’s also important for banks to have partnerships with, for instance, energy companies, building consultants and construction companies. ABN Amro teamed up with such parties to develop a tool which enables our clients to identify energy reduction measures. If they want to proceed with the measures, they immediately receive an offer from a specialised construction company.
Biemans ING: Everything needs to work together to make this happen, and I think the banks, in general, are just a very small part. So yes, I agree with Miguel, we as banks are important players, but there needs to be other regulatory incentives.
Erlandsson, Strukturinvest: We should just look at some of the examples out there, right? Who’s the biggest green bond issuer in the world? It’s Fannie Mae. Why are they the biggest green bond issuer? Well, because they have a more lenient treatment of their Green MBS book in terms of capital charges than they have on the traditional book. They issued $25bn in one year and that’s how we also get transformational change.
If you’re serious about what you want to achieve here as a policymaker you should not throw the green supporting factor off the table because the example is already there. Fannie Mae gets $25bn done in one year, that’s really transformational. It’s a straightforward question to ask those who are setting the policy guidelines whether they want to be transformational or not.
Lighardt, ABN: In the Netherlands we have a fiscal green scheme that stimulates innovation and, though it was too expensive for government to expand the scheme to large-scale transitions, it does finance mortgages where the building is at least 30% more efficient than the law requires.
GlobalCapital: Do you believe the EU’s green bond taxonomy could help enable green growth?
Lighardt, ABN: Yes, of course. If you look at the whole sustainable action plan which follows the recommendations of the High-Level Expert Group, I think there’s a lot of potential that it will facilitate the market for further growth. It provides definitions in sectors which are as yet untapped by the green bond market. Having said that, there is a fine balance between setting good definitions which spur the market and are environmentally and sustainably credible and which are accepted by all the European countries and maybe getting a weak consensus where the bar is too high.
GlobalCapital: Is the bar raised too high, do you think?
Lighardt, ABN: It will be very interesting for all of us to monitor and provide feedback on whether the green bar has been set too high or too low. I think it can only benefit everyone when you have a good balance.
GlobalCapital: If you have one gold standard does that diminish the value of anything else?
Lighardt, ABN: You have the EU green bond standard which is one dimension. But then many issuers get a second opinion, as well adopting the ICMA Green Bond Principles, and many also have the Climate Bonds Initiative certification. So maybe, when you meet this EU standard regulation, you don’t necessarily need a second opinion or you could potentially drop the Climate Bonds Initiative certification. I’m not sure how the market will evolve.
Hegelstad: Sparebank 1: In my view, it’s a little bit like accounting standards. You have to have an auditor who says, “yes, actually this issuer has followed the rules,” but I don’t believe it is necessary for this to be certified by two or three different bodies, maybe just one.
Biemans, ING: The taxonomy must stay very broad. If you look at this table and the definitions that the various issuers used for building their criteria in the various green bonds, they are totally different. That means you can’t go into much detail in such a taxonomy, otherwise you will lose many people.
Damerow, LBBW: Renewable energy efficient real estate is broadly understood as a taxonomy category and impact reporting is straight forward. When it comes to energy efficiency in industrial processes, and generally other sectors that are part of the broader economy, market innovation is key in illustrating a clear environmental impact. It’s vital that we start to share and replicate broadly recognised innovative pilot projects to scale up other sectors.
Biemans, ING: I’m very much a fan of using existing standards, not just when it comes to building codes and so on, but also across various other industries. For example, there are a few forestry standards some of which might be better than other, but they are already there. It is the same for many other industries where you see that green and sustainability standards have been developed over time. These existing standards are a good starting point.
GlobalCapital: Is there a danger, that we get too much standardisation that potentially stifles innovation?
Bärdges-Koch, MüHyp: I’m a bit concerned that if the standard is too ambitious it kills innovation. Do you think for example if we had had a completely fixed standard we would have seen the NRW Bank project where they re-natured the Emscher river? I would say probably not, because it would have been very challenging for someone to have formulated a standard for that project.
Fohler, DZ Bank: We will not be able to shy away from the EU Action Plan and the legislative proposals that they’ve put on the table. There are certain standards already out there that should be used. The question is what becomes of the EU’s efforts? A balance is needed where standardisation reduces transaction cost — which increases transparency and comparability — and yet leaves enough room for technological progress.
Lighardt, ABN: I think for certain sectors it can definitely help having experience with issuers in developing green bond frameworks. A lot of time is usually spent on arriving at proper definitions across different sectors and countries, such as real estate in the Nordics or Flanders. Or setting standards related to shipping, fishing or forestry. I think it does help if there is a taxonomy which tells you that initiatives in certain sectors across different countries are being recognised as sustainable.
Biemans, ING: And it’s dynamic, of course. An energy efficient car today is not the same as an energy efficient car in five years’ time.
Garcia de Eulate, Rural: I’m not a person who is very pro-regulation in most matters in life, but in the case of sustainability, where we have a business case that is profitable over the long run, I think there’s a natural need and justification for public intervention. Much of humanity behaves in a short-term way, which is to some extent unavoidable because our lives are normally shorter than the projects we serve. So, I think that it makes sense for the public sector to be involved in defining targets which are probably longer term than we would have otherwise tended to focus on. I think that we can benefit from having a framework which we can all work towards.
Fohler, DZ Bank: It goes back to what Ulf was saying earlier on. Policymakers have much more power to pull the trigger than us bankers. We have to be prepared and have all the frameworks in place but maybe some regulation will force us more into that.
Ultimately, there needs to be a change in the real economy. If the rise in global temperature is going to be capped at two degrees Celsius, €180bn investment per year is needed to reach that target by 2030. That kind of a push cannot come from our industry, it has to happen with a mix of subsidies, tax incentives, regulatory reforms, and most importantly a change in mind-set in our societies.
Bärdges-Koch, MüHyp: We are all in favour of long term financing and MünchenerHyp’s niche is to grant loans out to 20-30 years. But what if I grant a 30-year state of the art dark green loan today? What happens to the definition of that loan as more and more innovation improves the green quality of newly originated loans? Will there be some kind of grandfathering? Will it become ineligible for a green bond?
GlobalCapital: If the recent deals from Norway are any guide, only the top 15% of the most energy efficient buildings are eligible. By default, the other 85% are ineligible.
Hegelstad, Sparebank 1: We set the baseline at 15% which is the Climate Bonds Initiative guideline. In Norway that means the starting point is for houses built after 2007. In a few years that baseline will move to the 2010 building code in Norway. The continuous updating of building codes will work toward achieving the political climate change target. The banks’ role is to help finance all of this, including incentivising, by financing, customers to update their older buildings. So obviously, the average green quality of all loans on the balance sheet will go up over time. The simple calculation is to minimise the carbon footprint over the investment horizon.
GlobalCapital: How can the government play a role in greening the Spanish mortgage market in terms of energy performance certificates?
Garcia de Eulate, Rural: The regions in Spain are responsible for registering EPCs and we can access this database. The trouble is it’s based on postal alphanumeric fields which means there needs to be a postal address for each apartment and house. That creates a problem because we have to use this data with our own data base and it doesn’t match. So, you have to use algorithms, or sort manually or semi-automatically, and that’s a big headache.
I read that in the recent Barclays green unsecured transaction, their access to the UK land registry database was based on a number that could be clearly cross-referenced with their own database. This is something which I understand can be easily done throughout Europe. So, this is one thing which could be fixed. It would be a great thing for the Spanish retail banks to have access to these databases so they can create a map of EPCs. That could make it easier to develop a framework for green bond issuance.
Bertalot, ECBC/EMF: This is also the purpose of EMF, to give a voice to this kind of solution. We cannot complain about rules if we don’t bring up the existing problems. This will be done by baby steps because we will identify problems that maybe in Spain are not the same that Arnold is facing in Germany or maybe the same as those faced in Norway. We are trying to identify where the problems are and propose a common solution. We will then let the Commission know the key issues that need to be resolved.
Garcia de Eulate, Rural: Eivind: I’m curious know about Norwegian transactions. Would it be helpful for you to have this access to the registry of EPCs or is that something that is not that important to you?
Hegelstad, Sparebank 1: The labels are really key. In Norway and in many other countries, they do exist, but we don’t have access to them because of data protection laws. So, what we can easily do, if we get the database, is link it up with our mortgage portfolio data because we also have the land registration number of each property in the database too. Then, if we can do that, we can easily identify the loans and analyse the migration of EPC labels. So, if someone does something to their house, and it moves from EPC category D to category A, then it goes straight into the green portfolio. If we can get Brussels to set a directive requiring each country to open up their EPC database then maybe it will happen.
Biemans, ING: Miguel talks about the carrot and stick approach. One simple stick, maybe not a nice one but a simple one nevertheless, would be to get banks to only finance houses if there is an EPC upgrade. At ING we did that for the commercial buildings. These owners received a letter last year saying that they could only receive new financing if they had an EPC label of C or higher. If it’s lower than C, they must also provide a refurbishment plan to upgrade the energy efficiency of the building otherwise they will not get financing.
Hegelstad, Sparebank 1: The EPC databases in most countries took effect from a certain year. So, in Germany it was 2014, in Norway it was 2010, and so on and so forth. I believe Brussels needs to get each national government to create EPC data for their entire housing stock. That would be a really important move to get the knowledge base about the existing housing stock.
Bertalot, ECBC/EMF: It’s only a question of time. The EC has calculated that €180bn of investment is needed per year to be aligned with COP21. When the money arrives we have to be ready, and what Eivind is proposing is the first step. But unfortunately, to implement something like this takes time.
Biemans, ING: Arnaud, do you think that in the future, you will not be able to invest in a covered bond if, for example, the EPC label and energy data is not provided?
Lamy, BNP Paribas AM: It should become part of the Harmonised Transparency Template in the future, so yes that’s possible. But for the time being, we’re not there yet. If I look at just our euro aggregate and socially responsible investment fund we have €51bn of assets sitting with just one team. The green bond fund is only €160m which is small, but it is growing, and I believe supply will create demand. Even so, I can’t tell you that in 2019 we’ll only be buying green covered bonds secured on mortgages with a high EPC label as that won’t be possible.
Biemans, ING: No, but I think transparency could be a good first step because it would force people into providing this information.
GlobalCapital: So we have all these various efforts but it doesn’t really feel like there is any sense of urgency does it?
Erlandsson, Strukturinvest: The green bond market is about 0.3%-0.4% of the whole bond market which is tiny. It’s very good to see standards are being worked on but at the present pace the green component is still going to be a very small part of the market five years from now. The taxonomy work that is being done is very good but I fear it directs focus on something which might not be the most relevant if we really want to meet the climate challenge.
By 2021 we need to have really bucked the CO2 emissions curve and the way things are going the taxonomy is only going to be fully in place a short time before that. That doesn’t sound like an action plan! It sounds like a lot of people getting to work in sub-committees.
GlobalCapital: So what could governments and their agencies could to diametrically change the pricing differential between dirty and clean energy production?
Erlandsson, Strukturinvest: There is so much more that needs to be done in terms of trying to shift the relative price between green and brown energy production. You don’t just do that only by squeezing down spreads on the green stuff, you also need push up the spreads on brown energy production.
We have a quantitative easing programme which has flattened credit curves. So if you’re an oil major your bonds are going to be perfect material for the ECB’s Corporate Bond Purchase Progamme. CSPP has effectively meant you have a zero risk premium in terms of getting long-term finance. So, what do you do? You keep on excavating as much oil or coal or whatever fossil fuel it is for as long as possible. ECB policy has helped lower the cost of long term dirty financing.
I’ve been running a campaign in Sweden highlighting the extreme subsidies that the Australian government offers its coal industry. The fact is that Australia on its own can breach the Paris Accord globally in terms of CO2 emissions if they excavate the coal they plan to do. I don’t want the Riksbank to use my money or my kid’s money to lower the cost of finance for Australian coal excavation, it doesn’t make sense. I don’t believe it makes sense for the Swedish Riksbank to go and buy A$3bn of Australian government bonds.
Hegelstad, Sparebank 1: The Norwegian Oil Fund has now banned all its investment in oil companies and has nothing to do with coal worldwide.
Erlandsson, Strukturinvest: But are they still buying Australian government bonds?
Hegelstad, Sparebank 1: There are 75 coal relevant companies on the exclusion list.
Erlandsson, Strukturinvest: Exclusion lists generally work on the equity side, whereas when it comes to fixed income, people become much less sophisticated in terms of understanding where their money is going. I’m not necessarily talking about the Norwegian Oil Fund, but in general in the fixed income space. And that’s unfortunate because the bond market has a market cap of $100tr+ versus $60tr in equities. What we are doing in fixed income is so much more important, but I have yet to see a large institutional investor going out and even having a conversation around, for example, how buying Australian sovereign bonds is detrimentally hitting the climate.
Fohler, DZ Bank: You mentioned the Norwegian oil fund and you have talked about the Swedish way to invest. From the German perspective I still see a lot of upward potential where the government or government-related entities could lead by example as investor and issuer. That should come before those entities push for more regulation outside their ‘industry’, as some of our neighbours prove.
GlobalCapital: We talked about carbon taxes right at the beginning of this discussion and that’s something which, in the face of climate change, could quickly catalyse transition to a low carbon future. Does that present risk for financial stability?
Damerow, LBBW: This goes back to Mark Carney’s speech in 2015, Tragedy on the Horizon, where he clearly stated that climate-related financial risks are unknown, but they’re systemic. And what you see in the carbon markets is quite clearly that there is a massive effort to introduce carbon pricing either through tax or through the Emissions Trading System. And I guess the consensus now among many policymakers is that you need carbon taxes to solve the problem. For market participants that means you’ve got to consider carbon tax as a risk when reviewing your business strategy.
GlobalCapital: What could spur a rapid transition to a low carbon future?
Erlandsson, Strukurinvest: Hypothetically think what would happen if you had a large-scale levee breach in the Netherlands. What will be the reaction of the big Dutch pension funds in that case? If you know they are getting out of all fossil-related assets, then everyone on the Street will be trying to front-run that move and you will have a volatile and rapid repricing of these assets. It will be extremely painful to be long these assets when that time comes as it will happen very quickly. So, this is not going to be a slow transition.
GlobalCapital: And if you’ve got carbon taxation, then then surely there needs to be action on capital charges, in the sense that you may risk higher capital charges for fossil fuel and really dirty loans. Then conversely you should have lower capital charges for zero CO2 producing clean energy loans?
Bertalot, ECBC/EMF: We are not asking for a free lunch or a lower capital charge just for the sake of it. If you create a green supporting factor on one hand, then you have to create a brown penalising factor on the other hand. But we’re are not asking this.
We want to see a proper risk assessment. If you pay less on your energy bill because the carbon footprint of your house is zero, this should be reflected in the value of the house and the borrower’s disposable income, which should both be higher. I don’t believe the capital charge currently captures this dynamic. But it can be done using the Internal Ratings Based approach. We want to improve data on the mortgage assets with greater transparency via the Harmonised Transparency Template so as to facilitate a proper risk assessment of an energy efficient house and its borrower, who should be more financially resilient.
GlobalCapital: So tell us about how the pilot scheme that you’re doing now will help achieve that goal?
Bertalot, ECBC/EMF: The pilot scheme is simply bringing together a group of pioneers to demonstrate that the energy efficient collateral is less risky than other assets and should therefore get better capital treatment. Transparency is the key issue here and we have about 45% of the outstanding mortgage market represented in our pilot so the critical mass is there. We have official members of the pilot phase and then we have a smaller number of banks which are taking a more tentative approach for the time being, but they are nevertheless closely associated with the pilot. And with this, we want to have a very strong request to the European Commission to listen to the voice of the market. Then we want to see a policy framework that supports this transition.
Hegelstad, Sparebank 1: I like what you say but isn’t that risk already captured today in the IRB approach? There are a lot of factors involved in a house valuation and I absolutely agree with you that newly refurbished, newly built properties at the right location will obviously have a higher value. But for customers to refurbish their houses they’ll have to borrow more money. And ultimately we’re financing people that can default for many different types of reason. The borrower’s past history and his behavioural characteristics have a very high weight in the probability of default models and mortgage banks already capture that today. Then there are other regulatory issues that you face such as capital floors, for example.
Bertalot, ECBC/EMF: If you were to ask for a valuation on your house, do you think the valuer would use any green parameters? Do you believe the valuation methods used today are good enough to assess if you, as a borrower, can reduce your housing cost 30%-50%. I don’t think that this is really captured in the valuation. When it comes to Basel III’s capital floor of 72.5%, maybe we could ask, for example, for a waiver for green portfolios. Here we have the potential for a large part of the portfolio to be tagged as green. In the end it’s a debt-to-income story as the DTI ratio of the borrower will improve so he will be better able to manage any potential crisis.
GlobalCapital: What do you need to take into account when it comes to impact reporting?
Erlandsson, Strukturinvest: We always focus on CO2 equivalent savings, that’s what we need to see in terms of assessing the impact. We always do this on a sector by sector basis, so we look at what’s the equivalent measure for other companies in that sector. Having said that, there’s not always an investment portfolio where you have the time to do all the nitty-gritty analysis on everything. It’s much better to have comparable statistics and be able to form a diversified portfolio with pretty good measures, rather than having a very specific portfolio with very, precise measures.
The ability to compare is really very important. And when we look at impact reports we need to understand what the headline strategy of the issuer and see that there is a transition path towards the Paris targets in their strategy.
You don’t have to be here today, but you do have to show commitment that you want to get there, and then we can chug along on that train.
Lamy, BNP Paribas AM: We would welcome more standardisation. Of course, it’s tough to find a way to calculate the impact. Just giving an example, when you fund 20% of a project, some people will only allocate the 20% impact in terms of CO2. But others will take the CO2 reduction of the whole project, even though they’ve invested in only a fifth. So having some small steps towards standardisation on the impact report would be great. And until we have real standardisation on the impact reporting, we need the output, as well, so that we’re able to try to compare two different projects to be sure that the impact is in line with expectations or better.
Erlandsson, Strukturinvest: My experience as a fixed income investor and portfolio manager is that indices are extremely helpful but you can shift a lot of things when you start changing around the indices. We are actually doing some work with a firm here in London to build new bond indices which are not a pure green dimension, but tilted to withdraw allocations from the brown and into the relative greens. This works simultaneously between and within sectors. This will be a trial to see how you can bring green investing into the mainstream and get this shift from the 10%-20% brownest parts of the economy into greener parts.