Round Table: Ethical Finance Market Update - Keynote Interviews
Baillie Gifford – EFH Roundtable
16 December 2019, 16:00 – 18:00
Ethical Finance Market Update, Market Trends
Interviewer: Gail Hurley
Panel Participants: Andrew Cave, Thom Kenrick
Summary:
In a change to the usual format this session, once again hosted by Baillie Gifford, comprised of two keynote interviews which provided reflections (from the investment and banking sector) on the evolution of the ethical finance market and how the market will adapt to on-going political, economic, social and environmental uncertainty.
The interviews were conducted by GEFI Senior Consultant Gail Hurley who has recently completed 10 years with the UN in New York as a Senior Advisor.
Gail framed the session within the context of growing interest in driving a fairer, more sustainable financial system and the fact that 2020 will be a significant year for climate issues in Scotland as it welcomes the world to Glasgow for COP26, the UN climate conference.
Andrew Cave, Head of Governance and Sustainability at Baillie Gifford, was first up and he argued that ethical investing has moved from niche to mainstream. While in the past companies would not put their best people and resources into it, today the situation is changing. According to Andrew the overall direction is positive and there is a lot of interest from institutional investors. Continuing challenges include: the complications in defining a positive impact (as the market is still in its early days) and the intractable debate over what constitutes positive social impact.
Andrew offered some fairly candid views on confusion around terminology highlighting the fundamental difference between ESG, which factors issues such as climate risk, data privacy issues and regulation into existing investment paradigms, and responsible investing, which is more directive and it aims to reach a particular outcome. It was suggested that clear rules need to be designed to avoid a risk of diverting money away from those who can make a positive contribution. Another challenge mentioned by Andrew was the lack of quality data on complex value chains. A full view of impact requires improvements in disclosure and standardisation of data, which enables more sophisticated discussions about potential transformations in transportation and production systems.
Thom Kenrick, from the RBS Sustainable Banking team, was next in line to be interviewed by Gail. Unsurprisingly, Thom began by highlighting the major changes that have taken place in the banking sector in recent years and how this has driven RBS’s journey of reform and restructure. The financial crisis fundamentally changed regulation as banks were placed under greater scrutiny by both regulators and wider stakeholders. Thom described the growing interest in ethical finance from RBS customers but pointed out that many still struggle with the lack of consistency in terminology and approaches. In relation to social finance Thom suggested that this means financial inclusion to one, diversity to another and divesting from a power station to someone else. Unlike environmental impact, there is not a right or wrong answer as so many different aspects of social life have no scientific base.
Thom felt that while international standards may help in providing consistency, he pointed out that while PRI (2005) and TCFD (2015) have been around for a number of years few signatories are genuinely delivering to the required standard. That said, according to Thom, the situation is changing as customers, investors and the public are increasingly scrutinising firms so whilst such standards are voluntary, the consequences of not following them risks deterring prospective / existing customers and investors.
Despite the challenges outlined throughout the session the discussion ended on a positive note. Younger generations are more conscious, and their demand is expected to drive ethical finance in the long term. Change takes time and previous developments in ethical finance, whether successful or not, will have played a part in shifting mind-sets and practices. Although nothing is yet set in stone leading market players, such as big Baillie Gifford and RBS, have established dedicated teams, products and services to raise awareness and drive finance for positive change.
COP26 – Role of Finance in Tackling the Climate Crisis
COP26 – Role of Finance in Tackling the Climate Crisis
This year’s UN Climate Change Conference in Madrid has wrapped up, and all eyes will now focus on Scotland as next year’s host of what is arguably the world’s most important international conference. Also known (somewhat confusingly) as COP 26, Glasgow will be centre stage between 9 and 20 November 2020 as it welcomes an estimated 30,000 delegates from around the world.
Next year’s climate change conference will be particularly important since it will mark five years since the historic Paris Climate Agreement, which committed countries to strengthening actions to combat climate change and limit the global temperature rise this century to below 2 degrees Celsius. We know however that the world is not on-track to cut carbon emissions which must be halved on today’s levels to restrain temperature increases to just 1.5 degrees Celsius, the upper limit advised by climate scientists. Progress will need to be ratcheted up by next year.
Over 500,000 people marched through the centre of Madrid this month, joined by young climate activist Greta Thunberg, to demand quicker action to tackle climate change, yet many have been left frustrated by the lack of urgency that has characterised this year’s climate conference. Madrid has been dominated by disagreements over carbon emissions trading (where more polluting countries can purchase the right to pollute from countries that have not yet reached their emission limits – seen by many as deeply unfair and a false solution to the climate crisis) and an international push to have rich countries pay poorer countries for “loss and damage” associated with irreversible climate change impacts.
Next year, the spotlight is expected to shine on the thorny issue of how to pay for climate damage, and how to mobilise the trillions needed for international climate financing programmes.
Financing needs to tackle the climate crisis are estimated in the trillions worldwide, and are especially high in the poorest countries and those particularly vulnerable to climate change, such as small island states. The UN estimates a US$ 3 trillion annual shortfall in investments needed to meet internationally-agreed climate and sustainable development goals.
A decade ago, industrialised countries pledged to jointly mobilise US$ 100 billion annually in climate finance by 2020 to address their needs. Yet only US$ 71 billion was raised in 2017, mostly from public sector aid budgets (and with most provided as loans). There is a consensus that more resources need to be mobilised from private markets for climate-friendly investments and to support a “just transition” to net-zero.
This is where our work to promote Scotland as a leading international centre for ethical and responsible finance comes in. The climate emergency has underscored the importance – indeed urgency – of building a financial system that has better outcomes for people and planet at its heart. Our work at the Global Ethical Finance Initiative (GEFI) headquartered in Edinburgh, builds on Scotland’s proud heritage in ethical finance and financial services, to convene the world’s foremost political, business and civic leaders to define and shape the transition to a sustainable financial system.
Within the financial services sector, interest has increased significantly over recent years in the ways it can – and should – look beyond short-term profit and shareholder value towards how it can drive positive social, economic and environmental impact. Increasingly, investors and consumers want to be more thoughtful about the impact their money can make on the world. This has led to a plethora of new initiatives and financial products, such as ethical investment funds, sustainability bonds (where the proceeds are exclusively applied to finance green or social projects), and the development of UN-led Principles for Responsible Investment. Globally, the impact investment market is increasingly popular and is now estimated at over US$502 billion (impact investments are those that seek a positive social and environmental impact in addition to a financial return).
At this year’s climate conference, the European Union unveiled its “Green New Deal” intended to transform Europe’s economy and eliminate its contributions to climate change by 2050. Scotland is even more ambitious: this year it adopted landmark legislation to become a net zero society by 2045, and to reduce emissions by 75% by 2030. Delivering a green transformation that will support employment creation, build skills, boost wages and trigger technological advances will require building a new generation of infrastructure and industries. In addition to well-planned public expenditure that can crowd-in private investment, banks will need to ensure they are able to provide the kinds of financing needed to support this transformation. Aligning their business strategies with society’s goals will in turn will help them leverage new business opportunities and remain competitive with the emergence of the sustainable development economy.
Our view is that finance can be a positive force for change. As we enter a “decade of action” on climate and sustainable development, COP26 in Glasgow in 2020 provides an opportunity for Scotland to showcase the important work it is doing to accelerate the transformation towards a more socially responsible and inclusive financial system – one that serves both people and planet.
By Gail Hurley: Senior Consultant, Global Ethical Finance Initiative (GEFI)
Gail was formerly a Senior Advisor to the UN
Follow on Twitter: @gailmlhurley
Follow GEFI on Twitter: @Finance4Change
UN PRB Insights: Teething Issues
Teething Issues
The UNEP FI has begun a public consultation period, which is open until May 2019. It acknowledges that there are areas of weaknesses and invites suggestions. It also provides case studies of several institutions already practicing specific behaviours in accordance with the global goals, making it easier for practitioners to benchmark and contextualise how their institution can embrace the SDGs.
1. Over Encouragement
It encourages any change towards reducing negative impact and increasing positive impact however unprecedented or imperfect, giving an example of a bank that “does not yet have all the answers” (who does!) that has set an ambitious goal and linked it to targets. It also provides references to expertise that can support a bank’s journey towards responsibility. The materiality map by the sustainability accounting standards board (SASB) is a useful taster.
The UNEP FI goes further to encourage greater adoption of sustainability practises by making it easy for even the least prepared banks in the world to sign up. Although the ability to self-declare as a starter or intermediate when becoming a signatory will greatly reduce expectations for the first two to four on early stage banks, the UNEP FI team must ensure this mechanism is not abused by advanced banks trying to manage expectations.
Furthermore, this four-year honeymoon for some means that there may be a disproportionate number of signatories who only begin contributing significantly to the global goals from 2023 onwards. Given the timebomb ticking on our planet just now is that going to be soon enough? The Intergovernmental Panel on Climate Change (IPCC) report produced in October says we have “a little over a decade” from now (Maitland AMO Green Monitor).
C-Level Responsibility
Founding members must ensure seamless alignment within their organizations as they gear up for the signing ceremony later this year. It is easy to plug a team of junior sustainability professionals in the back office while bankers tap away on the trading floor working in silos from each other. Half of the heads of sustainability at a GreenBiz Conference Board meeting in the US in 2016 reported half an hour or more of face time with the CEO three times or less in a year. Really?
Let’s not read a report ten years from now that says what E3G’s Briefing Paper said in March 2017 of the UN PRIs: “Our analysis finds that 33% of signatories directly employ no ESG staff and a further 20% employ just one. This means over 500 PRI signatories, representing $6.9 trillion, directly employ one or fewer ESG staff. On an asset under management (AUM) basis, the average PRI signatory hires one ESG specialist per $14bn of assets managed.”
Change of leadership can also dilute the process if sustainability is not properly plugged into the C-suite. Take the example of Yes Bank in India. It’s share price plummeted 34% when news surfaced in September that Rana Kapoor, its CEO, would be forced to leave (by the Reserve Bank of India) by January 2019. The fact that it has a dedicated Chief Sustainability Officer, who in fact sits on the Global Steering Committee of UNEP IF, provides comfort that this will not derail the bank from its UN PRB drive.
There have been many peer to peer initiatives that have worked hard to transform specific areas of the banking industry by producing results such as the Soft Commodities Compact that supports the reduction of deforestation, or the Equator Principles used as an environmental risk management barometer in project finance. However, an international initiative to infuse sustainability into every vein and artery of a bank across business lines indicative of the UN PRBs has rarely come to market. We welcome the boldness of the UN PRBs in spirit and urge those involved to ensure even bolder results.
UN PRB Insights: The Cost of Deliverance
The Cost of Deliverance
The UN PRBs are meant to align banks with the SDGs and the Paris Climate Agreement through a single framework that “embeds sustainability at the strategic, portfolio and transactional levels and across all business areas” (UNEP FI). The principles make goal setting a priority, steering the focus towards high impact issues consistent with each particular organization’s materiality map and encouraging reporting that integrates the impact on all stakeholders. It goes further, something rarely done in initiatives like these, to declare it will delist a signatory if it does not step up. UNEP FI will need to bravely follow through with this threat for the UN PRBs to deliver past the semantics.
The UN PRBs are not perfect, but they are a desperately needed paradigm shift that will see a more innovative approach to a weary and disconnected financial system. Some of the enormous challenges include “being transparent on the scale of your contribution to targets”. Unless more work like the science-based targets initiative is done in a wider range of areas than climate change, other hair-raising issues will tend to fall off the agenda. In addition, sustainable impact takes often years to bear fruit complicating matters. The implied costs of integrating sustainability into the heart of each bank and the skillset of each banker, and spending yet more on technology after a booster year of tech spend is concerning. Who will eventually foot the bill? Banks will need to provide confidence especially to its skeptical retail customers that they won’t.
Banks have already had their share of margin erosions over the last ten years. Costs are still 25% above 2008 levels. Litigation expenses peaked to $137bn in 2014. They are now falling in line with legacy conduct improvements but that signals the expected peak of related restructuring costs (EY Global Banking Outlook 2018). Banks are also spending more on technology transformation and cybersecurity. Other risks such as reputational and conduct remain high as is “improving culture” and remaining relevant in an increasingly regulated environment with market uncertainties and socio-political differences not seen before, certainly not by the generations that make up the armies of bankers in suits today, all infringe on optimal performance of these institutions. So how will they cope with the additional pressure that embracing the UN PRBs will come with in the short term?
Banks will also need to do further stress testing against a wide range of scenarios to understand the impact of embracing sustainability goals within the organizational or business context and the greater marketplace and external forces that will result from potential wide spread adoption on their financial performance and hence their credit ratings. The impact of change on the health of their corporate clients across sectors will need to be considered as well. For example, high greenhouse gas emitters can be found in not only the energy, steel or cement sectors but also the glass, agriculture, real estate, transportation and glass sectors. Stricter environmental standards can lead to higher operating costs, which in turn can impact a client’s probability of default and hence a bank’s non-performing loan ratio, in contrary to the lower default risk UNEP FI seems to suggest.
Following the UN PRBs will require not only a change in the types of services and products offered by banks, but – if implemented in its holistic glory – drastic reformation of a bank’s belief system, its purpose of existence, its brand and communication strategy, its day to day operations, its client base, its risk management system and its approach to remunerating its people amongst other things. This is incredibly brilliant given the potential extinction of the world as we know it that we face today, but equally daunting. Everyone in the ecosystem – governments, NGOs, institutions, service providers, and community leaders – will need to help banks that are willing to work towards these reforms get there. We must see ourselves as stakeholders now and not victims.
UN PRB Insights: The Early Adopters
The Early Adopters
It has taken 12 turbulent years of uncertainty in the financial industry to get the sell-side to align with the buy-side which has embraced the UN PRIs. It now appears the balance could indeed shift IF the UN PRBs actually work, given their alignment with the SDGs and the Paris Agreement unlike the former which takes a softer dated ESG position. A strong signal will be if we have a few champion banks announce bold targets at the formal launch of the UN PRBs in May 2019. This is very likely given that many banks involved in the drafting of the UN PRBs have been actively implementing new standards of practice that align with the principles already.
Take SocGen for instance. Just four years ago (2015) SocGen was actively increasing its exposure to coal-based projects e.g. 770 MW coal fired power station project that would increase capacity by 80,000 tonnes in the Dominican Republic. Only a year later it announced that it would phase out its outstanding loans to the coal industry to less than 20% of its power production portfolio by 2020. BNP Paribas has taken similar measures and stepped it up with restrictions on some parts of O&G financing in addition to coal.
There are a myriad of banks in the founding group that are at very different points of their sustainability journey. This is very promising to see, as it reflects some level of initiative not seen before by an industry that has an inertia to positive change until regulation dictates otherwise. Take the case of Barclays, which continues to witness great friction with stakeholders. From activist investors (Ed Bramson’s Sherborne) and a CEO fined by the FCA for lack of diligence to protests by People&Planet at its AGM against the financing of the Kinder Morgan Pipeline in Canada. All of this happened last year. As a founding member of the UN PRBs, what can we expect from Barclays this year?
We could go through the list with a fine-tooth comb, but the point here is not to shine a torch on negative impact but to highlight a joint initiative that could lead to a lot more positive impact from an industry that continues to struggle with its past. The UN PRBs could catalyze systemic change that is long overdue. It is the first set of principles launched that takes a deep and holistic approach to sustainability integration into a major industry that has impact on all the rest of them. This could have a positive ripple effect on the entire economy, especially if the majority of global banks that continue to finance projects in laggard sectors that drag their heals towards sustainable practices sign up and deliver.
One such mass are the North American banks. Neither a Canadian nor a US Bank has participated in developing the UN PRBs. Just look into one arena as a litmus test: the financing of extreme fossil fuel power at “top companies” by banks over the three years from 2015 to 2017. The top 10 that made the league table (Banking on Climate Change 2018) are primarily Chinese and North American institutions: CCB, RBC, JPMChase, ICBC, Bank of China, TD, HSBC, ABC, Citigroup, and BoA. It is hopeful on the other hand to see a Chinese bank, namely ICBC that ranks forth on the league table, participate in the UN PRB initiative.
The UN PRBs not only link deliverables to the global goals but also to “other relevant national, regional or international frameworks”. Without a relevant national framework in every country around the world, the scope is limited. Brazil, for example, champions this notion. In 2014, the Central Bank of Brazil (BCB) published a mandatory Resolution 4,327 for financial institutions to have social and environmental responsibility policies. Lobbying with local governments and policymakers around the world will be essential to see more countries do the same. Rabobank is another strong role model, actively voicing its views of the role of government in sustainable finance. In its June 2018 position paper, for example, it talks about coordinating policies at the EU level and suggests “targeted – and temporary/ evolving – subsidies, such as for green loans, for green deposits”. Financial incentives will most certainly help Banks generate more positive impact.
Therefore to maximise the impact of the UN PRBs, the world will need a lot more than 28 signatures. It will need dedication, courage, and resources from all early adopters, crafters, and endorsers to summon the masses into the UN PRBs and pressure national and local government bodies to issue and revise policies, incentives and legislations to augment it.
UN PRB Insights: The Spirit of Responsibility
The Spirit of Responsibility
The UN PRBs, unlike the UN PRIs and more like the SDGs, are expressed with proper and specific nouns first before any statement such as “we will…”. This gives it universal gravitas, and freedom to be applied in every way possible and every way that becomes possible. Given this property, the UN PRBs are relatively ageless to the UN PRIs. Here are the principles briefly reintroduced with their expansive character supported by extracts from the principles documentation issued publicly so far.
We find that a major challenge will be to understand metrics and apply frameworks and collect data that are not only standardized and normalized across banks for better assessment but also equally weighted on each SDG. Much of the supporting information provided by the UNEP FI so far is climate change heavy and cannot granulate completely how to quantify the principles’ universal and multifaceted character.
Principle 1 (Alignment) beyond alignment with global goals attempts to ensure improvement continues indefinitely by recommending that targets should “exceed mere alignment with the SDGs, the Paris Climate Agreement and other relevant national, regional or international frameworks.” There are standards such as the yet to be released ISO14097 relating to climate change that will be necessary for signatories to make progress addressing issues adverse to the SDGs embedded in their business practices.- Principle 2 (Impact) encourages growth into new sectors or client segments to increase positive impact as well as invest in technology and innovation for better outcomes. Banks will need to think about forward looking scenario-based assessments of risks and opportunities. Again an approach and methodology to do this in the area of climate change is provided by the Task Force on Climate related Financial Disclosure (TCFD). The PI Impact Radar can help identify impact across the greater sustainability spectrum. Banks are encouraged to “provide remediation for adverse impacts, which the enterprise has caused or contributed to.”
- Principle 3 (Clients & Customers) suggests mapping clients by sector to identify their impacts on the SDGs and to play a role to support their management. It covers the integration of sustainability questions in onboarding and know your customer procedures and creating a “race to the top among clients” by giving incentives to the sustainable ones. Again the use of technology is encouraged to innovate and offer better suited products to a better understood client base in line with the global goals.
- Principle 4 (Stakeholders) highlights the need to build relationships across the supply chain, contractual (e.g. employees and suppliers) and non-contractual (e.g. trade unions and governments), in different dosages to enable a bank to “deliver more that it could by working on its own”. It also calls for signatories to “proactively advocate for sustainable regulations and frameworks.” and to address “affected” stakeholders defined as those affected by a bank’s indirect impacts (e.g. wildlife) via NGOs. Once again, the use of technology for engagement is advocated.
- Principle 5 (Governance and Target Setting) is more like two principles in one. The first being governance and culture, suggesting sustainability be shifted to the core of governance. Staff should integrate this into daily work practices, decisions and reward schemes and senior management need to communicate the company’s vision and mission in tune with its sustainability targets. The second being target setting, highlighting the need to set ambitious targets in line with one or more goals at a timescale in sync with that of the goals or, even better, earlier.
- Principle 6 (Transparency and Accountability) draws on the need for accountability for a bank’s actions and its positive or negative impact on the global goals. 14 months after signing and annually after that, members will need to include UN PRB implementation data in their public reporting. It refers to frameworks that can be used, giving evidence that a guidance on assessing climate related risk will be released in May 2019. There will be two methods by which an external review process could be conducted: third party assurance or a defined scope review. The latter being where an accredited review partner only uses public information to assess whether a set of criteria are met by the bank.
UN PRB Insights: UN PRIs Pass the Baton
UN PRIs Pass the Baton
On 26th November 2018 28 banks from 20 countries came together as the founding members of the UN Principles for Responsible Banking (UN PRBs). In this historic move, despite a diversity in culture, beliefs and systems, these financial institutions, representing $17 trillion in total assets, showed a common interest to align business with society’s goals.
The UN PRBs, launched in draft format by UN Environment Finance Initiative (UNEP FI) at its global round table in Paris, offers the first comprehensive framework on the integration of sustainability through every function of a bank. It comes twelve years after the UN Principles for Responsible Investment was launched with 20 signatories representing $2 trillion in 2006, which has now grown to 1750 signatories with $70trillion in AUM. The global banking industry is at least twice that much in size ($134 trillion, 2016, MarketLine). It is very interesting to see this sector dislodge from its inertia and pave the way to far greater positive change than defined in the UN PRIs.
The six principles are presented below alongside the UN PRIs for comparison.
Perhaps the UN PRIs need to be updated to reflect the SDGs now. Currently, it is limited to ESG issues prime to the period when it was launched but which represent a minor area covered by the SDGs. It’s marginally effective if one part of the industry is dancing to a different tune.
Having said that, the responsible investor movement is more mature than the responsible banking movement in a greater sense. It took inspiration from the lives lost in the 2008 financial crisis, the rise of the environmental and socially conscious newer generations with growing affluence and the track record of faith-based investors since as far back as the 1600s.
It is the less mature responsible banking movement that needs a push. The UN PRBs tackle the industry’s consciousness. If implemented well, we could see greater alignment between banks and investors whether the UN PRIs are updated or not. This could unlock significantly more capital towards SDG-linked investment opportunities and the four Ps: people; planet; prosperity; peace.
During their consultation period open until May 2019, we will post insights on the UN PRBs regularly.