Green subordinated bonds issued by banks may not stay green in a stressed or crisis scenario, Fitch Ratings has warned.
The ratings agency said that, in a stressed scenario, regulators could force bonds to absorb losses and write-downs on all assets. That raises questions about ring-fencing sustainable assets and liabilities in a stressed situation "and the potential clash between sustainability objectives and prudential regulation of banks," Fitch said in a news release Wednesday.
Fitch cited European examples but said the concept applies more broadly, especially for countries with advanced creditor hierarchy and bank resolution regimes in place, said Janine Dow, senior director-sustainable finance and author of the report.
The issue is being complicated by green AT1 bond structures — a type of bank capital — as there is no regulation or market precedent for how to track the use of proceeds from these bonds should they be used to absorb losses, Fitch said.
"Tracking the usage of green bond proceeds is already difficult given the fungible nature of cash and the loose labeling that many banks use to reference sustainable and green projects," Fitch said.
While there has been progress to define which projects and assets can be financed by sustainable bonds, via the EU Green Bond Standard, which includes a taxonomy for sustainable activities, the standard "is less clear on technical considerations for complex green instruments beyond senior unsecured bonds."
While there is no mechanism in the cases of bank liquidation or resolution procedures that allows assets to be segregated and protected, such as green assets, doing so "would firm up the green credentials of subordinated instruments and could significantly increase green asset expansion due to the inherent leverage of green regulatory capital instruments."
However, Fitch warned such a move would also weaken banks' capital resilience because the ring-fencing of assets "limits the ability of stronger parts of a banking group to support weaker parts."