Transitioning to a sustainable economy is becoming the defining issue of the next cycle for banks. European banks have already committed to roughly €1 trillion of sustainable financing for the economy into 2025.
Environmental, social and governance (ESG) investing is extending deeper into the market, and industries are being reconfigured in response to shifts in consumer behaviour and government policies. Morgan Stanley Research believes that the momentum on moving to a low carbon economy will be maintained as the economy recovers from the COVID-19 pandemic.
Morgan Stanley Research believes climate change and sustainability will be the defining trend of the next cycle for banks, just as digital disruption dominated the last. Growing numbers of savers and investors are likely to choose products that offer sustainable investing credentials without sacrificing financial performance, driving capital towards those companies leading the charge on climate change, and away from those which are lagging.
European investors and corporates head the rest of the world on integrating ESG into business and investment decisions. The European Green Deal, which aims to transform the EU economy for a sustainable and climate neutral future by 2050, should have profound consequences for several industries across Europe. For banks, as allocators of capital, the Green Deal is likely to dictate the broad roadmap to manage transition and physical risk in lending portfolios, develop new products, and most importantly drive capital towards the greener businesses.
Banks have already committed roughly €1 trillion of sustainable financing in the next five years. In financing Europe’s Green Deal investment needs of around €4.7 trillion over 2020-30, banks will play their part. The pool of bank sustainable lending was around €530bn at FY2019 (9% of total Europe Corporate loan stock), and most banks have sustainable financing target timelines extending from 2020-25.
New methodologies are emerging for assessing climate-related risks, such as scenarios, exposure and vulnerability. Banks are working to embed climate measures in their risk management and origination processes. The climate-related credit framework is also expected to influence loan pricing, for example companies charging a lower rate for a green mortgage versus a regular mortgage.
Managing transition risk and opportunities over the last few years has changed the banks’ strategic and stakeholder thinking, particularly in Europe. Boards have embraced their responsibility for oversight of the financial risks of climate change and overall responsibility for setting strategy, targets and risk appetite.
The development of green infrastructure will require private-public partnerships and private financing – whether through ‘green bonds’, sustainable investment funds, or green crowd-funding. Green bond issuance has more than tripled over the last three years to around €400 billion, yet still represents only 0.75% of total outstanding corporate debt. Europe has led this charge, accounting for approximately 80% of total issuance in 2020 and approximately 66% of the cumulative issuance to date.
Morgan Stanley Research believes stakeholders are increasingly focused on the important role banks can play to enable and accelerate the transition to a cleaner economy, by mobilising capital and managing risks in the process. Successfully managing exposure to transition and physical risk in the lending portfolios, measurement of progress and future proofing the business will become much more important deliverables for banks.
Understanding of the relationship between financial transactions, the real economy and climate goals has improved significantly. However, there is still a long way to go and progress will be essential on refining methodologies, improving data sources, and on standardisation of disclosure. That said, Morgan Stanley Research thinks the financial sector has moved beyond commitment, to action, particularly in Europe.
Societal awareness of environmental issues is higher than ever, while regulation to drive capital towards green activities is likely to catch up quickly, particularly in Europe. Demand for sustainable investing is likely to remain. Asset owners are driving the broader adoption of ESG across equities and fixed income and we see no reason for this to change.
For more Morgan Stanley Research on banks and ESG investing, speak to your Morgan Stanley financial adviser or representative for the full report, “Banks and Climate: Tides of Change" (2 Oct, 2020). Plus, more Ideas from Morgan Stanley's thought leaders.