EIB’s Hakan Lucius: “Agreeing on a common language about sustainable finance is key”

Headshot of sustainable finance expert Dr. Hakan Lucius, European Investment Bank's Head of Corporate Responsibility

Long before sustainability and sustainable finance were on, well, everyone’s minds, Hakan Lucius was pounding the drum for the world to pay attention.

Over his two decades in the field – and now in his current role as Head of Corporate Responsibility at the European Investment Bank (a new client of VitalBriefing’s services in Sustainable Finance), Dr. Lucius has amassed a stellar background as a leading authority in the field, structuring billions in investments, loans and equity for multinational teams negotiating sustainable initiatives with governments, businesses and civic organisations.

In this interview with VitalBriefing CEO David Schrieberg, he discusses the EIB’s role as a global sustainability leader and the challenges in a field that is catching fire at a time the world never needed it more.

What are the key criteria for distinguishing between genuine ESG, green or sustainable financial instruments or products and those whose promoters are seeking to jump on the bandwagon?

It is important to look behind the headlines, into the actual activities, standards and appraisal processes. The European Investment Bank (EIB) is the world’s largest multilateral lender.  Ensuring that sustainability is embedded in all our work means three things:

  1. A number of activities are excluded from EIB lending because they are incompatible with our sustainability objectives.
  2. All projects and investments have to comply with the EIB’s Environmental and Social Principles and Standards to incorporate environmental and social sustainability considerations into our investments.
  3. We perform a separate economic appraisal to assess the cost and benefits of our investment projects to society.

While embedding sustainability into our processes, we are also one of the biggest providers of climate finance. 

We have been Europe’s climate bank for a long time. 2015 was a milestone year in this field, when the EIB Climate Strategy was launched and EIB Climate Action finance had reached a record high of EUR 20.7 billion, representing 27% of overall EIB financing.

Now the EIB has decided to make a quantum leap in its ambition, becoming the EU climate bank. We will stop financing energy projects reliant on fossil fuels and we will increase our ambitions in climate action and environmental sustainability.

Our approach builds on three pillars: The first is to increase our own financing; we are aiming at 50% for climate and environmental sustainability by 2025.

The second pillar is a commitment to support €1 trillion of investment for climate action and environmental sustainability by working with our public and private partners in the decade to 2030.

The third pillar is to align all our activities with the principles and goals of the Paris Agreement starting by the end of this year.

This new ambition will help unlock the massive investments that will be needed for the decarbonisation of our economies. In this regard, the EIB is a central piece in the implementation of the European Green Deal to make Europe the first carbon-neutral continent by 2050.

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How big a problem do you believe greenwashing really is, as opposed to honest confusion or differences between conflicting sets of sustainability criteria?

We put sustainability at the heart of what we do. The ultimate goal of projects and investments financed by the EIB Group is to improve people’s lives by promoting sustainable and inclusive growth within the European Union and beyond. We focus on four priorities areas: innovation and skills, access to finance for smaller businesses, infrastructure and climate and environment.

Being a policy-driven Bank, the EIB appraises and monitors all the projects it finances with regard to their sustainability credentials. We only finance projects that pass our financial and sustainability due diligence.

Appraisal and monitoring ensure that projects comply with the stringent EIB Environmental and Social Standards based on the EU legal framework. In addition, we also measure and publish the carbon footprint of all projects with a significant impact.

On the borrowing side, sustainability plays a major role in our fundraising activities.Two debt products stand out for their very specific sustainability criteria: Climate Awareness Bonds (CABs) and Sustainability Awareness Bonds (SABs).

While CAB proceeds are allocated to projects contributing to climate change mitigation, proceeds from SABs are allocated to projects contributing to environmental and social sustainability objectives beyond climate.

We are subject to an external assurance and we have a methodology which is harmonised with all the multilateral development banks on what can be called green. We report on the allocation of proceeds, transparently listing amounts disbursed to individual investments.

Transparency is key.

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What kind of activities are ‘beyond the pale’ in terms of sustainability? What about fossil fuel energy producers or other carbon emitters investing to reduce their carbon footprint? How should one draw the line?

Firstly, I would like to highlight that we have a new Energy Lending Policy and we are stopping all financing for unabated fossil fuel projects. This means in the energy sector, lending for energy efficiency projects, renewable energy projects and for power distribution and interconnection.

A second aspect is the assessment of our projects. Our sustainability due diligence demonstrates how we ensure sustainability in carrying out our financing.

We support projects in sectors that make a significant contribution to growth, employment, regional cohesion and environmental sustainability in Europe and beyond.

The EIB can only support projects that (a) are eligible, (b) fulfil financial criteria, and (c) meet our separate sustainability due diligence.

— — —

Does the sustainable and responsible investment sector suffer from a lack of universally-recognised criteria and standards? Will the EU’s sustainable finance package fill the gap?

Agreeing on a common language about sustainable finance is key. The EU is taking the lead on defining the term, as well as the subsequent actions.

The EIB Group contributed to the EU Action Plan on Sustainable Finance, it helped develop an EU taxonomy for climate action and other environmentally sustainable economic activities.  It will provide specific technical screening criteria and determine which economic activities can qualify for each environmental objective.

Our contribution to the EU Taxonomy also includes the establishment of an EU Green Bond Standard. This technical work can bring about a significant increase of climate finance.

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Do you believe that refinancing of existing projects or programmes through instruments designated as green or sustainable meets the spirit as well as the letter of ESG investment?

The EIB finances only new projects and does not refinance. We provide funding and expertise for sound, sustainable investment projects in support of EU policy objectives.

We focus on four priority goals: innovation, environment, infrastructure and SMEs with two cross-cutting goals: climate action and cohesion. We support projects that make a significant contribution to growth, employment, regional cohesion and environmental sustainability.

The EIB cannot do it alone, we need private investments. The EIB’s fundamental role is to attract private investors to the projects it finances. This is why current work to make the financial system greener is so important and we are contributing to current initiatives to make this happen.

— — —

How does the EIB strike a balance between the goal to promote sustainability worldwide and the pressing financial and investment needs of loan recipient countries, for example in the exploitation of natural resources or employment/working conditions?

The EIB was created to support economic and social cohesion in Europe. We dedicate at least 30% of our financing in the EU to increase cohesion and this will also support the transition to a sustainable economy.

In the current situation, the EIB is finding solutions for COVID-19, but we should not reduce our commitment toward climate and environmental issues. It is important that one sustainability goal is not pursued at the expense of other goals.

Public financing institutions like the EIB must play a leading role in that regard, facilitating the flow of private capital into sustainable investments at the needed scale globally by supporting the creation of the necessary enabling environment and partnering with the private sector.

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There Are Too Many Shades Of Grey In Green Finance

There’s no escaping the growth of green finance. Every quarter charts new records for issuance of green bonds or investment in funds that describe themselves as sustainable or that follow an investment policy guided by considerations of environmental, social responsibility and governance.

Meanwhile institutional investors around the world are using their weight as providers of corporate financing to push companies toward greater respect for the environment and the welfare of employees in their own operations and in supply chains and, increasingly, to commit to reduce carbon emissions in measurable ways or set a date to achieve net zero status.

This trend is now a fact of life in the financial industry, not least because of the role of institutions in pressing companies and financial service providers to embrace environmental and other sustainability goals, as well as the determination of the EU to implement legislation to increase public accountability.

Here’s a telling data point: the proportion of global investors that apply ESG criteria to at least a quarter of their total investments has risen from 48% in 2017 to 75% last year, according to Deloitte.

Open questions about the ‘green’ in green finance

Yet, the significance of this green finance trend in changing corporate and financial behaviour is less easy to measure.

In fact, the size of the market and its different segments is open to wildly different estimates, both in terms of current levels and projections into the future.

And just how green or how sustainable some, or even most, of these investments or assets really are is an even more ‘known unknown’.

The problem is the absence of standardised, universally accepted definitions and rules setting out what constitutes sustainable or ESG investments, assets and projects — and similarly standardised mechanisms to measure compliance.

The EU’s Taxonomy Regulation, which seeks to define sustainable activities, should help to fill the gap, although it won’t be applicable until the beginning of 2022.

That’s why arguably ‘greenwashing’ — promoters awarding financial assets and products an environment-friendly or sustainable label they don’t warrant — is a lesser problem than the simple inability to determine what green (or sustainable) actually means.

The green bond market, which currently totals around €660 billion in outstanding debt, is forecast to rise to €1 trillion by the end of next year and €2 trillion two years later, according to the Netherlands’ NN Investment Partners.

However, it warns that only 85% of green bonds deserve the label; the rest are issued by companies that may be undertaking environment-friendly projects but whose practices in other areas breach environmental standards.

bar graph showing total number of new green bond issuers 2016-2019

Varying definitions of green finance

Take the investment funds numbers, for example.

Data provider Morningstar says European sustainable fund assets passed the milestone of $1 trillion during the third quarter, and global assets reached $1.26 trillion, while a record 166 new products were launched worldwide over the three months to the end of September, taking the total to 3,774 worldwide.

By contrast, the Global Sustainable Investment Alliance last year estimated that “some kind of environmental, social or governance analysis [in] investment decisions is now a factor” in $31 trillion of assets under management,

Meanwhile Optimas, a Boston-based capital markets consultancy, says the value of “global assets applying environmental, social and governance data to drive investment decisions” has almost doubled over four years, to $40.5 trillion this year. (By way of comparison, Boston Consulting Group estimates that the global asset management industry oversaw $89 trillion at the end of 2019.)

These numbers could conceivably all be correct, but it begs the question of what investments these very different totals include, how they are calculated, what constitutes the applicable sustainability or ESG principles, and how compliance with them is measured.

Misleading marketing

Some of the problems with the credibility of sustainable products are relatively easy to spot and have caught out major players like Fidelity Investments and State Street Global Advisors.

More broadly, the 2 Degrees Investing Initiative, a non-profit think-tank, has claimed that 85% of all “green-themed funds” have misleading marketing materials.

Together with the UN Principles for Responsible Investment network, the French-headquartered organisation has drawn up the Paris Agreement Capital Transition Assessment (PACTA), an online tool to measure the alignment of equity and fixed income portfolios with climate change scenarios. It says PACTA is used by more than 1,500 financial institutions worldwide, as well as by supervisors and central banks to assess the entities they oversee.

But it’s far from the only system in play and the credentials of providers aren’t always clear, notes Alessandro d’Eri, a senior policy officer at the European Securities and Markets Authority. “We have seen a boom in the number of..ESG rating and scoring providers, a largely unregulated area,” he says. “It is difficult for us to make sense of the scoring and rating if there is no clarity on the underlying methodology.”

Asset managers increasingly complain that some companies issuing green bonds are financing environment-friendly activities at the same time they’re involved or implicated in businesses whose impact is the contrary — like state-owned monopoly Saudi Electricity Company, which raised €1.3 billion from a green bond in September to install smart meters across its grid.

Constructive engagement

The Australian state of Queensland has issued bonds for initiatives including preserving the Great Barrier Reef, which is under threat from the impact of global warming, at the same time that it continues to promote expansion of its coal industry.

Others, like car manufacturers, are dressing up as green initiatives investment in production facilities for electric vehicles that they would be carrying out anyway. Still others are using green bonds to refinance investments they have already made.

Some equity investors in polluting companies or high carbon-emission industries justify their state on the grounds that it gives them the opportunity to engage with the businesses and encourage them to change their practices.

Maybe. But this, too, risks delivering an outcome that challenges quantification.

There’s no shortage of initiatives underway today to measure environmental and other sustainability factors to assist investment decision-making. The EU sustainable finance framework, which is well advanced, will progressively extend transparency requirements throughout the European financial industry, which could create the foundation for a standardised global rulebook.

Until then, though, when it comes to green finance, determining what is sustainable and what is not, what’s real and what’s greenwashing, is likely to remain as much art as science.

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Don’t miss LuxFLAG’s Sustainable Investment Week 2020

Banner ad for LuxFLAG Sustainable Investment Week 2020

As sustainable finance catches fire around the world, propelled in part by the social and economic needs created by the global Covid-19 pandemic — and as a central pillar, of VitalBriefing’s economic coverage — we are proud to be media sponsors of the upcoming LuxFLAG Sustainable Investment Week 2020, a follow-up to its successful debut conference last year.

Over five days, starting on October 12, distinguished speakers who are immersed and versed in the issues will present 21 digital events covering, among other topics, Climate Finance, ESG (Environment/Social/Governance), Impact Investing and Sustainable Development Goals — all topics that are central to our own work at VitalBriefing.

Unlike most other Luxembourg-based conferences, this one is free not only for professionals in the financial industry – who will hear experts discuss issues ranging from portfolio decarbonisation and preparing sustainable finance action plans for investment funds to measuring the impacts of social investments and understanding relevant European regulation – but also the general public.

LuxFLAG was founded in 2006 by seven public and private founding partners and whose charter members include VitalBriefing clients such as Luxembourg for Finance, the European Investment Bank, ALFI and the Luxembourg Ministry of the Environment, Climate and Sustainable Development. It has steadily grown in influence, recently granting 100 funds the right to use its label, raising the total of such investment products to 303, representing €128 billion in assets under management – and extending its reach to Denmark, Finland and Spain, in addition to Belgium, France, Germany, Italy, Ireland, the Netherlands and the Grand Duchy.

LuxFLAG awards its label to eligible investment vehicles in Climate Finance, ESG, Environment, Microfinance and Green bonds. The label must be renewed after one year, ensuring that the products maintain their validity as sustainability vehicles.

Don’t miss out! For more information and to register for the LuxFLAG Sustainable Investment Week 2020 conference, click here.

This Is Why We Need High-Quality News Sources

ball of generic newspapers with the word NEWS visible

Take a quick scan of online news and you might conclude that the internet has played an important role in democratising the spread of information.

Makes sense. There appear to be more news providers than ever, liberated by the near-zero cost of digital publishing.

No longer is the flow of news restricted by the time, trouble and, above all, cost of printing and distributing news content to readers.

Instead, the process of publishing news is reduced mainly to its essentials: gathering, selecting and collating.

Certainly the proliferation of information sources complicates our task at VitalBriefing of searching, curating and summarising relevant news to distribute to our clients. The volume of online information relating to a particular topic or issue has exploded massively in recent decades. As such, it significantly increases the importance of our role in assessing and selecting the sources we use to find the news our clients need.

Yet, what we’ve found is that even as the number of news sources rises each year — and in a multitude of languages — the proportion of those that are high-quality and reliable is diminishing. And not only as a proportion of the overall information flow, but in absolute terms.

In short, as quantity is swelling, quality is waning.

Shrinking pool of experience

There’s no secret behind this. Gathering news in a serious way is an expensive business. Across Europe and other parts of the world, the number of news organisations with the resources to provide comprehensive coverage of current affairs at a national and international level is shrinking.

The erosion of newspapers’ advertising base (not to mention those of TV and radio stations) by competition from internet platforms has undermined their ability to employ journalists and editors of the highest quality.

Experience is a particularly expensive quality, and many news organisations find they cannot afford much, if any, or at least not as much as in the past. And many news businesses have struggled to really understand the internet, its business models, audience behaviour — and to compete successfully for revenues there.

An aspect of the shrinking of breadth and depth in the news business long predates the internet. Until some 20 years ago, many newspapers employed teams of foreign correspondents, bringing their readers first-hand accounts of international news.

Starting in the 1970s and accelerating, however, their numbers have steadily been shrinking as media instead turn to news agencies such as Reuters, the Associated Press, dpa and Agence France-Presse.

The wire services strive to provide a good service but they are not immune to budgetary headwinds. This has an impact on the number, experience and expertise of the journalists they employ, and even more the editors who act as gatekeepers of the quality of their work.

Over the past couple of decades, I have seen numerous examples of how these constraints are eroding quality and accuracy.

When information matters

It doesn’t help that news information as a commodity is significantly less valuable than financial data — which is important, but to large segments of the public, even among decision-makers in business and politics, often means little without expert and cogent analysis.

Not that financial and business news are exempt from the overall trend toward erosion of expertise and quality. Quite the contrary: Many more lucrative activities can be performed with a sound knowledge of finance, economics and business than to write about it.

That shows in the output. The result is a diminishing pool of capability and understanding in areas in which it matters greatly.

I see too many young journalists trying to deal with complex topics for which they lack sufficient grounding. I should know — I was one of them. But I was fortunate to benefit from the guidance of mentors and editors who taught me over the years. I fear there are far fewer such influences around today. As noted, they’re expensive.

And the quality of coverage is all the poorer for it.

Original content and press releases

In the absence of sufficient journalistic expertise to create valuable original content, the void is filled by official information and press releases.

True, thanks to Google and its peers it’s so much easier today to seek out information online than by making phone calls or, perish the thought, visiting libraries. But scraping data from companies’ websites is no substitute for critical analysis and asking difficult questions.

The notion of press releases takes us full circle to the issue of the proliferation of what appear to be online news sources. A substantial proportion of the information found online is simply that — recycled press releases begging for clicks that bring revenue from advertisers.

Yes, it’s information of a sort. But journalism it isn’t.

So you’re thrown back to a diminishing circle of news organisations that still remain dedicated to reporting and analysis that enhances the knowledge and understanding of its audience. In many cases they support themselves through subscription plans that inevitably restrict the availability of that high-quality information.

Some, bravely, are trying to avoid this fate. I’m thinking of outlets such as the left-of-centre UK newspaper The Guardian, which asks readers to donate what they can, or The Washington Post, that found a high-rolling saviour in the form of Jeff Bezos.

Why quality matters

If you ever doubt the value of high-quality news sources, consider the more than five years spent by the Financial Times (full disclosure: I have worked for the FT from time to time over many years) investigating the credibility of the financial statements of Germany’s fintech stock market darling of the 2010s, payment processor Wirecard.

For years, the newspaper’s journalists kept nagging away at inconsistencies and discrepancies in Wirecard’s accounts that pretty much wholly escaped the company’s regulators. Wirecard dismissed the FT’s reporting as lies encouraged by the company’s rivals and short-sellers — right up until June 18 this year, when it acknowledged that €1.9 billion on its balance sheet was non-existent and it collapsed into bankruptcy.

As an illustration of what makes high-quality news sources valuable amid so much online noise, it’s hard to improve on that.

Private Equity In The Covid-19 World: Hero Or Villain?

Covid-19 impacts economies across the globe

The private equity industry has long struggled to overcome a public reputation for maximising profit and jeopardising healthy businesses by loading them with unsupportable debt and charges. In light of the new world we live in, can the sector restore its image by helping to relaunch economies after the Covid-19 pandemic?

Over the past two decades the private equity sector has evolved from a marginal and mostly obscure corner of the investment industry into a core element of the financial system.

Now the Covid-19 pandemic and its aftermath poses unique challenges for private equity firms and their investors living in a world where company valuations are fluid and volatile, creditworthiness is cloudy and governments seem set to play a far more prominent role in economic management than at any time this century.

In terms of financial heft, private equity should be well placed for a leading more in economic recovery. Worldwide, the industry is flush with cash — or at least commitments.

Private equity funds have a record $2.5 trillion available in ‘dry powder,’ money pledged by investors that firms have not yet drawn down.

The environment promises to be welcoming for firms with money to spend, especially those specialising in distressed debt, of which there is plenty expected to emerge over the coming months and years, or those seeking to build industry-leading portfolio companies through bolt-on acquisitions that add scale.

Alternative to turbulent public markets

True, the market environment for private equity investment was looking less favourable before the pandemic emerged and lockdowns began. The huge pile of dry powder reflects in part an increasing shortage of suitable investment targets, which had been pushing up prices.

But private equity, along with other types of more complex and longer-term investment, looks more attractive to institutional investors than turbulent public equity markets, cash earning next to nothing in interest and bond markets yoked to the imperatives of central bank monetary easing strategies.

Not to mention the clouds gathering over that staple of institutional investment portfolios, commercial real estate.

However, private equity has its own hurdles to overcome to position itself as a saviour of struggling companies and stuttering economies.

First and foremost? A wretched public image, fuelled by both misunderstanding of what private equity is and does and by the industry’s frequent tone-deafness to wider concerns of society.

Private equity’s opaqueness, complexity and lack of public accountability is often placed in contrast with the (supposed) transparency of companies listed on public markets.

Critics such as Sheila Smith, a former senior economist at the UN Development Programme, describes the sector as “termite capitalism”, targeting a business model characterised by reliance on borrowed money rather than investors’ capital, asset stripping and job destruction, opaque fee structures, unsustainable extraction of returns through dividends funds by further borrowing and use of debt and offshore structures to reduce, often to zero, tax liabilities in the companies in which portfolio companies operate.

Investing for the long term?

In vain do private equity companies protest that their business involves not wanton extraction of assets but the creation of value through the restructuring and re-energising of struggling, directionless companies, the empowering of capable managers and the incentivisation of employees, and that they focus on companies’ long-term development, not just the next quarter’s bottom line.

Because it’s such an emotive phrase, they don’t like to speak of ‘creative destruction.’

But that’s a key driver of the private equity model: stripping away dead-end jobs and businesses and replacing them with new ones that are more productive and have a long-term future.

Some of the criticism is certainly unfair. The obsession with the offshore tax haven structures of private equity (and other alternative investment firms) tends to ignore the key classes of institutional investor that are non-taxpayers, such as university endowments and charitable organisations.

Rather than a pure creature of plutocratic vampire capitalists, the private equity industry is driven principally by the needs of their investors: pension funds to meet their commitments to retirees and insurance companies to meet policy-holder claims.

It’s against this unfavourable reputational backdrop that the private equity sector must face the challenges of the post-pandemic world.

What will it look like?

Swings and roundabouts

In the short to medium term, the industry is suffering similar hits to revenue and profit as other businesses. Antoine Drean, founder of private equity placement agency Palico and consultancy Triago, expects profit-sharing – carried interest – on above-benchmark returns to dry up, especially for firms with heavy exposure to the most vulnerable areas of the economy, such as the hospitality, travel and energy sectors.

Hugh MacArthur, Graham Elton and Brenda Rainey of consultancy Bain & Company argue that dealmaking is set for a slump while firms focus on the health of existing portfolio companies and bank lending to the sector is likely to be significantly constrained and subject to significantly tighter conditions (although this is likely to be offset by the sheer volume of dry powder and likely lower valuations of acquisition targets).

They say private lenders, a significant force in the market since the global financial crisis, should also help fill the gap while the need to exit mature portfolio companies in order to provide returns to investors will also spur deal flow.

The Bain & Co. partners also warn that some investors may find themselves financially squeezed if calls on existing capital commitments exceed private equity distributions.

This points to a reduction in fundraising, at least temporarily, after a decade of soaring inflows from investors looking to private equity’s historically higher levels of return to offset the impact of interest rates at rock-bottom or worse.

While the industry’s overall levels of return are likely to take a quick hit from lower valuations on existing investments, especially those made near the peak of the market, the recessionary environment should yield more profitable opportunities.

Private equity and Covid-19: Core role in institutional portfolios

Can we expect a better reputation for private equity in the months and years after Covid-19? There’s no guarantee that public perceptions will change radically in the near future.

Since the onset of the pandemic, the sector has drawn fire from politicians and others over the insolvency of venerable names of American retailing such as Neiman Marcus and J. Crew, although the critics tend to ignore that the businesses have been deteriorating for years in the face of changing consumer habits and growing internet competition.

However, with near-zero interest rates apparently locked in for years to come, barring an upsurge in inflation that stubbornly refused to materialise despite a decade of loose monetary policy, the core position of private equity in institutional asset portfolios seems more likely to strengthen than to diminish.

In a world where job preservation is now a central economic policy objective, private equity firms will also be under pressure to avoid wholesale layoffs and business closures.

They and their investors likely will have more skin in the game as the peaks of bank leverage of recent years recede and the days of egregious debt-driven dividend recapitalisations are probably mostly over for the foreseeable future. If private equity can claim to be playing a role in saving viable companies and jobs, it may become less of a bogeyman for critics of capitalism.

But it shouldn’t count on being better loved.

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From the 2008 Financial Crisis to Coronavirus Recession: Are the Banks Safe This Time?

It took massive public-sector bailouts financed by unprecedented levels of borrowing to reverse the global financial crisis of 2008-09 brought on by rash lending and investment policies of banks in the United States and elsewhere. With the world on the brink of a coronavirus-triggered recession, how is it different this time?

“In 2008, the banks were to blame for the crisis, but the real economy was not in crisis,” CSSF CEO Claude Marx observed recently. “Now we are in the reverse situation, where a health crisis is causing an economic crisis, and…the banks are part of the solution.”

In fact, the abrupt cutback of bank lending in 2008 and 2009 contributed to the plummet of most countries’ economies into recession.

However, Marx notes, the confidence enjoyed by the banking sector is a critical aspect of governments’ response to the current coronavirus pandemic. One reason: new rules designed to ensure that institutions are substantially better capitalised than 12 years ago, as well as guarantee schemes expanded to protect retail deposits.

Imprudent parents

Increased transparency affecting both regulators and investors, as well as tools such as stress tests, have been established to prevent both a ‘business-as-usual’ mentality and disregard of the lessons of the century’s first decade.

In the grand duchy in particular, cautious business practices are a well-engrained habit already. For that, we can credit the two Luxembourg institutions that required state rescue: Dexia BIL and Fortis Banque Luxembourg, both brought down by the imprudence of their parents abroad.

For the most part, privately-owned commercial banks have played the key role in channelling government funding into loans and guarantees to preserve businesses and jobs.

But Marx acknowledges that the risk of a recession brought on by the coronavirus cannot be ruled out altogether.

If the economic shutdown prompts widespread bankruptcies and defaults on the share of government-backed loans where the risk is retained by commercial institutions, as well as on previous lending, we may be headed again for trouble.

Because of the banks’ capital strength, and in several cases deep-pocketed shareholders, the risk of a coronavirus-based recession affecting Luxembourg is lower than in most other countries.

But policymakers worldwide must consider seriously the risk as the confidence of a rapid rebound that was widespread just months ago — remember the famous V-shaped recession and recovery? — has begun to fade.

Today, economists are illustrating the recovery with hockey stick charts more like Nike’s trademark swoosh logo.

Risk of losses

Federal Reserve chairman Jerome Powell has argued that US economic activity could contract temporarily by as much as 30% and that a full-scale recovery may be delayed until the end of 2021. He says it depends on people regaining confidence that their risk of illness is low, which in turn may rest on the widespread availability of a Covid-19 vaccine.

He expects unemployment to continue to climb for at least another couple of months before a rebound begins in the second half of this year.

Already, the Fed has warned in its semi-annual report on financial stability that US banks are at risk of material losses that could strain even their post-financial crisis capital and liquidity buffers, as well as the billions of dollars they have set aside in provisions for potential non-performing loans.

Any renewal of volatility in financial markets could create additional financial stress if asset prices fall, it adds.

There is also concern in France’s banking sector about the longer-term implications of the government’s credit guarantees. Industry members warn that a significant number of companies taking government-backed loans could be heading for a debt crunch over the next next years — perhaps as early as this summer — given that their profitability is likely to remain depressed for some lime.

Encouraged by the European Central Bank’s ultra-low interest rates, companies have been loading up on debt in the form of bank loans and bond issues for years.

“The risk is that by putting French companies that were already not in good health on life support, we could be adding a financial crisis to today’s consumption crisis, perhaps in a year, when companies are no longer able to refinance themselves and banks may be closing the credit taps,” worries Pierre-Arnoux Mayoly, a partner with law firm McDermott Will & Emery.

Apart from general concern about businesses, especially small ones, and households whose financial equilibrium may have been eroded by loss of income since March, policymakers are closely examining companies in particularly vulnerable sectors, along with those that were already heavily indebted before the pandemic took hold.

Potential problem areas that were already causing concern before the pandemic include highly-leveraged hedge funds disproportionately affected by market volatility and asset price declines.

They also may have contributed to the turbulence by having to sell assets to meet margin calls or reduce portfolio risk. A year ago 14% of US hedge funds accounted for half the industry’s net borrowing.

Leveraged but not covenanted

Red flags are also waving over so-called leveraged loans — lending to companies that were already highly indebted, typically with debt exceeding five times their earnings before interest, tax, depreciation and amortisation (ebitda).

These include a significant number of private-equity-owned companies burdened with debt from their acquisition cost or from special dividends paid to investors — paid not out of profit but additional borrowing.

Analysts say the two high-profile, private equity-owned US retailers, J. Crew and Neiman Marcus, that have filed for bankruptcy over the last two months were crippled by debt burdens — $1.7 billion and nearly $5 billion respectively — that prevented them investing to meet the challenge of e-commerce and new shopping habits.

The sector’s problems aren’t purely coronavirus-recession-related. Indeed, they have been worsened by the steady erosion over the past seven years of loan conditions imposed by banks, especially for leveraged loans and private equity-backed companies.

This trend has developed over the past decade amid rock-bottom interest rates that prompted lenders to compete for the business of more lucrative but riskier borrowers.

According to Moody’s, syndicated leveraged loan covenant quality set a decade-long low in the fourth quarter of 2019, with the majority of credit agreements permitting, for example, collateral-stripping asset transfers, the retention by owners of excess cash flow of the proceeds of asset sales, and substantial ebitda adjustments.

Easing capital rules to avoid a coronavirus downturn

Meanwhile, central banks and regulators have been accommodating with banks in the interests of keeping loans flowing into the economy, allowing institutions to draw on capital buffers introduced since the global financial crisis and to delay for a year compliance with new Basel III capital standards, measures designed to prevent a repeat of the banking sector’s problems in 2007-09.

The European Parliament is considering legislation that would ease stricter bank leverage ratio requirements due to take effect next year.

In addition to a one-year delay, the European Banking Federation also is backing an existing measure that would allow national regulators to exclude deposits held at the European Central Bank from their balance sheet total for the purposes of calculating the ratio.

Some governments want to go further. France’s finance ministry says the government-guaranteed loans issued by banks should receive the same treatment. There are even calls for the state debt on banks’ books to be excluded from leverage ratio calculations, a measure already temporarily in place in the US.

So while the banking industry may be confident right now that this time it is not the problem but the solution, a little caution is appropriate — the potential of a coronavirus recession is very real.

Neither the Covid-19 pandemic nor its economic consequences are close to being fully played out, and not even the most prescient expert can predict with assurance where all the chips are going to fall — or when.

You might also be interested in: Coronavirus’s Impact On Sustainability – What To Expect

Europe uses sustainable finance initiative to curb climate change

Europe is using its Sustainable Finance Initiative to fight climate change. But will it work? VitalBriefing Editor-in-Chief Simon Gray shares his expert insights on the matter.

With much fanfare, the new European Commission president, Ursula von der Leyen, has unveiled the continent’s “man on the Moon moment”: Europe’s Green Deal plan to to achieve carbon neutrality by 2050.

True, details of just how the EU plans to meet this challenging target will be revealed only in June. And Poland, where 80% of the electricity comes from coal, is holding back on committing to carbon neutrality until the EU earmarks more financial assistance to ease its transition.

Crucially, though, as the Trump administration sneers publicly at climate science, the EU is now formally on board for taking a global lead.

The Commission declared that to become the world’s first climate-neutral continent is “the greatest challenge and opportunity of our times”.

Its plan, announced in mid-December, includes investment in green technology, sustainable solutions and the creation of new businesses, acting as a catalyst for economic growth through a transition that’s “just and socially fair …[and] designed … to leave no individual or region behind”.

Immediate impact

Arguably, though, a less high-profile decision earlier that month may have a more immediate impact on carbon emissions and the environment.

On December 5, EU finance ministers and representatives of the European Parliament reached agreement in principle on the “taxonomy” of the Commission’s sustainable finance initiative: a common set of rules governing how to determine which activities can and cannot be counted as green investments.

The finance ministers’ accord still must be formally endorsed by EU leaders. But the road now appears clear for the full sustainable finance package to become EU law – and it could start influencing corporate behaviour in Europe and beyond well before the European Green Deal takes effect.

The Commission’s initiative features three elements, two of which were endorsed last year by the European Parliament and member states.

The first would require institutional investors and asset managers to reveal how they integrate — or fail to integrate — environmental, social and governance criteria into their risk management processes.

Green benchmarks

A second measure would amend the EU Benchmark Regulation by creating  a new category of standards comprising low-carbon and positive carbon impact measures to provide investors with better information on the carbon footprint of their investments.

The Commission also has proposed changes to subsidiary legislation to MiFID II and the Insurance Distribution Directive that would incorporate ESG criteria into the advice that investment firms and insurance distributors must offer individual clients.

But taxonomy has always been the most critical element. The biggest issue in sustainable or green finance is how exactly it’s defined. Critics argue credibly that the lack of standard definitions has led to an epidemic of ‘greenwashing’ – investment firms and other businesses spouting green principles without adopting meaningful changes to their energy use, carbon emission or waste practices.

Universal classification

The proposed taxonomy regulation would set the conditions and framework for a unified classification system that defines an environmentally-sustainable economic activity.

But it hasn’t been without dispute and controversy — which explains the delay in approval from EU member states.

Most notably, France sought to have nuclear power deemed a low-carbon source of energy. But Paris appears to have admitted defeat in the face of vehement opposition from Austria, Germany, Luxembourg and the European Parliament.

However, the finance ministers agreed to a “do no harm” provision expected to exclude nuclear power when detailed rules are drafted.

The deal would create three categories for sustainable investments: “green”, “enabling” and “transition”, obliging companies with more than 500 employees to reveal the extent to which their activities fit these categories.

Cost of capital

How will all this affect businesses? By intensifying pressure on fund managers and institutional investors such as insurance companies and pension funds to focus their investments on companies that meet the Commission’s criteria — and to withhold their money from businesses that can’t or won’t do so.

So, expect the cost of capital for fossil fuel-oriented companies to rise, affecting their profitably and undermining their ability to compete with rivals that embrace renewable energy.

Yes, there’s already plenty of activity in the green investment sphere. But the lack of common standards has proved a major drawback. With the possibility that EU standards become widely adopted around the world, the Commission’s taxonomy could become the gold standard that, at last, vaults the green economy to global acceptance.

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How the EU’s green finance ambitions could revolutionise fund management

The European Commission will soon launch ambitious plans that would position the EU as a global leader in the reduction of carbon emissions and the transition to a more sustainable economy that can contribute to curbing climate change. On behalf of our client, KNEIP, VitalBriefing looks at how Europe’s green finance goals could be a gamechanger for the fund management industry.

Click here to read How the EU’s green finance ambitions could revolutionise fund management.


Monetary and Fiscal Policy Divide North and South Europe

VitalBriefing Editor-in-Chief Simon Gray discusses the worrying current state of monetary and fiscal policy in Europe.

Countries in the north and south of the continent are divided in opinion as to what they believe the role of monetary policy should be in stimulating the economy. Moreover, consensus cannot be reached regarding the fiscal rules governing participation in the euro, Europe’s single currency.

With both sides of the debate entrenched in their positions, US banks have been able to dominate global finance and even steal investment banking business from their European counterparts.

With the global economy facing a possible recession, how will Europe solve this inter-continental discord?

Read the full article on Toolbox.com.

Tackling cyber crime: Shared threat needs shared response

Cyber security has become a major worry for the banking sector. The digital nature of business has been accompanied by evolving risk dynamics that call for constant reassessment. Meanwhile, it’s easier for cyber criminals to mount attacks, endangering individuals and organisations of all kinds and sizes.

Due to the complexity of this segment, financial institutions must take measures necessary to protect themselves and their clients. ING, a client of VitalBriefing, has been laser-focused on the threat. To show its valued customers just how seriously it takestheir cybersecurity, the bank asked VitalBriefing to create a suite of articles on the subject. Click here to read one of them: Tackling cyber crime – A shared threat needs a shared response.