Liquidity and impact
- Demand for a liquid repo market in sustainable assets is likely to grow
- Developing a ‘sustainable repo market’ presents opportunities and challenges
- Sustainable repo market is worthy of further investigation
Insight trades extensively in repo markets to support our clients’ fixed income exposures, particularly in liability-driven investment portfolios for UK pension schemes. We are also a committed responsible investor, seeking to take into account material environmental, social and governance (ESG) factors in our investment decisions, and we actively participate in the impact bond market.
Issuance of green, social and sustainable bonds continues apace2. Demand is also increasing, as a growing proportion of our clients develop sustainable investment targets, and regulatory and policy initiatives encourage further investment.
Demand for a liquid repo market in sustainable assets is likely to grow
Over the longer term, we expect this to have a direct impact on the repo market. In the UK, defined benefit pension schemes’ LDI portfolios use gilt repo extensively to efficiently hedge their liability risks3. The UK government is set to issue green gilts for the first time later this year4.
If UK pension funds decide to hedge their liability risks using green gilts, rather than conventional gilts, there will be demand for a liquid market in repo for green gilts to maintain efficiency in pension schemes’ LDI portfolios5.
Our primary concern is that, for our clients who need it, there should be a liquid and functioning repo market for relevant assets. Over time we expect these assets to include sustainable assets.
Opportunities and challenges associated with a sustainable repo market
The ICMA consultation asks about the opportunities and risks associated with developing a “green and sustainable repo market”.
We believe there are two key questions to consider:
- how such a market would support liquidity for green and sustainable assets, and
- how it would help investors achieve a positive impact (such as an environmental impact).
To support liquidity for sustainable assets, ‘repo on green collateral’ may be appropriate terminology in cases where investors repo a green bond, even if the proceeds are used for non-green purposes. This term could be used for defining financial incentives for such transactions, thereby supporting liquidity for green and sustainable assets. For example, the consultation document mentions that regulators or policymakers could consider preferential capital treatment or haircuts for green assets, which may have a positive impact.
However, developing a green and sustainable repo market that explicitly helps investors achieve a positive impact presents difficult challenges. Some might argue that it only seems appropriate to define a repo as ‘green’ or ‘sustainable’ if the proceeds from that repo are used to achieve a green or sustainable impact. But independent monitoring and certification of the use of those proceeds would be required to avoid misleading or misinterpreted categorisation, and this would be challenging to implement.
A sustainable repo market is worthy of further investigation
The market for sustainable assets has boomed in recent years and we expect demand for repo liquidity to follow suit. While it remains unclear whether a separate market or ‘green repo’ structure is necessary to encourage or sustain a liquid repo market in sustainable assets, we expect our clients’ demand for exposure to these assets to grow, and so we are keen to engage on any developments that can help our clients achieve their goals efficiently and effectively.
To find out more about Insight’s approach to responsible investment, please click here.
To read our response to the ICMA consultation on the role of repo in green and sustainable finance, please contact your Insight representative.
5For more on UK pension schemes and green gilts, please read our update: https://www.insightinvestment.com/investing-responsibly/perspectives/green-gilts-an-update/
Responsible investment, Fixed income
Responsible investment in fixed income
Monitoring corporate climate risk
Putting principles into practice: responsible investment annual report 2021