CACIB’s 2nd ESG Bank Day: Greening the business model

While GSS bonds have hitherto represented a way for issuers and investors to engage on sustainability, ESG is being integrated more broadly and deeply into their strategies. Regulatory initiatives are furthering this move, with environmental and social factors being increasingly put at the centre of business models. Here, Crédit Agricole CIB analysts highlight the key developments, and the risks and opportunities they bring.

You can download a pdf of this article, also including insights shared by regulators, issuers and investors, here.

Campus Evergreen lablis BiodiverCity Life web

Until now, sustainable bonds have for investors represented a proxy to integrate ESG into their investment strategies, and for issuers, a way to show that they are taking action against climate change, according to Léa Le Leonnec Serra, green bond-ESG fixed income analyst, Crédit Agricole CIB.

Despite challenging funding conditions, financials and non-financial corporates had contributed around 60% of year-to-date sustainable bond issuance, she noted, with financials alone accounting for one-quarter of the overall sustainable supply. Senior preferred and senior non-preferred have been the most popular issuance format for financials and Crédit Agricole CIB expects sustainable supply in the two formats to meet last year’s issuance level thanks to a catching-up of sustainable issuance at the end of the summer.

Although the past two years have witnessed a diversification of sustainable fixed income products from the traditional green bond into the newer sustainability-linked bond (SLB) format, this has been stronger on the corporate side, noted Le Leonnec Serra (pictured below). Financials have continued to focus on use-of-proceeds bonds, with the European Banking Authority still discouraging the use of SLBs by banks for MREL/TLAC-eligible instruments.

Lea Le Leonnec Serra web

Greenium has meanwhile become increasingly visible, with Crédit Agricole CIB analysts putting it at some 6bp-8bp based on data across 15 European banks’ senior preferred and non-preferred bonds. A lack of relevant comparable bonds means that an analysis of subordinated debt is still limited.

“That said, we see that the bottom of banks’ capital structures seems to offer more spread room for the greenium,” added Le Leonnec Serra.

Within covered bonds, the greenium has improved recently amid high issuance that resulted in spread-widening, with green bonds attracting buyers whose appetite for classic covered bonds was already filled.

Buyside adapts to challenges

Within a context of increased ESG integration, in particular with regard to climate and transition objectives, the buyside is facing new constraints and opportunities, Valentina Sanna, green bond-ESG fixed income analyst, Crédit Agricole CIB, told delegates at the event.

“Firstly, investors are exposed to increased scrutiny on the climate impact of their activity, and also the impact of climate change on their activities,” she said. “On the one side, climate change and the energy transition impacts the profitability of companies they invest in, through in particular the negative potential impacts of physical climate risk, but also transition risk, meaning that investors need to integrate this new risks and opportunities into their return expectations.

“On the other side, they are also exposed to increased scrutiny of the climate impact of their investments, particularly some sectors like coal, oil and gas. This means they have to complement their financial objectives with environmental objectives.”

Secondly, investors are increasingly participating in net zero initiatives to show their willingness to take action against climate change, noted Sanna, such as the Net Zero Asset Managers initiative, the Paris Alignment Investment Initiative, the UN-convened Net-Zero Asset Owner Alliance, and the Net-Zero Insurance Alliance. This involves setting interim and long term targets, and periodically reporting on progress.

“And thirdly, increasingly investors need to adapt to new regulation that is bringing new ESG disclosure.”

Sanna cited three such regulatory developments facing investors: Article 8 of the Taxonomy Regulation, requiring disclosure of the Taxonomy-aligned percentage of their activities; the Sustainable Finance Disclosure Regulation (SFDR), requiring disclosure of how ESG risks are integrated into investment decisions as well as classification of funds according to ESG characteristics; and MiFID II, requiring that investors check clients’ ESG preferences and propose them appropriately adapted products.

“Faced with these new constraints and opportunities, the question for investors is how to integrate them into their operation,” said Sanna (pictured below). “Indeed, integrating climate risks and opportunities as well as aligning to net zero objectives and initiatives, and adapting to new reporting requirements, requires them to adapt their strategies as well as to adopt new data and metrics.”

Valentina Sanna web

New strategies could include engage with companies to drive change, she added, as well as capital allocation strategies such as tilting between and within sectors, divestments, and investment in climate solutions — with green bonds being a concrete example of the latter. To this end, investors can employ metrics such as absolute CO2 emissions and emissions intensity, and reductions in these, while also aligning with sector-specific pathways.

However, these approaches face challenges, not least in finding sufficient data, noted Sanna.

“While it is true that the Taxonomy adds a burden to the reporting of companies,” she said, “it will also be helpful, since it will increase the availability of data on the share of green activities at the issuer level, while also giving standard definitions of climate solutions and also standard CO2 product intensity for some sectors.”

Regulations spur change

As well as rising up the agenda of investors and regulators, climate and environmental risks are becoming top priorities for banks, who are increasingly putting such matters at the centre of their business models.

“Climate change and the transition to net zero poses risks to households and firms, and therefore to the financial sectors,” said Gwenaëlle Lereste, senior credit analyst, bank analyst, Crédit Agricole CIB. “Banks finance around two-thirds of the economy and as a consequence they are playing a key role in accelerating the move to a more sustainable economy.

“Reorienting private capital to more sustainable investments requires a comprehensive shift in how financials work,” she added. “This transformation will trigger business opportunities for banks, but at the same time will also lead to potential financial and reputational risk.”

This has been reflected in regulatory developments — Lereste cited revisions to CRR2 and CRD5 to include climate factors, as well as Pillar 3 disclosures and Pillar 2 requirements, with the integration into the SREP of the outcome of the first ECB stress tests — raising questions about potential climate capital rules.

“We view the ECB climate stress test as a credit positive start for the banks,” she said, “because it helps banks embed more climate factors into their strategies.”

An acceleration in banks’ ESG strategies has been reflected in the incorporation of climate factors in strategic plans, including long term commitments to reduce exposures towards fossil fuels, while supporting their counterparties to lower carbon emissions. European banks have also joined the Net-Zero Banking Alliance, thereby committing to aligning their goals with the Paris Agreement, as well as the Science Based Targets initiative (SBTi), with La Banque Postale in October 2001 being the first European bank to have its decarbonisation pathway recognised by the SBTi.

“ESG is gaining momentum from liabilities to assets,” said Lereste (pictured below). “However, even though the ECB has recognised the progress being made by banks, they are lagging in several areas and do not yet sufficiently embed climate risk in their business models.”

Gwenaelle LERESTE web

She highlighted discrepancies among European banks and a lack of clarity over commitments, targets and metrics.

“ESG risk will increasingly be a credit differentiator,” said Lereste, “but available and harmonised data remain a big obstacle.”

The data issue should also make it challenging for banks to report on their Green Asset Ratios (GARs), noted Sanna. Banks will have to start disclosing the key KPI in 2024.

“Some of the challenges include the availability of company data, quality and comparability,” said Sanna, “but also the need for new expertise, to assess the alignment with the technical criteria of the Taxonomy and do-no-significant-harm.”

In a pilot exercise last year, the EBA calculated a first estimate of just 7.9% for the EU-aggregated GAR.

“While the disclosures present some challenges,” said Sanna, “we think that more transparency could also be seen as an incentive for banks to green their balance sheets, which ultimately need to be decarbonised.”

You can download a pdf of this article, also including insights shared by regulators, issuers and investors, here.