10 - Banking & Debt

DCM

DCM

• play a pivotal role in allocating capital to finance solutions to environmental, climate change, and transition challenges.

Categories of DCM

• organised guaranteed bonds

  • •These raise money for general purposes and are backed by the issuing organisation as a whole. Government (sovereign) bonds and corporate bonds are the main type of issuer (with some other issuers such as multilateral organisations like the world Bank). Use of the money raised (proceeds) of these may be linked to certain qualifying assets or purposes.

• asset-backed securities

  • •These raise money for general purposes and are backed by the issuing organisation as a whole. Government (sovereign) bonds and corporate bonds are the main type of issuer (with some other issuers such as multilateral organisations like the world Bank). Use of the money raised (proceeds) of these may be linked to certain qualifying assets or purposes

organised guaranteed bonds

• These raise money for general purposes and are backed by the issuing organisation as a whole. Government (sovereign) bonds and corporate bonds are the main type of issuer (with some other issuers such as multilateral organisations like the world Bank). Use of the money raised (proceeds) of these may be linked to certain qualifying assets or purposes.

ABS

•These raise money for general purposes and are backed by the issuing organisation as a whole. Government (sovereign) bonds and corporate bonds are the main type of issuer (with some other issuers such as multilateral organisations like the world Bank). Use of the money raised (proceeds) of these may be linked to certain qualifying assets or purposes.

factors affecting yield

1. prevailing IR (base IR)

2. characteristics of the bond

3. time to maturity (term structure)

4. type of issuer (credit worthiness)

5. state of the economy

risks associated with investing in bonds

1. IR risk

2. reinvestment risk

3. call risk

4. credit risk

5. inflation risk

6. exchange rate risk

7. liquidity risk

8. volatility risk

9. risk risk

relevance of sustianbility to bonds

• ESG

• factors influencing creditworthiness

• credit risk indicators

Factors influencing creditworthiness

relevance of sustainability to bonds

ESG integration in bonds

1. research

2. security ad portfolio analysis

3. investment decisions

Is debt suited for sustainability?

Debt capital is particularly suited for financing many green and sustainable projects, particularly those involving renewable energy such as wind or solar and play a considerably more important role in financing renewables energy infrastructure projects than equity capital.

McKinsey (2016) found that the average debt-to-equity ratio of 3,700 renewable energy projects worldwide is 70 to 30 debt to equity

Categories of GSS bonds

• Transition

• Sustainability linked

• GSS

  • social

  • sustainability

  • green

    • recourse to the issuer

    • green project bonds

    • green revenue bonds

    • green securitised and covered bonds

Green bonds

where proceeds raised are allocated to environmental projects or uses

• majority issued to date are use of proceeds

  • speicific green projects and backed by entire balance hseet

4 Green bond principles

1. use of proceeds

   1. dedicating funds to environmentally beneficial projects

2. project evaluation and selection

   1. chosen based on enviro impact

3. management of proceeds

   1. allocation of funds must be transparently managed and tracked

4. reporting

   1. regular updates on environmental impact of funded projects are provided

recourse to the issuer debt obligation

• green use of proceeds bond where capital raided for a specific green project and bond are backed by the issuers entire balance sheet

• gives confidence to investors and ratings agencies by significantly reducing credit risk and risk of default

transition bonds

issuer’s climate change-related commitments and practices, aligning with the Paris Agreement’s ambitions.

To facilitate the transition, the climate transition finance handbook provides guidance to capital market members on the practices, activities and disclosures required for raising funds for climate transition-related instruments on the market.

There are two formats and key elements for this purpose:

1.Use of Proceeds instruments, as defined in the GBP, SBP, and SBG

2.General Corporate Purpose instruments aligned with the SLB principles

greenium

pirce differen e between green bonds when they trade at a premie to conventional bonds

• questionable whether this exists or not

climate bonds

subcategory of green bonds

where proceeds are used to finance projects to mitigate or adapt the effects of climate change

blue bonds

designed to support sustainable marine and fisheries projects

green project bonds

not backed by whole glance sheet - only project assets

• higher return to compensate for risk

• •Many project bonds are issued, supported by and/or underwritten by national and multinational development banks

green revenue bonds

backed by pledged revenue streams from a project usually with no resource to issuer

green securitised bonds

a group of project into. single bond with bondholders having recourse to assets underlying complete set of projects

green covered bond

• covered pool

• investors have recourse to the issuer but if the issuer cat make debt payments then holders have recourse to covered pool

social bond

proceeds for projects with positive social outcomes (education or gender equality)

•The social Bonds principles

set out guidelines for use of proceeds for a bond to qualify as a social bond.

sustainability bond

aspects of green and social bonds with proceeds funding green as well as a wide range of projects intended to have positive social outcomes, often linked in SGDs

sustainability linked bond

do not finance particular projects

finance general functioning of an issuer that’s explicit sustainability targets

proceeds from the issuance are not ring-fenced to green or sustainable purposes (unlike “use of proceeds” green bonds or sustainable bonds) and may be used for general corporate purposes or other purposes.

5 components of a SLB

1. selection of KPIs

2. calibration of suitability performance targets

3. bond characteristics

4. reporting

5. verification

elements of transition bonds

1. issuers climate transition strategy and governance

2. business model environment al materiality

3. climate transitionstartegy to be science based

4. implantation transparency

What determines the choice between market lending through bonds and Bank lending?

•When uncertainty about the company’s cashflows is relatively small (the asymmetric information between the firm and the lender is limited), the company can borrow in the market.

•As the uncertainty increases, banks come into play as they have more possibilities than credit rating agencies to ask for information and intervene when necessary (private information)

•When the uncertainty becomes too great, a company cannot obtain finance

functions of the financial system

• channel savings to real investments

• risk transfer and diversification

• liquidity and information

• payment mechanism

• timing of consumption

Banks role in financing

• main credit provider

• large role in CapM

• investment decisions within banks have material consequences on the enviornemt and on society

• reallocate credit and mobilise capital away from environmentally harmful actiivites towards green and sustainable project

• •By continuing to finance high-carbon, environmentally damaging activities, banks contribute to the acceleration and impacts of climate change

  •By supporting green and sustainable finance , banks have a key role to play supporting the transition towards a more sustainable low-carbon economy

lending business of banks

• screens for creditworthiness (adverse selection)

• monitors the borrower (moral Hazard)

types of lending

1. Corporate

   1. SME, Cororpalte loans, interbank loans, syndicated loans, mortgages, credit lines

2. Government

   1. loans, mortgages,c credit lines

3. social enterprises

   1. loans mortgages credit lines

4. households

   1. mortgages, consumer credit, Microfinance, overdraft

susitnability in lending

risk based approach - lending

• various social and environmental factors and risks are included in credit risk

• affecting probability of deaf an the loss given default

• susutianbilty criteria should be used to determined the cost price of the loan

  • credit spread of risk permm

• higher IR forces social and environmental business models

3 project finance risks

1. impact on environment and socieyt

   1. impact materiality

2. income of projects may suffer from susutianbiity risks

   1. financial materiality

3. repetitional risks

climate risks and banking

• physicalal risks

  • from direct impact of climate hazard

• transition risk

  • transition to a lower carbon economy

• liability risk

  • arise from parties who have suffered loss and damage from effects of climate change and who seek compensation form this reeposnbile

new exposure indicators

• Weighted average carbon intensity

• Bank carbon footprint

• carbon financing tilt

  • credit weighted emission intensity

• taxonomy alignment

  • estimates the level of alignment of financial profits within EU taxonomy

• concentrated emissions exposures

  • share of lending to certain sectors

• expsoures to physical hazards

  • shift in return periods of river flooding ex

UN principles of responsible banking

• 2019, signed by 130 banks from 49 countries

• unique framework for ensuring signatory bak’s strategy and practice aligns with SDGs

• 3 steps

  1. impact analysis

     1. identifying the most isngiicant impacts of products and services that the bank operates in

  2. target setting

     1. measurable targets in area of most significant impact

  3. reporting

     1. pulicaly report of progress being transparent

6 principles of responsible banking

1. alignent

2. impact and target setting

3. clients and cusotmers

4. stakeholders

5. governance and culture

6. transparency and accountability

green & sustainable banking pratices

1. mainstreaming sustainability factors across bank strategy and governance, risk management, culture and skills

   1. risk management (price risk)

2. mobilising private capital for green investments

   1. efficient allocation of capital

mainstreaming banking practices

• credit and lending

  • enviro due diligence

  • emerging environmental risks

  • enhancing positive performance

• savings

  • reducing enviro impacts of banking operations

• capital markets

  • nitrating enviro risks into ER

mobilising branking pratcies

• credit & lending

  • extending green credit to key sectors

• savings

  • offering green products

• capital markets

  • raising capital thru equity placements & IPOs

  • raise capital thru debt market

green loan principles core components

1. use of proceeds

2. process for project evaluation dn selection

3. management of proceeds

4. reporting

EU green loans = ~4.5% of Toal loans

value based banking

3 dimensional looking at return ris and impact

money for projects with positive societal impact in

• economic resiliience

  • micro finance

• social empowerment

  • education/healthcare/scoail inclusion/special needs housing

• enviornetmtnal reugaltion

  • renewable energy

barriers to sustainable lending

1. account manager knowledge

2. status quo of client

3. mautorty of bank loans

   1. myopic bankers

incentives for sustianbe banking

• bans can choose to charge a higher rate for loans with ESG risk

• Nudging theory of change

  • applying a bee lending rate for projects with no ESG risk and risk premia to those with esg concerns

guiding principles for a positive financial transition

1. from financial to integrated value

   1. A first guiding principle is a financial institution’s measurement, targeting and reporting of integrated returns, rather than purely financial returns. This is embedded in a serious statement of purpose of what the institution’s value creation looks like and who it will benefit (linked to sustainability transition; SDGs). Effective systems are needed for transmitting information on social and environmental capital to and from corporates, citizens and governments. New mental models and new business school programmes will be based on integrated value creation;

2. stewardship based on a direct link between financiers and companies

   1. For banks, it will again include a stronger role for relationship banking. For asset managers and asset owners, it will likely include more concentrated ownership stakes, deeper engagement, and shorter investment chains. This second guiding principle enables a direct dialogue between financiers and companies on targeting integrated value (aligned with the SDGs) without intermediary actors;

3. capital allocation based on long-term social value

   1. . Quantified and accountable positive impact on ecological and social capital is obtained by financing sustainability transitions. The emerging nature-positive economy will be based on completely different financial logics of a circular, non-extractive and service and sharing-based economy. The market transitions in food, energy, production, mobility and so on need to be financed as well as they require a financial transition strategy.