It seems obvious that low rates encourage the low-cost financing of the energy transition. Except that it is not, writes Mirova's Bertrand Rocher.

By Bertrand Rocher, Portfolio Manager and Senior Credit Analyst at Mirova, an affiliate of Natixis Investment Managers

Capitalism, according to its defenders, is the most efficient capital allocation system of all. Thanks to capitalism, resources (rare by definition) would go towards organizations that would best know how to create value from them. This value would be measured in light of these organizations’ ability to make a profit by optimizing the difference between what they spend (in order to design, manufacture and distribute the products and services they offer) and the price they charge their clients.

As for the economic players whose clients would not value the products and services they offer, enough to provide returns covering, and in relation to the resources they exploit, they would be edged out, or even disappear, since they would not generate enough gains and could therefore no longer attract capital.

Zombie Companies

The issue with zero or negative rates is that they disrupt this functioning: they make room for a lot of unprofitable and indebted companies (sometimes called «zombie companies») to remain, at the expense of their more efficient competitors, thus squeezing their margins. Moreover, they probably divert an important part of capital flows to unproductive assets, since it does not make more sense to take the risks induced by investment in companies whose additional gains remain low.

For those, who believe that organizations involved in ongoing environmental and social transitions should on average outperform, if not outlive their less committed competitors, low rates are a threat because they threaten the emergence of the former by allowing the survival of the latter.

Creative Destruction

Furthermore, capitals that would not be supporting zombie companies would go towards historic real estate, the art market, vehicles collection, gold and other assets considered as «real», but that do not in any way increase the kind of wealth which allows for an improvement of the material situation of humanity.

Therefore, low rates stand in the way of the mechanisms of creative destruction dear to Schumpeter. And yet, what is the current environmental transition if not a case of creative destruction? The example of Japan, however, offers some reason to believe that long-term reduced cost of capital does not necessarily prevent economic transformation.

Japan: Twenty Years of Low Rates

As a brief reminder, in the 1990s, Japan began its low-rate cycle following the bursting of the real estate bubble in the 1980s, which had been fed by the spectacular post-war growth and demography emphasizing the population density on the archipelago.

It was then necessary to drain Japanese banks’ excessive balance sheets: resorting to consolidation proved to be the solution. As a consequence, Japanese finance, which was among the most powerful at the end of the 1980s, gave way to an ersatz of huge administration of savings and funding, but involving private capital. Contrary to general belief, this transition was nothing short of painful considering that:

  • the financial sector scaled down,
  • zombie companies survived and the great champions of Japanese capitalism were not so different from the ones who triumphed afterward,
  • if the senior employment rate seems so high in Japan, it is because pensions are not enough to guarantee them a decent standard of living. However, the good news is that this assessment is tempered by the capacity to invest in new technologies: Japanese companies (zombie or not) have maintained their efforts regarding research which allowed them to follow long-term transformations, although probably not at the same pace as in the 1960s, 1970s, and 1980s.

Capitalism Without Cost of Capital and Fundamental Statism

Should private capitals holders lose interest in directing them towards financing the energy transition, public authorities could take over, especially since they are now financed at very low, or zero, or even negative costs. Besides, they would play an almost regalian function, not necessarily as capital allocators but rather as supervisors of infrastructure serving political objectives, such as land-use planning.

The idea that applying the observations of Schumpeter could lead to States being actively involved in the financing of a largescale economic transition may seem surprising, but it would not be such an incongruity in a world that would reward borrowers for getting into debt.

Promising Message

But do not assume that finance has given up on contributing to this transition; quite the opposite in fact: regardless of their motivation, the efforts from players committed to taking more ESG factors into account when it comes to their investments send a clear and promising message.

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