Banks Pitching SRT Deals Find ESG Is Fast Route to Investors

(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.

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.

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.

Banks can claim an SRT has ESG characteristics either by transferring risk from a portfolio of ESG loans, or by pledging to allocate the freed-up capital to green or social projects. A third option is to tie pricing to ESG criteria.

Lenders that have embraced such deals include Deutsche Bank AG, which earlier this year teamed up with the European Investment Bank to transfer risk on a portfolio of green mortgages. Societe Generale SA has described its SRT program as being “completely embedded” in its wider approach to ESG. And BNP Paribas SA, which has consistently underwritten more green bonds than any other bank, has this year expanded a loan portfolio tied to an SRT. 

European banks lead their US counterparts in the market for SRTs, and currently account for roughly 70% of this year’s global issuance, Chorus Capital Management estimates. The rapid growth has led some to voice concern.

Pacific Investment Management Co. lists SRTs among areas of asset-based finance that investors should approach with care, “given significant capital formation or hidden risks that have yet to be tested.” And earlier this month, the European Central Bank, which is generally supportive of SRTs, sought information from banks doing such transfers amid signs that some investors are getting bank loans to buy the instruments. 

Because the SRT market is opaque, it can also be hard to confirm ESG claims. IACPM hasn’t set its own definition of what constitutes an ESG SRT, Leung said. Instead, the association uses definitions provided by banks in each deal, as “these are primarily bilateral or small-club transactions,” he said.

For investors relying on standardized ESG labels, that may pose some problems.

“It’s certainly something that a lot of people talk about, certainly relative to regulators,” Leung said. “Lots of people complain that there are no standards and that’s a difficulty.”

Meanwhile, the European Commission is reviewing the bloc’s rules on securitization — a process that will include SRTs — with a view to finding more ways to help fund the green economy. 

“Banks are capital constrained,” Leung said. “If one of the goals is to help them lend more to the real economy, they need tools to reuse and recycle capital.”

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