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(Bloomberg) — Fixed income investors are expressing skepticism about Europe’s ability to use investment banks to finance defense spending, as they worry about lenders’ sustainability credentials and borrowing costs. They point out risks in the rise in
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Given the European Investment Bank’s focus on environmental and social projects, it will need to reach out to investors outside the ESG industry for military financing. For analysts and fund managers, a better option would be for the European Union to raise funds directly through a joint borrowing program.
How to counter the threat of Russian aggression and the EIB’s role in defense spending will be on the agenda at Thursday’s EU summit. Several countries, including France and Germany, have called on the EIB to reconsider its policy of restricting support for military projects.
However, using EIB poses some challenges. As an example, the agency bills itself as the EU’s climate bank, and its high ESG ratings, which lead to cheaper borrowing, could be at risk if lending standards are relaxed, including for defence. Matt Cairns, head of credit strategy at Rabobank, said the ESG-focused clients he advises are typically prohibited from making military-related investments.
“The EIB is a green bond issuer. It’s a climate awareness bond issuer. It’s a social bond issuer. So what exactly are investors looking for in bonds that currently fund military equipment? Are you going to raise your hand to buy it?” he said. “Everyone I talk to has their hands tied with things like that.”
An EIB spokesperson said President Nadia Calvino will speak to member states in April about increasing the “scope and amount of support” for European security.
With no end in sight to the Ukraine war, the EU is under pressure to spend more money to defend itself. The EIB can currently fund spending on cybersecurity and drones for civil and military purposes, but expansion into munitions and weapons is likely to trigger a review of environmental, social and governance assessments.
The bank has some room to expand its defense spending without jeopardizing its top rating, according to Morningstar Sustainalytics, but any major changes could lead to changes. The EIB gives him the fifth strongest ESG rating among the approximately 16,000 companies covered by the company. MSCI rates it as AAA, the highest level.
“They may have to accept that they are implicitly diluting the EIB’s ESG credentials,” said Brian Mangwiro, a portfolio manager at Barings. “I think the EU is the simplest, most direct and most reasonable way to fund this. The EIB would be a more complex path.”
The EIB has outstanding debt of around 430 billion euros (about $466 billion) in various currencies, according to data compiled by Bloomberg. HSBC Holdings estimates that an additional €10 billion to €30 billion a year may need to be raised over the next few years to support the defense industry.
To do so, the bank may need to remove its lending cap, currently set at 250% of underwritten capital. However, HSBC analyst Frank Will said in a client note that removing that cap could have a negative impact on the company’s triple-A rating.
Investors also said any EIB defense bonds were likely to have higher yields. The company’s bonds, due in 2034, currently yield 2.9%, compared to similar EU bonds that yield around 3%. However, Kasper Hense, senior portfolio manager at RBC BlueBay Asset Management, said that if these were to be issued for military purposes, the EIB would charge a A basis point premium may be charged.
Analysts believe the EU is a better route due to its larger investor base and fewer ESG constraints. French President Emmanuel Macron is expected to push for a joint issue at Thursday’s EU summit, the Financial Times reported.
This could also move EU debt from a tool deployed only in times of crisis to a more permanent institution with governmental status, Hense said. Some believe that if yields are high enough, the EIB and the EU will have no trouble finding buyers.
“The situation on the investor side could change over time if defense investments are deemed essential,” said Jussi Hiljanen, head of European macro and fixed income research at SEB. “Without security and protection, there is no ESG.”
–With assistance from Greg Ritchie and William Horobin.
(Adds context about macrons in third-to-last paragraph.)
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