By Bryony Collins, BloombergNEF. This article first appeared on the Bloomberg Terminal.
Natixis SA has started to incorporate climate risk into its credit decision-making process, with deals deemed to have a negative environmental impact required to be more profitable than so-called ‘green’ deals.In the “most extreme” cases, a deal might not be struck at all if the adjusted profitability doesn’t add up, said Orith Azoulay, global head of the Natixis CIB green and sustainable hub, in an interview with BloombergNEF.The Paris-based investment bank is working to improve progressively the environmental impact of its balance sheet by applying a color rating to each deal that it does with every sector worldwide, apart from the financial sector.
For deals ranked dark green, such as debt-financing an offshore wind project, the bank will reduce the risk-weighted assets (RWAs) placed against the deal by 50%, whereas for deals rated dark brown, the RWA will be increased by 24%, said Azoulay. “A brown deal will need to be much more profitable, to counteract the RWA-increase that was placed against it” as a result of its lower environmental performance, she added.
Natixis started to use the methodology in late-September “as one of the components of credit decision” for every transaction, with the ultimate aim of “altering the color mix” of its activity so that more of its balance sheet is classified as green.
After using the methodology for one year, Natixis plans to set targets in line with the Paris Agreement to increase the proportion of its balance sheet dedicated to environmentally positive lending activity.
Read the Q&A below.
Q: How does it change Natixis’s financing approach to reduce the risk weighting for green deals and to increase the risk weighting for deals seen to have a negative environmental impact?
A: The objective of this mechanism is to measure, monitor and steer the progressive greening of our balance sheet and activity. The Green Weighting Factor (GWF) is an internal mechanism that links analytical capital allocation to the degree of sustainability of each financing.
The idea is to develop a green- and brown-adjusted vision of all the deals we do, as one of the components of the credit decision.
Every deal that we do with all sectors worldwide, apart from the financial sector, will have to be color-rated, on a seven-level scale from dark brown to dark green.
This means applying the methodology we’ve designed to evaluate the climate impact of our deals, and adjusting it through the other material environmental externalities, ahead of a credit decision.
That color will translate into an adjustment mechanism for our risk-weighted assets (RWAs), which leads to an adjusted return-on-equity vision.
Q: Will this mean that you will divest from some brown-weighted assets?
A: It’s less about drastically ceasing to finance some industries than it is about progressively transitioning our mix of activities by incentivizing green business origination, including by helping the transition of our clients active in carbon-intensive sectors. It is also about incorporating climate transition risk in the assessment of financing opportunities.
Whenever we lend 100 euros, there is a risk-weighted amount of capital with which we back the loan, and it’s usually based on the maturity, credit rating and a number of other parameters that dictate how much capital we need to put aside. We are now adding environmental performance as another parameter for that. The capital placed against each of our loans is a measure of how much capital each of the deals will consume. If you increase the allocated capital to a given deal, it means that you change the expected return-on-equity (ROE) for a given deal.
So a brown deal will need to be much more profitable, to counteract the RWA increase that was placed against it [as a result of its lower environmental performance].
Q: So Natixis is allocating less risk-capital to deals deemed as green, and more to those deemed as brown?
A: Exactly. When a deal is rated dark green, the RWA associated with the deal will be reduced by 50%, whereas when a deal is dark brown, the RWA will be increased by 24%.
Q: So, greener deals will have a higher analytical return-on-equity and you will be more likely to sway toward doing those deals?
Q: Could you give an example of a ‘green-weighted’ deal?
A: Firstly, there are three shades of green and three shades of brown. We’ve divided our universe of loans into two parts – those we call ‘dedicated purpose loans’ – meaning that we know what we’re funding (asset / project financing), and ‘general purpose funding’ – where we are financing the general corporate use of a company.
The evaluation starts with a color rating reflecting the absolute climate impact of the specific sector, and that gets adjusted according to the specifics of the actual asset, such as location, technology choices, impact mitigation and other material environmental externalities.
For example, wind deals tend to range in the green colors, but an offshore wind project could be ranked lighter or darker, according to its impact on biodiversity, or the energy mix / carbon intensity of the country or some specific features of the project (such as grid integration or intermittency offsets).
Also, under GWF methodology, gas-fired power generation final scores range from medium brown to medium green depending on the technology’s greenhouse-gas intensity, whether it supports renewable integration, or whether it is equipped with carbon capture sequestration technologies.
Q: How do you assess companies when ranking by your green-weighting factor?
A: For general purpose deals, a color rating is attributed to each client. It is based on carbon intensity (scope 1 to 3, and avoided emissions) as well as a forward-looking evaluation of the company’s climate strategy. We also integrate a range of environmental externalities, such as pollution, water, waste and biodiversity where relevant.
Q: Does Natixis aim to increase the proportion of its balance sheet classified as green in nominal exposure terms?
A: Yes, the ultimate aim of the process is to alter the overall color mix of what we are doing.
Q: Have you set a target yet for how much you’d like to increase it to, by which date?
A: Not yet. We’re giving ourselves one year of using this mechanism to define the targets, with the aim to align overtime with the Paris Agreement. From now on, whenever a deal goes to the credit decision committees, it will have been color-rated and matched with the adjusted RWA and adjusted ROE.
Q: Is it more likely now that, for brown-weighted assets, the Natixis credit decision party turns down some of those assets and favors green-weighted ones?
A: That could be the case for the most extreme and least profitable ones, yes. The mechanism is not a sector policy excluding some sectors, but about progressively shifting our mix of financing, according to environmental impact. In some instances, it could lead to not doing a specific deal because of its adjusted profitability levels.
Last week, the mechanism was embedded in all of our credit processes and IT systems, so we are now able to use the mechanism on all new transactions to make credit decisions.
Q: Do you intend to spread this further to widen the impact?
A: We’ve announced our intention to share this with the market. It has already raised some interest, including from regulators. One of the original drivers of launching this internal tool was about anticipating what we expect the regulators to take action on. All banks are looking or will need to look into how to evaluate the environmental impacts, positive and negative, of their lending activity. We are convinced that this is a sector trend.