Green (washed) Collateral and the Spectre of Carbon liquidity spirals in Shadow Banking.

Keywords: Shadow banking, climate change, risk, collateral, finance, greenwashing, securitization
Session Type: Virtual Paper Abstract
Day: Tuesday
Session Start / End Time: 3/1/2022 11:20 AM (Eastern Time (US & Canada)) - 3/1/2022 12:40 PM (Eastern Time (US & Canada))
Room: Virtual 1

Abstract

Contributing to geographical scholarship on the “qualification of things as assets with more-or-less specific carbon properties” (Langley et al, 2021), this paper explores recent developments in shadow banking and the creation of “green” repurchase agreements (repo). Shadow banking institutions finance their own activities using collateralised loans known as repo. These are extremely short-term contractual agreements between banks and other financial institutions, in which a lender provides cash in exchange for collateral to secure against default. Repo therefore allow the conversion of credit risk into collateral risk and creates an insatiable demand for collateral. Within repo the same piece of collateral can be re-used several times by different intermediaries and this widespread practice creates collateral chains. Such chains are vulnerable to margin calls and the evaporation of liquidity when core collateral pieces fall in price.

The financial system is increasingly responding to the Net Zero transition by developing ESG related derivative instruments such as “green repo” agreements. This development raised financial stability issues such as ambiguity over the definition of ‘green collateral”, green washing and the securitization of mispriced assets. This paper investigates the techniques in which carbon collateral is being ‘translated’ as green and assesses prospects for ‘carbon liquidity spirals’ within collateral chains if such taxonomies and definitions of green collateral occlude possible losses due to climate transitions. In particular, the analysis focuses on the way shadow banking is likely to represent a flawed “spatial fix” for climate related tail risks that cannot be diversified in the traditional banking system.