The green shoots of sustainable repo are visible, but the market needs clarity to grow further
Key Takeaways
- Green repo is growing, but standardization, and greenwashing are concerns.
- Industry needs more regulation and clearer definitions.
- Initiatives underway to improve efficiency and transparency.
Sustainability and the environment are often front and center of investors’ minds as organizations and governments mobilize financing to tackle climate change and sustainable development.
According to the UN Conference on Trade and Development (UNCTAD), the value of sustainable investment products hit USD 7 trillion in 2023, 20% more than the year before. Issuance climbed to USD 872 billion, driven by sustainable bonds, particularly green ones. From 2018 to 2023, the global issuance of green, social, sustainability, and sustainability-linked bonds grew fourfold.
A thriving repo market—where collateral (usually bonds) is loaned for cash, typically overnight—is essential for the efficient functioning of financial markets by mitigating risk and ensuring liquidity. Interest in sustainable repurchase agreements (repo) is gaining traction, but challenges exist. Defining what constitutes ‘green’ and ‘sustainable’ is one.
The findings of the International Capital Market Association’s (ICMA) 2024 Repo & Sustainability survey show that the obstacles hampering progress range from a lack of standardization to limited investor demand, and ‘greenwashing’. The latter, UNCTAD says, remains the most significant challenge to the sustainable fund market.
Overcoming these hurdles requires not only regulatory incentives but also more precise guidance and labels.
What color is green repo?
The survey notes that the majority sees the importance of so-called green repo, but there needs to be a better understanding of the market. The concept has various interpretations, so ICMA outlines the differences and similarities with its traditional counterparts. Most notably, they share the same structures, legal documentation, and functions. The divergence is in the funding component, which the trade group divides into two main categories.
The first covers repo transactions in which the buyer and the seller use sustainable assets as collateral for the trade. It also comprises deals that consider the sustainability credentials of the counterparties. Most sustainable collateral refers to green bonds meeting specific requirements, such as the European Union (EU) Green Bond Standard. However, “sustainability-screened” collateral, as highlighted by ICMA, uses environmental, social and governance (ESG) ratings or company in-house metrics with no agreed market standards.
As with collateral, there are currently no agreed market protocols for recognizing sustainable counterparties. ICMA states, “it is difficult to tell whether such transactions can be labeled as truly sustainable.” This explains why respondents are calling for greater regulatory and central bank inducements to help support the development of this segment of the industry.
The second, which involves repo providing sustainable financing, offers two routes. One is sustainability-linked (SL) repo, where the characteristics of the transaction are linked to the seller’s performance regarding a set of predefined sustainability criteria. The other examines the sustainable use of proceeds (UoP) and whether they are exclusively deployed to fund eligible sustainable projects or the borrower’s sustainable asset portfolio.
Again, it is not easy to judge the outcomes. As ICMA notes, “Most of the UoP repos do not necessarily use sustainable assets as the underlying collateral, as the focus is purely on the cash proceeds, although an integrated approach which combines the UoP with sustainable collateral also started to appear in the market.”
Better alignment needed
Unsurprisingly, survey respondents want a better alignment between UoP and a firm-level sustainability framework. This is crucial for ensuring consistency with organization-level key performance indicators (KPIs) and sustainability performance targets.
There was also consensus that sustainability-linked repos are more suitable for maturities exceeding 12 months and that the sustainability-linked bond principles (SLBP) should be used as a temporary template. SLBP guides issuers wanting to raise environmentally friendly debt with terms tied to specific ESG goals and targets.
The next step for ICMA is to continue monitoring the market evolution around green repo and to work on expanded guidance. In the meantime, various initiatives have been working towards developing an efficient, liquid, and transparent market for sustainable finance.
Green repo initiatives
On the deal front, the last four years have seen large European banks such as BNP Paribas and Deutsche Bank launch green repo transactions. More recently, MUFG EMEA and Doha Bank joined forces to debut their first green repo in the Middle East and North Africa (MENA) region. Cash proceeds from the repurchase of green bonds issued by the State of Qatar will be directed to fund and acquire green assets aligned with Doha Bank’s Sustainable Finance Framework.
As for exchanges, Eurex has expanded its menu by adding a new green bond basket to its general collateral (GC) pooling repertoire. This basket complements three others introduced in its special and GC repo divisions in 2020 and 2021, respectively.
While the initial basket was considered too broad, the Germany-based exchange said the latest product targets sustainable bonds in renewable energies, sustainable waste management, biodiversity preservation, and sustainable land. It enables clients to leverage euros, US dollars, sterling, and Swiss francs against a selection of 80 green bonds issued by sovereign and supranational entities across seven countries within the European Economic Area.
Collateral received from the basket can be reused for Eurex Clearing margin with ClearStream TriParty, leveraging the established GC pooling market design to mitigate the risk of transaction failures.
Eurex’s rival, the London Stock Exchange Group, has also pushed the green envelope through its Paris-based clearinghouse. It kicked off 2024 with its first GC triparty green basket, which includes euro-denominated investment-grade bonds aligned with the issuer-reported green bond reference data from Bloomberg.
The net proceeds will finance projects or activities that promote environmental-related activities, including climate change mitigation. The basket expands on the firm’s existing triparty basket repo offering following the merger of its two clearing services—€GCPlus liquidity and its EUR 3.3 trillion RepoClear liquidity pool—in July 2023.
Work to be done
The benefits of green or sustainable repo are unquestionable. It can facilitate price discovery and enhance the liquidity of green bonds and other sustainable assets, making them more attractive to investors. This leads to more funding sources for environmentally friendly projects, thus promoting sustainable development, which is critical for emerging economies. Private and supranational initiatives are particularly helpful here. For instance, the UN and Afreximbank’s Liquidity and Sustainability Finance Facility enables investors to use African debt issued in foreign currencies in repo transactions to improve the flow of cash and reduce borrowing costs.
Nevertheless, the road ahead is far from smooth. As with ESG, there is a danger that investors will tire of the concept. A 2023 report by the BBC (How ‘ESG’ came to mean everything and nothing) looked at why some companies were ditching what it called an umbrella catchphrase that meant different things to different people.
A lack of consistent regulatory frameworks, fuzzy definitions, and the risks of greenwashing (where assets are misclassified as green without meeting the necessary environmental criteria) are a few of the obstacles to establishing a thriving green repo market. Addressing these will be the first step toward allowing green repo to play a more significant role in sustainable finance.
Don't miss out
Subscribe to our blog to stay up to date on industry trends and technology innovations.