Banks, capital requirements and the EU’s new Sustainability Strategy

The EU has hinted that mortgages will become the first asset class in the world to receive preferential capital requirements based on their greenness. 

In its Sustainable Finance Strategy, the European Commission said it will “propose to recognise that measures to enhance energy efficiency of a mortgage collateral can be considered as unequivocally increasing property values,” in the section dedicated to amending capital requirements. 

 In 2017, the Commission’s Vice President, Valdis Dombrovskis, identified energy efficient mortgages as a focus for a proposed ‘green supporting factor’, which would lower capital charges on assets seen to support the EU’s climate goals.

That sparked the Energy Efficient Mortgages Action Plan (EeMAO), which saw European banks defining parameters for ‘energy efficient’ mortgages, and creating a pool of eligible assets on which to perform risk analysis. 

“It gave clear scientific evidence that energy efficiency has an impact on the loss given default and loan to value, and also on the probability of default of the borrower by having an impact on disposable income,” said Luca Bertalot, Coordinator of the Action Plan and Secretary General of the European Mortgage Federation-European Covered Bond Council (EMF-ECBC). “So I think the words of the European Commission are actually recognising it and we were very pleased yesterday to get strong recognition from Commissioner McGuiness,” he added, referring to Commissioner McGuiness’ remarks that the Commission would be exploring green mortgages. 

The strategy will explore ways to support the uptake of green mortgages during the upcoming review of the Mortgage Credit Directive and the Commission has asked the European Banking Authority to explore options to facilitate their uptake by 2022. 

In February, EMF-ECBC launched the Energy Efficient Mortgage label sponsored with European Commission funding. Danske Bank in Denmark is the first bank to have signed up to it. 

The Commission’s new strategy will now explore whether ESG factors improve the risk profile of other asset classes, with a view to “propose amendments to the prudential framework for banks to ensure ESG factors are consistently included in the risk management systems and supervision”. 

The Commission will bring forward to 2023 (from 2025) the European Banking Authority’s mandate to assess whether a “dedicated prudential treatment of exposures related to assets and activities associated substantially with environmental and/or social objectives would be justified”. 

And as part of the 2023 Solvency II review, the Commission will mandate EIOPA to investigate whether it should carry out the same exercise for the insurance sector. It will also ask the supervisor to assess the effectiveness of the current prudential regime, especially in terms of asset allocation and the resulting impact on cost of capital of firms operating in sectors with different carbon intensity.  

The Commission is also considering building climate stress tests into the Capital Requirements Directive that governs European banks, and climate scenario analysis into Solvency II for insurers. 

Some NGOs have warned that there is too much focus on rewarding green investment via capital requirements, instead of penalising allocation to polluting activities. 

The Sunrise Project said it was unclear if the strategy will lead to banks moving money from fossil fuels to climate change solutions. The non-profit also raised concerns about the Commission’s decision to delay the publication of a controversial advisory report on climate change and banking conducted by BlackRock. 

Last year, BlackRock was appointed to assess whether EU policymakers should integrate ESG factors into banks’ prudential framework, in a move that was later slammed by the European Ombudsman, which said the Commission “did not sufficiently consider conflicts of interest” when choosing BlackRock to conduct the study.

The asset manager is among the two largest shareholders of Europe’s biggest fossil fuel lenders, according to campaign group Change Finance, which recently had a request to access BlackRock’s report – and related correspondence – rejected by the Commission.  

In its response, the Commission explained that "the disclosure of those documents could affect the decision-making process of the Commission, as it would reveal preliminary views and policy options which are currently under consideration; the Commission's services must be free to explore all possible options in preparation of a decision free from external pressure."