Hedge fund veteran Andrew Hohns, Investment manager at Newmarket Capital, is proposing a novel securitisation strategy to banks aimed at cutting their balance sheet foot print through innovative financial transfers, Bloomberg reported on Sunday.
Banks are familiar with offloading credit risk to investment funds for better returns and more business flexibility. Newmarket is proposing a comparable scheme for banks to also shift the carbon emission risks tied to their financing activities, particularly relevant for banks heavily invested in fossil fuels.
The concept involves banks transferring both credit and emissions risks to external investors, which is a novel approach in the financial industry. This method is part of a broader trend toward creating innovative financial products to address climate-related risks.
However, it is still in the experimental phase due to challenges in valuing emissions risks and the lack of regulatory guidelines.
Regulatory-driven green finance reshaping succinctly describes the increasing pressure on European banks by regulators to integrate environmental and social risks into their capital requirement frameworks, altering risk assessment and management in bank portfolios.
Emissions-weighted risk transfers allow banks to claim they have lessened the emissions intensity of their portfolios using established regulatory capital models. Yet, there is debate over whether such transfers truly drive emission reductions or merely restructure financial risk.
The demand for financial instruments that transfer emissions risk is linked to regulatory changes. Banks are considering structures like a “black carbon pool” to consolidate emissions-heavy financing and offset it with carbon credits.
The market for synthetic risk transfers, which help banks manage credit risk, is expanding, with deals reaching $20 billion last year. Major banks in Europe and Canada have been active in this area, and US banks are increasingly participating.
These instruments are expected to grow as they become more accepted and as regulations evolve. They also provide banks with capital relief, which can be redirected to fund green initiatives.
