Natixis has revamped its internal capital allocation systems to consider environmentally-friendly assets less risky and carbon-intensive assets more risky, making the French bank the first to introduce the controversial green supporting factor mechanism.
In practice, the measure involves putting aside less capital as insulation against potential losses from green transactions and allocating more capital for riskier high-polluting, or brown, transactions. This effectively makes green assets cheaper to hold for banks, by freeing up balance sheets and reducing pressure on earnings, while making brown assets more expensive.
Under Natixis’s proprietary Green Weighting Factor (GWF) framework, each financial transaction is assigned a colour rating on a seven-point brown to green scale which determines individual risk weightings and their corresponding capital requirements. Green transactions can have their risk weighting reduced by up to 50%, while weightings for brown transactions can be increased by a maximum of 24%.
Colour ratings will also impact the profitability assessment of each transaction as risk weightings are a component of the analysis.
The GWF will apply across the portfolio of Natixis’s Corporate & Investment Banking (CIB) arm, affecting a total of €127bn worth of assets, with the exception of the financial sector. The bank said that assessing the environmental performance of its lending to other financial institutions was “very difficult”.
Nominally, 38% of the Natixis CIB balance sheet comprises brown assets, 19% neutral assets and 43% green assets. With the GWF, the provision for brown assets is at 51% of the total capital allocation, 26% is allocated for neutral assets and 23% for green assets.
As of now, 70% of the CIB balance sheet has been assessed and assigned a colour rating.
The green supporting factor has so far been at the fringes of mainstream finance because of prudential concerns that it would increase bank exposure to the risk of insolvency. In 2017, Moody’s warned banks that such a policy would have a negative credit implication for this very reason.
Subsequently, the EU’s High Level Expert Group (HLEG) on Sustainable Finance said in its final report that while the policy had its merits, conclusive evidence that green assets were less risky is “still missing”.Instead, “existing public proposals for a green supporting factor do not seem to be quantitatively grounded in a risk assessment”.
Addressing these concerns, Orith Azoulay, Head of Green and Sustainable Finance for Natixis CIB, said to RI: “Our aggregate regulatory risk weightings remains unchanged, which is one of the reasons we wanted to use both a green supporting factor and a brown penalty. Obviously, the main thing for a brown penalty is to take into account climate-related risks but it also has the benefit of maintaining the overall balance at inception of the mechanism.
“I consider it a significant competitive edge with regards to green and sustainable finance”
“The concerns of the credit rating agencies, if I understand correctly, are more to do with the aggregate level of protection. Since we are maintaining a stable regulatory risk weighting it should not be a problem.”
On the strategic implication of the GWF, she said: “It’s a tool that we are going to use for our strategic dialogue with clients and is a way to continuously develop our team’s competencies around green and brown topics. I also consider it a significant competitive edge with regards to green and sustainable finance because will have to put out a green / brown assessment on every deal that we do.”
According to Azoulay, specific targets are to be decided after a one year trial of the new methodology. Examples of those being currently considered are targets for the colour mix of a given business line, and how much or how fast that can be transitioned toward green.
Natixis first announced its plans to develop the GWF at the end of 2017. Over the next 18 months, the methodology was designed by working groups drawn from across the CIB including front office staff such as originators and portfolio managers, and sustainability experts. Technical advice was sourced from sustainability consultants Carbon4, I Care and Quantis.
The roll-out also involved major changes to the IT system for the purposes of embedding the GWF into existing credit processes instead of introducing an additional adjustment. KPMG is due to provide independent assurance of the GWF in 2020.