The International Capital Markets Association (ICMA’s) European Repo and Collateral Council (ERCC) has released a summary report on the role of repo in green and sustainable finance.
This publishes preliminary findings of an ICMA consultation process, which was launched on 22 April 2021 with the release of an ICMA consultation paper and extended until 4 June 2021.
The trade association intends that this should serve as a starting point for promoting broader debate in the repo community around sustainability issues and steps to explore existing opportunities and potential risks in this area.
The paper examined three potential areas of intersection between the repo market and sustainable finance objectives: repo with green and sustainable collateral; repo with green and sustainable cash proceeds; and repo between green and sustainable counterparties.
The summary report is based on 20 responses submitted during the consultation period, representing the views of 18 firms. However, the ICMA says that discussion on the topic is ongoing and further feedback on these questions is still welcome.
Asked which of the three intersections between repo and sustainability (outlined above) are most relevant to respondent firms, 62 per cent said that ‘green collateral repo’ is most relevant to them and “that it is the most straightforward concept to implement”.
Asked whether there are other possible intersections between the repo market and sustainable finance that are not addressed in the paper, four respondents highlighted the idea of sustainability-linked repo, where counterparties need to fulfil certain environmental social and governance (ESG) key performance indicators (KPIs) or sustainability performance targets to access cheaper cash (ie pay lower interest).
Other respondents highlighted the use of other green, social, sustainability and sustainability-linked debt instruments (GSSS) beyond bonds, including loans, trade finance and letters of credit.
The consultation process identified potential demand for green collateral swaps, where one party receives high-rated liquid non-GSSS collateral and transfers GSSS collateral to the counterparty for a fee.
Respondents also identified value in creating mixed collateral baskets or pools, which may be a mix of different underlying GSSS collateral, or a basket of GSSS collateral mixed with a small amount of non-GSSS collateral.
Reflecting on where they identified greatest potential risks to their firms linked to a green and sustainable repo market, 59 per cent of respondents identified ‘greenwashing’ as being their top concern.
Specifically, they associated greenwashing with the risks associated with incorrect classification of products as ‘green’ investment, or ‘double counting’ of green collateral repo, where no additional green assets are created through the transaction and no additional funding goes into green activities but both counterparties claim the green collateral as a commitment to green investment.
Responding to this point, a number of respondents underlined the importance of maintaining a clear methodology to ensure that green investments are only counted once. For example, they should only be considered for the sustainability metrics of one of the parties to the repo transaction.
Beyond greenwashing, respondents highlighted the need for clear procedures to ensure that collateral eligibility criteria are applied throughout the lifecycle of the repo transaction — and that the ESG quality of collateral is not compromised through collateral substitution that replaces ‘green’ assets by ‘brown’ assets for example.
Other respondents indicated that collateral quality is a potential risk as “green does not necessarily mean better credit”.
In providing guidance on what the ICMA’s role should be in developing a green and sustainable repo market, the most-popular response was that the association should provide clear definitions and standardised approaches for different types of ‘green repo’, potentially through a specific framework similar to the ICMA’s Green and Social Bond Principles.
The consultation also indicated that the ICMA should continue with its regulatory engagement in developing the foundations for a green repo market, as well as encouraging debate and working with other trade associations and market bodies.
