Wall Street Has a Dire Warning About Green Investments Under New ‘Endgame’ Rule

(Bloomberg) -- Senior Wall Street bankers are warning that a plan by US regulators to rewrite the rules of tax-equity investing will deliver a major blow to a market dominated by JPMorgan Chase & Co. and Bank of America Corp.

At issue is the perceived risk of tax-equity investments, which are a form of financing in which banks provide capital to green projects in exchange for tax credits. It’s a market in which JPMorgan and BofA have been estimated to do more than 50% of the roughly $20 billion worth of annual transactions. 

Last July, the three agencies that decide bank capital requirements in the US (the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency) unveiled what’s come to be known as the Basel 3 Endgame. Their goal is to wrap up the sweeping regulatory overhaul that started after the financial crisis of 2008, and ensure that banks have enough capital to see them through the next market meltdown.

A part of that broader proposal is a requirement that banks quadruple the risk weights they assign to tax-equity investments, forcing them to significantly raise the amount of capital they set aside for renewable energy projects. 

Dermot McDonogh, chief financial officer at Bank of New York Mellon Corp., said if the rule goes ahead, it will “severely reduce” or even “eliminate” the capacity of banks to invest in renewable energy projects, according to a written consultation response. 

It’s an assessment that’s in line with warnings put forward by the clean energy industry and legal experts.

Law firm Clifford Chance has warned that the risk-weight proposal would make it “prohibitively expensive” for banks to continue doing certain tax-equity investments, which is “certain to have a harmful” impact on green finance. ACORE, a trade group that represents renewable project developers, has said the plan threatens to “derail the clean energy transition.” 

Bank of America and JPMorgan declined to comment for this story. 

In connection with an earnings call earlier this month, JPMorgan’s chief financial officer, Jeremy Barnum, said regulators “should just be aware of the likely consequences of what’s happening here and make sure that the results are intentional and that we’re looking around the corner a little bit.” 

Last year, JPMorgan, Bank of America and Wells Fargo & Co. were involved in one of the largest single asset tax-equity financings ever, with a $1.2 billion allocation to an offshore wind project intended to provide renewable energy to Massachusetts. Barnum warned in October that JPMorgan is already rethinking such deals, in light of the risk-weight proposal.

Wall Street has been particularly vocal in its criticism of the wider Basel 3 Endgame proposal, warning that it will hit everything from mortgage lending to small-business loans. The campaign has been public and coordinated, encompassing everything from attack ads to appearances on Capitol Hill. 

“The banking industry officially submitted comments to US regulators during the week of Jan. 15 over the rule known as the Basel III Endgame, which stands to increase capital requirements around 20% for big banks like JPMorgan, Bank of America and Citigroup. Yet our analysis of the comments shows that regulators will likely have to scale back the rule to finalize it in 2024, and that the threat of legal actions is real,” according to Nathan R. Dean, a senior government analyst with Bloomberg Intelligence. 

Responses submitted by a Jan. 16 consultation deadline reveal the scenarios Wall Street is now anticipating. Crucially, bankers expect the planned risk-weight rules to undermine many of the green tax credits that the Biden administration’s landmark climate law, known as the Inflation Reduction Act, sought to streamline. 

US wind and solar developers have relied on tax-equity financing for years, with the IRA underpinning the model.But since most green project developers don’t have tax liabilities that are big enough to take advantage of available tax benefits, they often end up selling equity stakes to a bank, which can then claim federal tax credits against that investment.

Opposition to the proposed risk-weight regulations is so intense that there’s now speculation the Fed, FDIC and OCC will need to make changes before proceeding, according to industry executives. 

Wall Street’s “hope” is that the proposal is “either completely revised” or “very materially” reworked, Jane Fraser, Citigroup Inc.’s chief executive officer, said when asked about the planned risk weights in connection with the bank’s quarterly results.

Capstone, an investment advisory firm, calls tax-equity investments a vital source of financing for clean energy projects, especially since passage of the IRA in August 2022. It notes that regulators have made exceptions in other corners of the economy, such as low-income housing tax credits, for which risk weights are capped at 100%. JPMorgan and BNY Mellon are among Wall Street firms who have publicly backed this idea.

Adam Gilbert, a partner at PwC who’s a former head of regulatory policy at JPMorgan, said that if the goal of the US government is to channel more capital to clean energy projects, then “why would we try to make them more capital intensive and therefore less attractive from a business standpoint, from an economic standpoint?” 

Gilbert, who’s also been a vice president at the Fed where he was given the task of coordinating its work with the Basel Committee on Banking Supervision, said financiers who end up filling the gap created by the proposed regulations “will not be as stable as the banks themselves and therefore less reliable.”

What Bloomberg Intelligence Says...

“The eight US-based G-SIBs may collectively have about $154 billion of surplus capital with the inclusion of 2023 stress capital buffers (SCB) and 2024 G-SIB surcharges. 2023 SCBs took effect in 4Q23. The constraint on capital returns for most big US banks may be on their CET1 ratios as a percentage of risk-weighted assets. JPMorgan Chase may have the most surplus capital ($51 billion), followed by Wells Fargo ($31 billion). Share buybacks may be muted as an option to build capital ahead of the full implementation of Basel III endgame’s RWA inflation in 2028. If RWAs were to immediately increase 20-40%, big US banks may collectively have a $44 billion deficit, with JPMorgan most impacted.” 

Click here to read the full report by Bloomberg Intelligence’s Arnold Kakuda and Nick Beckwith.

(Adds Bloomberg Intelligence comment in 12th paragraph.)

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