NatWest Markets Strategy & Sales

Green FINgers | Financials gear up for ESG risks
Financials Credit Trading Strategy
13 October 2021 14:50


Authors
Financials Credit Trading Strategy

Contributors
{{contributor-span-repeater}}

If you wish to discuss the content of this article further, please contact your usual sales person. Reminder, clients of Natwest Markets NV should reach out to their relevant NV sales person.

In our previous ESG note we looked at the role of bank supervisors to prevent "greenwashing" with stress tests.

In this note we look at potential new rules on banks and insurers to help them prepare for climate related risks. We also revisit our relative value metrics like green bond premium monitors for senior and sub financials and we note the continued entrenchment of “greeniums” for most bonds.

Banks – potential capital buffers for climate change risks

  • We have seen articles suggesting that banks could face climate-related capital requirements. In an interview with Bloomberg, Pilar Gutierrez of the EBA regulator suggested that once banks report climate related disclosures, they are more likely to be encouraged to build capital buffers against ESG related risks. As we highlighted in our previous Green FINgers note, ESG minimum disclosure requirements such as the Green Asset Ratio are expected to be part of bank Pillar 3 disclosures from 2022. Although there is no clear timeline for this resulting in climate-related capital requirements for banks, Gutierrez suggests that the disclosures could be a catalyst for banks to get the ball rolling for better climate change risk management.
  • Along with reputational and operational risks that bank face with climate change, the ECB will examine whether banks’ trading books are exposed to ESG shocks such as losses on the debt of oil companies. ECB authors published a paper for the methodology of the climate stress test which said that the ECB will “construct market-risk shocks driven by climate change dynamics that could be used to reprice corporate bonds”. The ECB said that “an internal ECB model has been developed to approximate the shock on credit spreads from transition and physical risks under the three climate scenarios”. Ultimately, the ECB authors said that “the impact of market risk is somewhat limited as compared with the credit-risk channel” – as shown in graph 1 below, portfolio losses for the vast majority of banks is below -1% in both an “orderly transition” and “hot house” scenario.

Graph 1: Market losses for banks' corporate bond portfolio

Source: ECB Occasional Paper Series No 281, September 2021


  • Even if the ECB stress test next year does not result in immediate capital requirements for banks, it is clear from an ECB Supervision newsletter in August that banks are still far from ready for ESG risks and that the regulator wants banks to do more. The ECB newsletter says that “very few banks have incorporated sound climate and environmental risk management processes… into their strategies or risk mitigation processes”. For example, graph 2 below shows that only one-third of banks have plans in place that are at least broadly adequate (in the right hand column) and that a fifth of the banks have (somewhat) inadequate plans that will barely improve (in the bottom left square).

Graph 2: Alignment of banks' practices with expectations against the adequacy of plans

Source: ECB Supervisions Newsletter, 18 August 2021


  • The ECB Supervision newsletter also highlights that banks need to speed up their efforts to adequately manage climate and environmental risks in a timely fashion. In graph 3 below, less than 35% of banks expect their credit risk and liquidity risk management practices to be aligned by end-2022. The ECB also highlights that some banks will miss meeting end-2022 plans and also have not defined short-term deliverables to meet by end-2021 (the red bars in graph 3), which is particularly high for liquidity risk management at nearly 40%.  

Graph 3: Banks' projections of the timing of plans and deliverables

Source: ECB Supervision Newsletter, 18 August 2021


  

Insurers – EC wants climate risks to be better managed

  • Last month, the European Commission proposed amendments to the Solvency II Directive and a new Insurance Recovery and Resolution Directive. As explained in a Q&A document, the European Commission said that it will be “introducing a requirement for a long-term climate change scenario analysis [which] will take into account climate change-related risks that may not always be captured when calculating capital requirements. In addition to this, EIOPA will conduct centralised climate stress tests in the (re)insurance sector and the Commission will launch a Climate Resilience Dialogue and explore ways to improve the collection of insured loss data.” Mentions of stress tests and scenario analysis clearly indicate that insurers will be scrutinised more by regulators on their management of climate related risks.
  • According to a Fitch report on these Solvency II reforms, the rating agency thinks that lower capital charges for insurers investing in longer-term assets could boost the demand for environmentally sustainable infrastructure and renewable energy projects. However, Fitch notes that the impact could be “gradual as it will take time for insurers to source investments they consider suitable”. We would welcome more involvement from regulators on developing insurers’ ESG related disclosures, as was done by bank regulators with the Green Asset Ratio.
  • Insurers have clear economic incentives to effectively manage risks, particularly losses from natural catastrophes and weather related claims. Given the increasing severity and frequency of extreme weather events, we note a recent S&P report which looked at how reinsurers are incorporating climate change risks. S&P said that “scenario analysis suggests that reinsurers’ estimates of their exposure to natural catastrophe risk could be underestimated by 33-50%”. The S&P report also says that “71% of reinsurers consider climate change in their pricing assumptions, but only 35% include a specific component of the price allocated to climate change”. As such, the report suggests that reinsurers can do more to better protect their capital and earnings volatility from physical climate risks.

Graph 4: Natural disasters have led to an increase in insured losses from catastrophes

Source: S&P, 23 September 2021


  

"Greenium" in seniors – green bond premiums remain entrenched for most

  • Like our previous Green FINgers ESG notes, below we highlight our “greenium” monitor for seniors. In graph 5 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 previous Green FINgers note we noted that “GSS bonds have held onto their green bond premiums and therefore not reversed earlier outperformance over non-GSS bonds”. Such entrenchment of “greeniums” has generally held true in recent months, despite the sell-off. For example in our June Green FINgers note, we had highlighted how the green CMZB 0.75% 26-25 SNP had outperformed and compressed flat on spread to the non-green CMZB 1.125% 25s counterpart. This green bond outperformance has continued in Q3 so that the green CMZB now trades 3bps tighter than the non-green equivalent, as per graph 6 below.
  • As can be seen in graph 7 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 we which had already identified in June. Here we can see than the green AIB and BKIR seniors still offer ~20bps pick-ups over their respective non-green equivalent, albeit for a maturity extension too.
  • We note one exception is SHBASS SNP where the green bond has underperformed the non-green. As seen in graph 8 below, the spread differential has nearly doubled in Q3 and now the green SHBASS 0.01% 27s offers an all-time high pick up of 9bps over the non-green.

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

Source: Bloomberg, NatWest. * denotes callable. Underlying bonds listed in appendix at the end of pdf


  

Graph 6: CMZB 0.75% 26-25c green SNP vs CMZB 1.125% 25s non-green SNP, Z spread bps

Source: Bloomberg


  

Graph 7: Selected € GSS senior bond Z spread pick-up vs non-GSS, 12 month range

Source: Bloomberg, NatWest. Underlying bonds listed in appendix at the end of pdf. SP = senior preferred. SNP = senior non-preferred)


  

Graph 8: SHBASS 0.01% 27s green SNP vs SHBASS 0.05% 26s non-green SNP, Z spread bps

Source: Bloomberg


  

"Greenium" in sub debt – AT1 and Tier 2 greeniums moved oppositely

  • Similar to seniors, graph 9 below is another quadrant chart to track if the green bond premium for subordinated debt is related to duration. We again note that the apparent green bond pick-ups and shorter maturities available in the green quadrant for the JUSTLN and UQA insurance Tier 2s are not drawn from perfect like-for-like comparisons.
  • As shown in graph 11, the green BBVA AT1 used to trade up to ~30bps wider than the non-green BBVA AT1 during the summer which likely reflected the credit curve steepness from a 2024 call to 2026 call. However in the recent sell-off, we can see that the green BBVA AT1 has outperformed so that it now trades ~10bps tighter. We recognise that the green BBVA 6% 26c AT1 has a higher reset level (+6.456%) than the comparable non green BBVA 6% 24c (+6.039%), which is also a strong reason for its recent relative outperformance. This is a theme we discussed in our AT1 Alert publication, and so we caveat that the relative resilience of this green BBVA AT1 should not be attributed all to its green bond status.
  • In contrast to the outperformance of spreads for BBVA’s green bank capital, we have seen green bank T2 such as AIB 2.875% 2031-26c underperform in Q3. As seen in graph 12 below, the green AIB T2 underperformed the non-green AIB T2 to reach an all-time high differential of ~26bps. We caveat that some of this increase will be from curve steepening due to the higher duration of the AIB green bond.

Graph 9: GSS sub bond Z spread pick-up vs duration extension, compared to non-GSS

Source: Bloomberg, NatWest. Underlying bonds listed in appendix at the end of pdf


  

Graph 10: GSS sub bond Z spread pick-up vs non-GSS, 12 month range

Source: Bloomberg, NatWest. Underlying bonds listed in appendix at the end of pdf


  

Graph 11: BBVASM 6% 26c green AT1 vs BBVASM 6% 24c non-green AT1, Z Spread bps

Source: Bloomberg


  

Graph 12: AIB 2.875% 2031-26c green vs AIB 1.875% 2029-24 non-green, Z Spread bps

Source: Bloomberg


  

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


Please click here to find all of NatWest Markets’ Strategy and Sales commentary/ideas. 

You can also find out more about our electronic offering and credentials for Rates here and for FX here.


This is Non-Independent Research, as defined by the Financial Conduct Authority. Not intended for Retail Client distribution. This material should be regarded as a marketing communication and may have been produced in conjunction with the NatWest Markets Plc trading desks that trade as principal in the instruments mentioned herein. All data is accurate as of the report date, unless otherwise specified.

This communication has been prepared by NatWest Markets Plc, and should be regarded as a Marketing Communication, for which the relevant competent authority is the UK Financial Conduct Authority.

Please follow the link for the following information https://ci.natwest.com/regulatory-information/market-abuse-regulation-mar-disclosures:

  • MAR Disclaimer
  • Conflicts of Interest statement
  • Glossary of definitions
  • Historic Trade ideas log

All data is accurate as of the report date, unless otherwise specified.

 

This communication has been prepared by NatWest Markets Plc, NatWest Markets N.V. (and/or any branches) or an affiliated entity (“NatWest Markets”), and should be regarded as a Marketing Communication, for which the relevant competent authority is the UK Financial Conduct Authority (for NatWest Markets Plc) and the Autoriteit FinanciĆ«le Markten (for NatWest Markets N.V.).

 

Please follow the link for the following information https://www.natwest.com/corporates/support/regulatory-information/market-abuse-regulation-mar-disclosures.html:

 

MAR Disclaimer

Conflicts of Interest statement

Glossary of definitions

Historic Trade ideas log

 

This material is a Marketing Communication and has not been prepared in accordance with the legal and regulatory requirements designed to promote the independence of investment research and may have been produced in conjunction with the NatWest Markets trading desks that trade as principal in the instruments mentioned herein. This commentary is therefore not independent from the proprietary interests of NatWest Markets, which may conflict with your interests. Opinions expressed may differ from the opinions expressed by other business units of NatWest Markets. The remuneration of the author(s) is not directly tied to any transactions performed, or trading fees received, by any entity of the NatWest Group, for example, through the use of commission-based remuneration.

 

This material includes references to securities and related derivatives that the firm's trading desk may make a market or provide liquidity in, and in which it is likely as principal to have a long or short position at any time, including possibly a position that was accumulated on the basis of this analysis material prior to its dissemination. Trading desks may also have or take positions inconsistent with this material. This material may have been made available to other clients of NatWest Markets before it has been made available to you and is not subject to any prohibition on dealing ahead of its dissemination. This document has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes. It is indicative only and is not binding. Other than as indicated, this document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of this material, nor does NatWest Markets accept any obligation to any recipient to update, correct or determine the reasonableness of such material or assumptions contained herein. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed. The opinions, commentaries, projections, forecasts, assumptions, estimates, derived valuations and target price(s) or other statements contained in this communication (the “Views”) are valid as at the indicated date and/or time and are subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes. Views expressed herein are not intended to be, and should not be viewed as advice or as a personal recommendation. The Views may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this material. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and make such other investigations as you deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this document. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. The information contained herein is proprietary to NatWest Markets and is being provided to selected recipients and may not be given (in whole or in part) or otherwise distributed to any other third party without the prior written consent of NatWest Markets.

 

NatWest Markets and its respective affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments giving rise to potential conflicts of interest which may impact the performance of such financial instruments. Such interests may include, but are not limited to, (a) dealing in, trading, holding or acting as market-maker or liquidity provider in such financial instruments and any reference obligations; (b) entering into hedging strategies on behalf of issuer clients and their affiliates, investor clients or for itself or its affiliates and connected companies; and (c) providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. NatWest Markets and its affiliates, connected companies, employees or clients may at any time acquire, hold or dispose or long or short positions (including hedging and trading positions) which may impact the performance of a financial instrument.

 

In the U.S., this Marketing Communication is intended for distribution only to major institutional investors as defined in Rule 15a-6 of the U.S. Securities Exchange Act 1934 (excluding documents produced by our affiliates within the U.S. which are subject to the following disclaimer https://www.agilemarkets.com/api/ds/v1/disclaimer/publication/2756 ). Any U.S. recipient wanting further information or to effect any transaction related to this trade idea must contact NatWest Markets Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700.

 

Where communicated in Singapore, this communication may be deemed an advertisement. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

NatWest Markets Plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority and is provisionally registered as a swap dealer with the United States Commodity Futures Commission. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised by De Nederlandsche Bank and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, The Netherlands. Branch Reg No. in England BR001029. Agency agreements exist between different members of NatWest Group. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer ( http://www.finra.org ), a SIPC member ( www.sipc.org ) and a wholly owned indirect subsidiary of NatWest Markets Plc. NatWest Markets Securities Inc. is authorised by NatWest Markets Plc to act as its agent for certain kinds of its activities.

 

For further information relating to materials provided by NatWest Markets, please view our Agile Markets Terms and Conditions

 

Copyright © NatWest Markets Plc. All rights reserved.