From Covid‑19 recovery to a greener economy

BNP Paribas asks, in a world challenged by the Covid‑19 pandemic and empowered by recovery from it, what’s next for the central banking sector? Also discussing how banks and central banks can collaborate to encourage sustainable growth and build a better society

The Covid‑19 pandemic marked the beginning of a complex and difficult period for the global economy. Now, as the focus shifts to the global recovery effort, there are clear signs of a move towards building back not only better but greener.

When the crisis hit Asia, Europe and the US, there were fears the subsequent impact on economies could spiral out of control. Central banks worldwide were quick to respond by deploying quantitative easing programmes and liquidity injections on an unprecedented scale to manage the crisis. Now, as economies look towards recovery, with one eye on inflation trends and the looming spectre of climate change, central banks are braced for turbulent waters ahead. Trends that emerged during the pandemic look set to remain in place as the public and financial sectors focus on the long-term effects of Covid‑19, and the outlook for a sustainable recovery in the societies they serve. 

BNP Paribas received the Global Markets award at the Central Banking Awards 2021 for its efforts working with central banks and the wider official sector through the turbulence. “After decades of building strong relationships within the central bank sector, BNP Paribas was proud to partner with central banks in navigating the crisis,” says Laurent Leveque, global head of official institutions coverage at BNP Paribas, “and we look forward to strengthening these relationships further for the recovery effort.” 

The bank’s role in supporting central banks scales a wide range of business areas from bonds investments, interest rate derivatives, cash and repo, to foreign exchange positions and gold swaps. With sustainable finance embedded across the range, this ensured much-needed support across the world’s healthcare and financial systems during the crisis, as well as aiding recovery at a time of intense
market volatility.

Sustainable finance aids recovery

At the heart of the official sector’s response in the fight against Covid‑19 was its reliance on social bonds. At the onset of the pandemic these were the go-to instrument for sovereign, supranational and agency (SSA) clients looking to raise funds in the form of so-called ‘Covid‑19 response bonds’, and central banks played a key role by investing heavily in those instruments. BNP Paribas was among the first to push this response, bringing to market two landmark transactions at the very start of this trend. Helsinki-based Nordic Investment Bank (NIB) and the European Investment Bank issued bonds to deliver essential funding to tackle the crisis across multiple fronts, including business and employment generation. This was just the beginning, as issuers from Latin America to Asia-Pacific adopted this means of fighting the effects of the worst health crisis in living memory. Corporación Andina de Fomento issued Latin America’s first Covid‑19 response bond, a €700 million (c.$771 million) five-year social bond to support its member countries. The Asian Infrastructure Investment Bank issued its inaugural CNY3 billion panda bond to facilitate its response to Covid‑19 and support sustainable development projects in the long term. 

In addition, BNP Paribas is the only bank to have acted as joint lead manager on both the first Next Generation EU bond issuance (in June 2021) and the inaugural support to mitigate unemployment risks in an emergency – or Sure – bond issuance (in October 2020), both of which demonstrate the scale of funding required to tackle the crisis. The challenge in issuing such high volumes to fight Covid‑19 involved not only executing jumbo bond transactions, but ensuring depth of liquidity in secondary markets. Banks played a vital role balancing both sides of this equation, ensuring issuers had sufficient runway to raise funding on this scale.

This was no flash in the pan – the effectiveness of social bonds as a means of mobilising finance for societal good (especially in the face of global adversity) has resonated well into 2021 and looks set to sustain momentum throughout the recovery period. As a result, the bond markets have seen exponential growth in primary sustainable issuance (which includes green, sustainable and social bonds) that has already crossed the $1.7 trillion mark. In particular, the pandemic-induced shift in demand for social bonds in 2020 showed that issuance volumes accounted for 30% of the total primary sustainable issuance and, by July 2021, the social bond issuance volume already accounted for a 29% share, and is set to outstrip previous records by the end of the year. 

These figures show not only the appetite but also the crucial role of the financial sector in sustainability both as a result of the Covid‑19 crisis and the growing concern and desire to be at the forefront of tackling issues such as climate change head-on. BNP Paribas is widely trusted and relied upon by central banks and SSA issuers for its green and social finance research, and is able to advise clients on their specific sustainability journeys, as well as play a leadership role in scaling up sustainable finance markets.

“Sustainable finance is part of our DNA, and we are a frontrunner in innovating new ways to help our clients integrate environmental, social and governance [ESG] into all their market activities, as well as scaling up sustainable finance markets solutions as part of our overall business strategy,” says Delphine Queniart, global head of sustainable finance and solutions at BNP Paribas Global Markets. 

BNP Paribas has long demonstrated its credentials as a catalyst for change in this regard and understands that sustainable initiatives should be tackled in a collaborative manner across a multitude of stakeholders. Covid‑19 highlighted and accelerated the need for the financial sector to take note and integrate sustainability into business models and governance. For example, BNP Paribas’ delivery of NIB’s response bond transaction was not only a direct mechanism to fund actions taken to relieve the impacts of Covid‑19, but also a way of supporting NIB in providing transparency and communicating a clear ESG strategy to its investors. 

Going for gold

BNP Paribas’ expertise in gold also shone through at the height of the pandemic. As one of the biggest banks in the gold forward market, the bank continued to provide significant liquidity, without disruption, to central banks to help manage maturing transactions on gold swaps, with gold often delivered back due to market conditions. Central banks were able to benefit from the favourable gold market conditions and huge demand for dollar liquidity worldwide to generate additional returns.

Central banks have been active in gold swaps for more than 20 years now, and their popularity has grown largely due to the very low-rate environment, so even the smallest gain from negative gold interest rates is valuable for borrowers. But, with market conditions ever-fluctuating, will gold ever lose its shine with the central banks? “It’s difficult to predict,” says Guillaume Picot, global head of commodity derivatives sales at BNP Paribas, “but, given that the central banks of some large countries like the US, France, Germany and Italy still have around 65–80% of their foreign reserves in gold, I would say that this asset will remain an important part of central bank reserves. And, as a leader in the gold forward market, our commitment to central banks in the commodities markets remains in place.”

Looking ahead

As the world gradually reopens and enters post-Covid‑19 recovery, a combination of rising commodity prices, supply chain disruptions, and imbalances between supply and demand are driving a price shock in the global economy, increasing fears of inflation running out of control. After being so quick to respond to the biggest global economic shock since the financial crisis of 2007–08, all eyes are on what the central banks will do next. It goes without saying that any action central banks take will be vital for the global economy as it recovers from the huge impact of Covid‑19. As far as markets are concerned, they have a narrow path to navigate. “Solid economic growth, which is accommodated by central banks and leads to more persistent and domestically generated inflation, such as wage increases, is fundamentally constructive,” says Luigi Speranza, chief global economist at BNP Paribas “However, a key risk of this scenario is getting too much of a good thing. If inflation continues to accelerate and price pressures become more widespread, markets might be concerned that central banks will have to put their foot on the brakes and significantly increase interest rates, and abruptly slow growth.”  

So far, the major central banks in the developed markets, such as the US Federal Reserve and the Bank of England, have resisted calls to significantly raise interest rates, preferring instead to see persistent inflationary pressures before taking action rather than move in anticipation of it. As a result, monetary policy will be tightened later than expected and proceed in a more gradual fashion than seen previously under similar circumstances. Reflecting on this, although BNP Paribas’ economists believe a 1970s-like inflation shock looks unlikely, they nonetheless expect the current inflationary episode to prove more enduring than is generally assumed.

Green is the word

Amid the general concerns regarding the future of the global economy is a renewed focus on ‘green transformation’ towards a sustainable, carbon-neutral economy and a socially responsible world – especially in the aftermath of a major health crisis. With the upcoming Cop26 United Nations Climate Conference in Glasgow, there is no doubt the financial sector will be competing to provide sustainable solutions to address the environmental and climate risks facing the real economy, allocating resources to sustainable investments and no longer financing activities that cause environmental damage. Governments across all continents are ramping up their commitments on working towards reducing greenhouse gas emissions and becoming carbon neutral by 2050, and the European Commission recently published its landmark Strategy for financing the transition to a sustainable economy, which includes critical developments for sustainable capital markets.

Furthermore, an increasing number of central banks in developed and developing economies – notably through the Central Banks and Supervisors Network for Greening the Financial System’s regrouping of 95 members and 15 observers – are already focusing their efforts on meeting sustainability challenges. For example, the European Central Bank (ECB) is strengthening its engagement in addressing climate risk, and announcing several changes to its policy strategy in a recent review. This includes disclosing climate-related information of the corporate sector purchase programme alongside requirements for greater disclosure of climate-related data, and the addition of climate change scenarios in the ECB’s macroeconomic models. The acceleration of the ECB to engage the market on this issue will likely have notable ripple effects across the sector.

But for global economies to meet carbon targets and adapt to the effects of climate change, billions of dollars in new spending will be required, as well as new tools and bold thinking to ensure lending goes towards climate-friendly projects in the real economy. And, with its expertise in the sustainable capital markets, green mobility, decarbonised real estate, leasing, sustainable investing and more, BNP Paribas is in a prime position to continue to advise the central bank sector on transactions that have a sustainable real-world impact on global communities and economies. 

Taking the next steps

“Being able to stand by our central bank clients during the most intense periods of the pandemic was a true honour, and confirmed the purpose of our role in the world economy. The past year was an important stress test for us, which demonstrated that we have the range and the capability to offer flexibility to our clients’ evolving needs,” says Laurent Leveque. “And, as we gradually emerge from this health crisis, we remain committed to offering our services to central bank clients across the full range of products on a global scale.”

With concerns over inflation, climate change and supporting the global recovery effort from Covid‑19, it’s clear central banks will have much to contend with in the years to come. But, as we’ve already seen, in a changing world, banks and central banks can work together to support responsible and sustainable growth and play their part in building a better society.

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