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Green FINgers | ESG stress tests

Bank supervisors increase ESG oversight

With special thanks to Caroline Haas and our FI Sustainable Finance colleagues.   

In our previous ESG note we looked at greenwashing and how regulators were trying to standardise disclosures to address concerns. In the note we said that “we think regulators can play a greater role in the prevention of greenwashing specifically from financials issuers, with measures such as climate-related stress testing”.

In this third ESG note of our series, we focus on the role of bank supervisors. We consider how stress tests conducted by central banks can help financials become better prepared for climate change risks.

We also revisit relative value metrics like our green bond premium monitors for senior and sub financials, which will be a recurring feature in our ESG notes and note the entrenchment of “greeniums” since our previous note.  

EBA continues developing Green Asset Ratio

  • In our previous ESG note we praised the European Banking Authority (EBA) for taking “a step towards mandatory ESG minimum disclosure requirements from banks, which includes a proposal for KPIs such as the Green Asset Ratio”.  We said that “standardised KPIs such as the Green Asset Ratio are a positive step towards helping address greenwashing concerns” and therefore welcome the EBA’s latest ESG effort which was an EU-wide pilot exercise on climate risk.
  • In the EBA’s report from the pilot exercise, the EBA wanted to begin quantifying the potential impact of climate risks on the banking sector to help build on future climate change stress tests and sustainable finance initiatives. The EBA’s exercise was conducted on a sample of 29 volunteer banks and found that more than half of banks’ exposures (58% of total non-SME corporate exposures to EU obligors) are allocated to sectors that might be sensitive to transition risk. Given a sample size of only 29 banks, we are impressed that the exercise involved EUR 2.35trn of corporate exposures which represents 42% of total corporate exposure and 78% of non-SME corporate exposures to obligors domiciled in EU countries.
  • The report also said that 35% of the total non-SME corporate exposures submitted in the exercise are to EU obligors with greenhouse gas emissions above the median of the distribution. The EBA says that there is great difficulty in an accurate estimate for the greenness of each bank’s exposures as “bank may use firm-level information to assess the greenness of an obligor… due to the lack of a clear and harmonised classification framework, banks’ assessments differ largely for the same obligor”.
  • The EBA calculated that the average Green Asset Ratio for banks in the sample was 7.9%. Figure 21 below shows that there could be great difficulty in accurately calculating and comparing the Green Asset Ratio across banks once it becomes part of Pillar 3 disclosures from 2022. For eight banks, their own Green Asset Ratio estimates are higher than the Taxonomy Alignment Coefficient (TAC) estimate, which may indicate that some banks overestimate the greenness of their exposure. However the dispersion goes back ways as there are also seven banks where the TAC estimate is much higher than the bank’s estimate for the Green Asset Ratio.

(Source: EBA report)

  • By their own admission, the EBA acknowledges that there are “data quality issues” that “pose significant challenges when comparing results across banks”. However, even if imperfect, we still think the EBA’s pilot exercise paints a useful picture to help understand the order of magnitude of climate change risks in the banking sector. We continue to see the EBA as an important agency to help shape the enforcement of ESG standards in the European banking sector.


Bank of England commits to Climate Biennial Exploratory Scenario

  • This week, the Bank of England (BoE) set out how they would explore the financial risks posed by climate change for the largest UK banks and insurers. In their report, the BoE set out the key elements of the Climate Biennial Exploratory Scenario (CBES). As explained by Andrew Bailey, the CBES is an exploratory exercise (not to be used to set capital requirements) that will look at physical and transition risks of climate change over a 30 year period for the largest UK banks and insurers. Below is a list of the participating firms and their size within the UK financial system – although the BoE does not intend to disclose the results of individual firms.

(Source: Bloomberg)  

  • The CBES considers the transition risks and physical risks under three scenarios: 1) an Early Action scenario 2) a Late Action scenario, with high transition risks from climate change, and 3) a No Additional Action scenario, with high physical risks from climate change. The inputs of each scenario are outlined as below in Figure 1.A

(Source: BoE)  

  • The CBES will reportedly focus on the credit risk associated with the banking book, with an emphasis on detailed analysis of risks to large corporate counterparties. A key metric of that risk will be the cumulative total of provisions against credit-impaired loans at various points in the scenarios, while traded risk and non-traded market risk would be out of scope. Meanwhile, for insurers, the exercise will focus on changes in Invested Assets (and Reinsurance Recoverables), and Insurance Liabilities (including accepted Reinsurance) assuming an instantaneous shock.
  • Whilst the BoE’s CBES takes a step in the right direction, we think that supervisors must go further in order to influence climate change outcomes for the banking industry. We think that climate change scenarios or stress tests will lead to more impactful changes by banks where there is an explicit economic incentive or penalty for greenness. In our view, a bank’s  management is more likely to proactively manage their climate change risk when it directly impacts the bank’s capital requirements or feeds in as an input into credit ratings and therefore funding costs.  


ECB to conduct climate stress test

  • The ECB announced in March that its next supervisory stress test in 2022 would focus on climate change risks. As shown below, the ECB is focusing on three scenarios that are very similar to those of the BoE:

(Source: ECB)  

  • On a BIS panel on climate change with other central banks last week, Christine Lagarde reportedly said that “we [the ECB] would be failing on our mandate if we did not account for climate change when it comes to understanding and measuring inflation” and “if we do not see that climate change could impair monetary policy transmission. Lagarde’s stance that central banks have a clear role to play in tackling change reflects the results of the “ECB Listens” survey below, where nearly half of respondents (including Civil Society Organisations) said the ECB should consider climate change. In our view, we think that the completion of the ECB’s strategy review later in 2021 could help formalise climate change risks or green finance as a more explicit central bank responsibility.


(Source: ECB)  

  • At the same BIS panel discussion, the governor of the Bank of France, Francois Villeroy, highlighted the importance of climate stress tests and invited bank supervisors globally to follow the lead of the Bank of France. In a climate pilot exercise conducted between July 2020 and April 2021 by the Bank of France and ACPR, the climate change risks for 9 banks and 15 insurers in France were explored over a 30 year horizon. The exercise concluded that “the exposure of French institutions to the sectors most impacted by transition risk, as identified in this exercise (e.g. mining, coking and refining, oil, agriculture, construction, etc.), is relatively low.”
  • The Bank of France pilot exercise is critical that banks and insurers “must step up their efforts to combat climate change”. We think this would be better done by adequate economic punishments or monetary incentives for ESG credentials. The Bank of France reports says that “while banks and insurers seem to be generally aware of this issue, their degree of maturity remains heterogeneous and some institutions have not necessarily yet integrated the proper degree of urgency to act.” We think that this can only be directly addressed if bank supervisors and regulators have explicit linkages between greenness and bank capital requirements or funding costs.  


"Greenium" in seniors - GSS bonds hold onto green bond premiums

  • Like our previous Green FINgers ESG notes, below we highlight our “greenium” monitor for seniors. In graph 1 below we track the difference in maturity/call date between a GSS and non-GSS bond compared to the Z spread pick-up. If a bond is in the green bottom-right quadrant of our chart, this would indicate that the GSS bond is attractive in the pair, as the GSS bond offers both a Z spread pick-up and a shorter duration than the non-GSS bond.
  • In our last Green FINgers note, we noted in March that “we have seen a significant compression of greeniums whereby GSS bonds have outperformed non-GSS bonds. This remains the case as there are very few green bonds that lie significantly within the green bottom right quadrant. Therefore GSS bonds have held onto their green bond premiums and therefore not reversed earlier outperformance over non-GSS bonds.
  • As can be seen in graph 2 below, hardly any GSS bonds offer a pick-up over a non-GSS equivalent for almost all the pairs, with the exception of Irish seniors. In graph 2 we can see that green AIB and BKIR seniors offer ~20bps pick-ups over their respective non-green equivalent. As shown in graph 1, these bonds do not fall within the green quadrant due to a maturity extension over the non-green, but their ~20bps green bond pick-up appears to be double than those of other tickers.
  • In our last Green FINgers note, we highlighted that the CMZB 0.75% 26-25 green senior non-preferred was in the green quadrant of graph 1 by offering a pick- up of ~6bps over the CMZB 1.125% 25s non-green during March. Since then, the green CMZB SNP has outperformed and now compressed to flat, as per graph 3 below.
  • In graph 4 below, we highlight RABOBK 1.106% 27-26 green senior non-preferred as an example where the green bond premium appears to have completely unwound and offers a ~4bps Z spread pick-up over the non-green RABOBK 1.339% 26-25.

Graph 1: GSS bond Z spread pick-up vs duration extension, compared to non-GSS

Source: Bloomberg, NatWest. * denotes callable. Underlying bonds listed in appendix in pdf


Graph 2: Selected € GSS senior bond Z spread pick-up vs non-GSS, 12 month range

Source: Bloomberg, NatWest Markets. Underlying bonds listed in appendix in pdf. SP = senior preferred. SNP = senior non-preferred


Graph 3: CMZB 0.75% 26-25 green SNP vs CMZB 1.125% 25s non-green SNP, Z spread bps

Source: Bloomberg


Graph 4: RABOBK 1.106% 27-26 green senior non-preferred vs RABOBK 1.339% 26-25 non-green, Z spread bps

Source: Bloomberg


"Greenium" in sub debt - ASSGEN greenium unwinding

Graph 5: GSS sub bond Z spread pick-up vs duration extension, compared to non-GSS

Source: Bloomberg, NatWest Markets. Underlying bonds listed in appendix in pdf


Graph 6: GSS sub bond Z spread pick-up vs non-GSS, 12 month range

Source: Bloomberg, NatWest Markets. Underlying bonds listed in appendix in pdf 


  • In our previous note, we had highlighted the significant spread pick-up offered by UQA 3.25% 2032-25c and JUSTLN 7% 2031-25c green bonds over the non-green equivalent, whilst having shorter duration to the first call date. While these two bonds continue to appear in the bottom right green quadrant of graph 5, we can see that the spread pick-up offered by the green UQA 3.25% 2032-25c has compressed to ~25bps from ~40bps in March, reflecting the outperformance of the green bond. However, we caveat that the comparisons of the green JUSTLN 7% 31-25c to the non-green JUSTLN 9% 26s and the green UQA 3.25% 35-25c to the non-green UQA 6% 46-26c are not perfect like-for-like comparisons.
  • As per graph 6, we can see that subordinated green bonds such as AXASA, ASSGEN, CNPFP, and MUNRE appear to trade tighter than their non-green equivalent. In our previous note, we had highlighted the ASSGEN 2.124% green T2 as an example of a bond which offered a “greenium of ~15bps over the non-green ASSGEN 3.875% 29s. In graph 7 below, we observe that since our note, the greenium has been significantly unwinding to ~2bps for the ASSGEN 2.124% so that it trades nearly flat to the non-green ASSGEN 3.875%.  

Graph 7: ASSGEN 2.124% 2030 green bond vs ASSGEN 3.875% 2029 non-green, Z Spread bps

Source: Bloomberg



With thanks to Ankita Agarwal for her contribution to this publication.  

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