(Bloomberg) -- While ESG is an increasingly hard sell in many markets these days, it’s gaining ground in one of the hottest corners of structured finance.
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Significant risk transfers, which are used by banks to get capital relief, are increasingly being marketed as ESG, according to the International Association of Credit Portfolio Managers.
After roughly doubling to 11% in 2023, the share of SRTs labeled ESG (environmental, social, governance) may have reached a new high this year, according to Som-Lok Leung, executive director at the IACPM. In the six previous years through 2021, the average had been just 3.4%, according to the association’s data.
The development belies the heated rhetoric around the role of environmental and social factors in financial decisions.
Policymakers in the EU, the largest market for SRTs, have pledged to roll back some ESG reporting requirements amid complaints that competitiveness is being hit, while in the US, Republican lawmakers are accusing the financial industry of forming a “climate cartel.” Despite the challenges, lenders are doing SRT deals to free up capital and are applying an ESG label because investors are asking for it, Leung said.
Banks’ primary goal in arranging SRTs is “to manage regulatory capital and-or risk” and they’re also increasingly responding to the fact that “sustainability is an important criterion for many investors,” Leung said in an interview. The IACPM expects to publish its latest figures for 2024 in the coming months.
Banks use SRTs to offload tranches of credit risk from a given loan portfolio. They transfer the first loss hazard to hedge funds or pensions managers who are often paid double-digit fees for taking on the risk. Doing so allows banks to free up capital with which to make more loans. The majority are called “synthetic” since the loans remain on the banks’ balance sheets.
As a broad asset class, SRTs have grown more than 30% this year, representing a record $1 trillion of underlying loans as of October, according to Chorus Capital Management. Of that, outstanding SRT contracts now cover roughly $70 billion of portfolio risk, the data show.
S&P Global Ratings wrote in a note last week that more banks may turn to SRTs with the Jan. 1 implementation of new global capital requirements.
Interest in adding an ESG theme to such transfers has been rising despite the label’s status as something of a punching bag. In the US, the Republican Party has sought to impose sweeping bans on ESG, which it derides as a “woke” perversion of capitalism that ignores traditional fiduciary goals. Donald Trump’s Nov. 5 election win already appears to have emboldened the party to mount more attacks.