A dozen years ago, the phrase “bad bank” was all the rage among investors.
The 2008 financial crisis had left the balance sheets of Western financial groups poisoned by subprime assets — but it was unclear how to identify or manage this. So entities such as UBS, Citi, RBS and West LB used various techniques to ringfence these toxic assets in “bad banks”. The aim was to clarify the problem, prevent the infection of the entire balance sheet — and then wind those assets down.
It often worked well. And now some financiers, such as Larry Fink, chief executive of BlackRock, are seeking to revive the concept — albeit not with banks’ subprime loans but with assets sitting on the balance sheets of industrial and energy companies that are toxic in both a financial and a literal sense.
More specifically, Fink recently told the Institute of International Finance that it would make sense for industry to create “bad banks” in which they could ringfence carbon-intensive activities, such as thermal coal.
He repeated the idea at the G20 meetings last weekend. And Mark Carney, the United Nations’ special envoy for climate, also told the gathering that Fink was now working with Jane Fraser, CEO of Citi and Oliver Bäte, CEO of Allianz, to discuss how industrial companies handle their dirty assets. The concept will almost certainly be debated at the Glasgow climate talks in November.
Should investors and policymakers support this? The answer is “yes” — but with qualifications. The key point is that the bad bank concept is only the second-best option for dealing with climate change; a better idea is to create a level regulatory playing field in terms of how entities of all stripes handle toxic assets.
The problem is that the business world is currently plagued by green regulatory arbitrage. Western governments are increasing pressure on big companies to cut carbon emissions; just look at the announcements tumbling out in Europe this week. Investors in public companies are also demanding that they act. And bodies such as the International Financial Reporting Standards group are creating green accounting frameworks, which G7 leaders recently pledged to make mandatory. That has prompted many public companies to create target dates for when they hope to become “net zero” — ie cut overall carbon emissions to nothing.
So far, so encouraging. But the rub is that many privately held companies in Western markets are not (yet) caught in these accounting nets, or facing the same level of investor scrutiny. In non-Western markets such as Saudi Arabia, entities are also generally still shielded from pressure.
Thus there is a strong temptation for listed companies to hit those net zero targets by selling their dirtier assets to privately held entities in Western markets or non-Western performers. Indeed, Wood Mackenzie, the energy consultant, reckons that since 2018 groups such as ExxonMobil, Chevron, BP, Royal Dutch Shell, Total and Eni have sold almost $30bn of their dirty assets to these operators — and estimates that $140bn assets are now for sale.
This — rightly — horrifies environmentalists. Dirtier assets need to be shut down, not shuffled into dark corners. Worse still, the fact that these new owners face less scrutiny might give them less incentive to cut pollution, harming the world overall.
There is a blindingly obvious solution to this: the G20 should rush to create a more level regulatory playing field, treating public and private capital alike. Investors in public companies should also censure such asset sales.
But it seems most unlikely that this will emerge anytime soon, or that Western investor complaints alone will halt those putative $140bn asset sales. Hence why that “bad bank” model might be the least bad option on the table.
If Western listed companies were able to place their dirty assets into vehicles that were ringfenced from their main balance sheets — and from their net-zero commitments — it might reduce incentives for rapid asset sales.
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This would also give investors and governments more clarity on the problem, and could even spark some badly needed joined-up policymaking. One option for dealing with thermal coal, say, would be for governments to buy mines at distressed price, and shut them down in a measured way, while also crafting safety nets to help vulnerable communities.
This approach has risks and disadvantages. If dirty assets are simply left untouched in ringfenced entities, without any effort to reduce emissions, it will be little more than greenwashing. And it should not be used to weaken attempts to create a more level playing field.
However, the reality is that many industrial, energy, utility and mining companies are already restructuring themselves to create some ringfencing of dirty assets. To cite one example: Rusal, the Russian energy group, recently demerged its high-carbon smelters and refineries into a new company, so that it can focus its energies on developing a “green” aluminium venture.
So if Western policymakers and green activists want to stop toxic assets leaking into darker places, they need to find a better way to handle the poison. Bad banks are not a sufficient solution. But they might help lessen the risk that regulatory arbitrage will hurt us all — and even more so than in 2008.