Responsible Investment in CRS
We aim to fully integrate sustainability into the investment process, alongside risk and return. We call it 3D Investing.
When investing in Credit Risk Sharing (“CRS”) transactions, we invest in the broader economy and not just in what is considered ‘sustainable’. Rather than solely looking at the current sustainability-linked characteristics of assets or companies, we look at how the real economy can transition to become more carbon-neutral and the role of both banks and investors in facilitating this transition.
Engagement – Energy Transition
CRS transactions increase the lending capacity in the banking system. Therefore, by investing in CRS we contribute to financing the transition of the broader economy through our risk sharing partner banks. Many companies that use bank financing have no publicly traded investment instruments (like equities or bonds) outstanding. Banks are well-positioned to motivate their clients to reduce their carbon footprint, by advising them and providing the related lending. We focus on supporting banks in providing loans, which help their clients’ transition. We track, on an on-going basis, the banks’ carbon reduction ambitions and performance with regards to their interim science-based targets. Over the time this reduces the CO2 footprint of the lending books and ensures that banks’ clients across all sectors are facilitated in the transition to a climate-neutral economy. The size of this influence should not be underestimated: because of the first loss nature of our transactions, the bank portfolio that is directly related to a CRS transaction is 10-14 times larger than the amount invested in that transaction. In addition, when selecting our risk sharing partners their ambitions set and progress made in the area of transition towards more sustainable economy is an important factor that is taken into consideration.
Positive Contribution – SDI
A separate category are CRS transactions classified as “Sustainable Development Investment” (“SDI”). These transactions traditionally reference project finance exposure to renewable energy projects as well as loans to the healthcare and education sector. By taking a first loss position on a portfolio of project finance loans, they free up capital which our risk sharing partner banks can then use to originate additional project finance loans. This allows such transactions to contribute to specific Sustainable Development Goals (“SDG”), in particular UN Sustainable Development Goal 7 (affordable and clean energy), 13 (climate action), 3 (good health and well-being) and 4 (quality education). An example is a transaction in which we take a first loss position on a portfolio of project finance loans which for nearly half can be classified as contributing to sustainability principles, of which the main part relates to renewable energy, with the remainder to education, health care, and waste treatment.
Investment opportunities in project finance remain relatively limited and small compared to the rest of the CRS market, while investors interest in such transactions is very high. Given the need to support the transition applies to many other lending areas, we see expansion of sustainability features to other asset type transactions as a key to enabling the transition at scale.
In addition to project finance transactions, we have been exploring options to include sustainability features in large corporate transaction and have successfully worked on a CRS transaction referencing corporate loans where the underlying loans have sustainability related KPIs, - for which the bank is rewarded with a lowered coupon in case the KPIs are met, mirroring the underlying loan margin dynamics, - as well as a transaction in an emerging market, where the risk sharing partner commits to use the capital freed up by our transaction to support lending to female homeowners. We are proactively learning from these experiences and uses them to further build our knowledge and to initiate further transactions with similar features with other partners.
Sustainability in due diligence process
As part of our core beliefs, PGGM integrates sustainability factors in the due diligence (“DD”). During the assessment of the bank’s origination strategy and quality of the risk management process, we investigate which sustainability-linked policies the bank has implemented, how it ensures these are being adhered to and impact the bank’s decisions, and to what extent the convictions behind these policies are part of the bank’s culture.
We conduct a sustainability-linked DD for each transaction using our proprietary DD framework so that we can score and benchmark across banks on their progress. Our framework includes amongst others:
- review of the lending policies of the bank in relation to oil & gas, thermal coal, human rights, and biodiversity,
- assess the bank’s Paris-alignment status, as reflected by their commitment to net zero, interim and long-term science-based emission reduction targets, as well as the level of disclosure and reporting standards.
- Commitments to responsible business conduct such as the United Nations (“UN”) Principles of Responsible Banking, the Equator Principles and UN Global Compact,
- an assessment how banks are managing and monitoring sustainability related risks, such as physical climate risk, transition climate risk and biodiversity risks for its lending portfolio.
Paris Agreement Alignment
Together with our client PFZW, we are committed to the goal of the Paris Agreement to limit global warming to 1.5⁰C. Please see PFZW Climate Plan: Klimaatplan 2024 (pfzw.nl)
PFZW and PGGM are increasingly focussing on moving towards sustainable and impact finance, and PFZW has announced to introduce a 3D investment strategy, balancing risk, return and sustainability. As part of this strategy, the Credit & insurance Linked team, responsible for managing the CRS mandate on behalf of PFZW, is developing specific sustainability related objectives with the aim to aligning the portfolio to the goals of the Paris Agreement.
Sustainability-linked data
For an investor it is important to have insights into the sustainability profile of the underlying portfolio, and how it develops over time. More specifically, in line with the net zero targets of banks, we would like to track progress of the underlying portfolio in relation to the transition. For example, progress can be shown by sharing the transition readiness score of the underlying borrower or by measuring GHG-emission intensity of the underlying portfolio. For this, good quality sustainability-related data is crucial. However, we recognise that some of this data, including the related scoring and assessment frameworks, is still being developed and as such may change over time. We encourage our risk-sharing partners to provide us with such data, despite the fact that it may evolve in the future. Ultimately, when it comes to our CRS transactions, we strive for the sustainability-profile of a portfolio to visibly improve during the life of that transaction as the underlying companies are making progress in the transition.
Please see as well our blog ‘Green securitisation: it’s all about the data’.
Questions?
For questions please contact Mascha Canio.
