Wednesday, April 24, 2013

Sign of the times: ESG Products & Services

Recent banking scandals have raised interest in corporate governance and organisational culture as make-or-break features of what makes a responsible financial institution. These can also be found in a longer list of sustainability expectations of financial institutions that have crystallised over the last two decades. In my work with Incite we have identified the ten core normative requirements found today in leading international ESG initiatives for the financial sector (banks, insurance, investment). They relate to:
  • Compliance
  • Corporate Governance
  • Decision-making
  • Risk Management
  • Products and Services
  • Internal Operations
  • External Value Chain
  • Monitoring and Reporting
  • Stakeholder Dialogue
  • Collaboration with Industry, Research Community and Regulatory Bodies

Other than governance and the quality of management in the institutions, two key features that emerge from the above is the requirement to integrate environmental, social and governance (ESG) criteria in risk management and business decision-making, and the requirement to develop products and services - "solutions" - explicitly dedicated to ESG themes. While the former lends itself to a focus on mainstream, core business and business strategy as addressed earlier in this three-part series on "Banking and Sustainability", the latter fits more easily with an explicit sustainability strategy that targets what is - leider, hélas - still a niche market.

It is known that insurance companies take their time in introducing new products and services. They need the relative certainty of historical data before rushing into new terrain. But banks are better positioned to introduce ESG-labelled solutions in the short term. This implies the promotion of ESG themes. It implies systematically addressing for example environmental goals when investigating the "purpose of the loan" and "use of proceeds" in making loan underwriting decisions.

A good collection of innovative examples of Green Financial Products and Services has been published by the North America Task Force of the UNEP Finance Initiative (2007). These include solutions such as green car loans and forest bonds. Some bank managers have expressed to me their fear that introducing ESG-labelled products and services may expose them to accusations of greenwashing and PR. Yet the introduction of such solutions sends an important signal to the market and consumers, and enables a bank to track the level of market demand for a solution to a clearly defined ESG problem. The introduction of ESG solutions can also help a bank to diversify and avoid concentration of its risk in lending areas that will increasingly face investor and regulatory pressure based on environmental and socio-economic trends.

Most banks are displaying slow progress in the use of ESG criteria - either in mainstream risk management or in the introduction of new products and services. The area of project finance, where environmental and social issues associated with large-scale infrastructure development tend to make the headlines, has been illustrative. The scale of the impact of the Equator Principles (2003), a credit risk management framework based on IFC standards, remains open to question. Project finance is nowhere near the booster for sustainable development that it can be. Amidst regulatory uncertainty, initiatives such as the Carbon Principles, launched by US banks in 2007 with a focus on the financing of electric power projects, and the Climate Principles, launched with British and French banks in 2008, have struggled to gain momentum. The Natural Capital Declaration (2012) still has to prove its impact, but expectations are high.

Will banks raise to the occasion, or will it take more shocking exposures of non-performing loans in public trust? On a number of occasions embarrassing findings published by independent research institutions (including NGOs) have put the reputation of mainstream banks in the spotlight and moved some to take significant action. Examples in recent years have been findings by Utopies on the carbon footprint of major French banks, reports by the Rainforest Action Network on funding by banks of mountain top removal mining projects, and studies by Oxfam on the impact of speculative trading in agricultural commodities. In the case of the latter, in February this year Barclays Bank announced that it will stop speculating on food commodities. BNP Paribas decided to suspend a USD 214 million agricultural fund, while Credit Agricole closed three related funds. The campaign message - "Banks: Profiting from Hunger" - clearly had impact in the short term.

In addition to ESG due diligence and leaving (exit) certain areas of business, some promising announcements related to the introduction (entry) of ESG-themed products and services came from the investment community in early 2013. Allianz Global Investors announced the launch of an infrastructure debt fund in the UK that will help build schools, hospitals and more sustainable transport infrastructure. The announcement reflected the value of infrastructure debt for institutional investors such as pension funds and insurance companies, who in their search for assets to match liabilities are frustrated by government bonds that offer very low yields. In another example, UBS Global Asset Management has launched UBS Clean Energy Infrastructure Switzerland. Linking institutional investors with market participants such as power suppliers, the fund provides investors access to a diversified portfolio of infrastructure facilities and companies active in renewable energy as well as energy efficiency.

It remains to be seen how the launch of new ESG-themed funds will be impacted by or influence calls by regulators and others for making a clear division between investment banking and commercial or consumer retail banking. Retail and business banking can certainly take inspiration from new ESG-themed funds such as those cited here. This will hopefully move more to seek new ways of scaling up their own range of products and services specifically dedicated to ESG issues. These are not products and services we cannot afford in times of struggling economic growth. These are products and services we desperately need to launch economic growth on a new, sustainable path. It is increasingly clear in both developed and emerging markets how the risks associated with the absence of action in this area will weigh heavier than the perceived risks of breaking new market ground.

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