Analysis: How much support is there for the EU’s ‘green supporting factor’ idea?

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The idea of a ‘green supporting factor’ first came to light in a 2016 report by the French Banking Federation (FBF) called How to Successfully Finance the Energy Transition.

“The key challenge is to reduce the relative cost of investing in the energy transition, by cutting either equipment costs or financing costs,” its authors claimed, adding that “the cost of financing the energy transition remains a major challenge”.

“In this context, the FBF wants to propose an appropriate prudential approach to financing and investment in the energy transition (incentivising the decarbonisation of bank balance sheets) to recognise the macro-prudential benefits of these assets in reducing the probability of the climatic risks,” it continued.

“From a regulatory perspective, this should mean lower capital requirements for financing and investing in these assets.”

The proposal has met with a mixed reception. Green Party MEP Sven Giegold warned last year of “another weakening of Solvency II”, adding that some sectors of the financial industry had been seeking looser capital requirements for years, and the transition to a low-carbon economy was simply being used as the excuse. “I really don’t want to see in the final report of HLEG [the High-Level Expert Group on Sustainable Finance] all these lobby demands,” he said.

But by the time the HLEG’s final recommendations came out last month, their hands were tied: the European Commission had got in ahead of the report, announcing in December that it was “looking positively” at the creation of a ‘green supporting factor’.

RI understands that the proposal was not a popular one within HLEG, and that’s reflected in the fact that – while the other two priorities outlined by Vice President Valdis Dombrovskis [taxonomies and investor duties] are in the report’s key recommendations – a ‘green supporting factor’ doesn’t make an appearance until page 67.

In a section dedicated to banking, HLEG acknowledges that the horse had already bolted on the topic. “While the HLEG debated the idea of a green supporting factor, and a brown penalising factor [strengthening capital requirements for fossil assets], the Commission made an announcement at the One Planet Summit in Paris in December 2017…. Therefore, the question is, what aspects need to be considered when exploring the appropriateness of a green supporting factor.”

In addition to having a clear definition of what assets would be eligible, and having a cap on lower capital requirements, HLEG also says there needs to be “evidence of significantly lower risk at the micro-level” for those assets. “At this stage, that is still missing, and existing public proposals for a green supporting factor do not seem to be quantitatively grounded in a risk assessment”.

The concern from some in the market is that green assets are simply not less risky.

Wilfred Nagel, former Chief Risk Officer at ING Group, said at a European Commission event last summer that the bank’s experience with green assets like renewables – particularly European wind farms – had been “very, very bad”.

“Governments and regulators don’t seem to find it a problem, three years into a 15-year financing, to withdraw green certificates or change tariffs or alter other support mechanisms.

“So in terms of the question ‘is sustainable financing really safer and does it merit a lower capital charge?’, my answer today would be no,” he told the audience.

Christopher Flensborg, Head of Sustainable Products at SEB Bank, agrees that “there is homework that still needs to be done”, but describes the idea of a green supporting factor as “spot on”. Importantly, though, he says the purpose should be to address macro-risks, not micro-risks.“Direct risk from an asset on a balance sheet should already be covered by a bank’s internal credit process and is not the responsibility of the regulator. But regulators are responsible for managing societal risk, so if there is research that proves that there is societal financial stability risk associated with climate change – which is not directly relevant to individual credit institutions – then regulators should be giving incentives to activate the financial sector to engage in dealing with those risks.”

HLEG concedes that, although there is not currently strong evidence on micro-level risks, developments such as the Paris Agreement might mean that there is an increasingly “valid differential” between green and brown assets. “One tool for establishing green/brown risk differentials is forward-looking scenario analysis, as advocated by the Taskforce on Climate-related Financial Disclosure [TCFD],” it concluded.

It’s worth noting that when Dombrovskis made his remarks in December, he suggested that a green supporting factor would initially focus on “lowering capital requirements for certain climate-friendly investments, such as energy-efficient mortgages or electric cars”.

This dovetails with recent changes to European legislation, requiring issuers to disclose the green characteristics of real estate and vehicles when using them as the basis for securitisations. Technical standards are in the pipeline.

Luca Bertalot, Secretary General of the European Mortgage Federation – European Covered Bond Council, is overseeing an EU-funded project called the Energy Efficiency Mortgage Action Plan (EeMAP), which is working with more than 30 banks to create a new asset class for energy efficiency mortgages, as RI reported this week. ABN Amro, Barclays, Berlin Hyp, BNP Paribas, Credit Agricole, ING, Societe Generale, UniCredit and Volksbank Banco Popolare are all involved.

“We want to provide the Commission with a clear set of evidence of the risk implications of energy efficiency in mortgages,” says Bertalot. “We’ve put down a concept of what an energy efficiency mortgage would be in Europe, and whoever is creating mortgages under these guidelines will be eligible to class them as official energy efficiency mortgages.

“The idea is that, if the risk was reflected in the capital charges, it would become cheaper for a bank to offer energy efficiency mortgages, and they should be able to pass some of those savings on to the borrower. And, on the other side, institutional investors buying covered bonds linked to these assets will get better collateral and a better cash flow in the long term.”

The European mortgage market is worth around €7trn, and banks including Triodos, Lloyds, BerlinHyp, ING and ABN Amro already have green real estate products and portfolios in place.

However, HLEG warns in its report that “mortgages, which are generally low-risk assets, already have a low capital weight, leading to potentially high degrees of leverage. This will have to be actively monitored and managed.”

RI understands that central banks in Europe are generally not keen on the idea of a green supporting factor, on the basis that altering capital requirements should always reflect direct risk. However, there is no doubt that the broader banking community seems to be on side.

“The second there is a financial impulse hitting a cash flow or evaluation, it has to be implemented into financial advisory,” explains Flensborg. “And that will have a massive impact on how banks like SEB make investment decisions.”