Held to account
Held to account
As public interest in and knowledge of the intricacies behind the financial services sector’s ESG performance and green initiatives grow, the risk of being perceived to be greenwashing or sidestepping the real challenges in providing a truly neutral or positive impact on the environment have become a priority concern.
It’s been widely reported that banks’ environmental, social and governance (ESG) performance is of growing interest
to investors and other stakeholders, with discrepancies between goals and actions now coming under scrutiny and even attracting litigation. With the pursuit of profit no longer enough, banking professionals, like many others, are also more focused on their organisation’s purpose and ESG performance.
But, as interest in – and knowledge of – sustainable practices and reporting improves, do institutions have the measures in place to support the type of ESG-linked reporting required? And what is the risk for organisations not assuming accountability for their climate-related claims?
To explore this, we have to look at how the approach of banks – and the demands placed upon them by the 2015 Paris Agreement – has changed over recent years.
“Clients in the investment management space are increasingly sophisticated in their understanding of what ‘good’ looks like in terms of ESG risk integration,” says Caroline McGill, Sustainable Finance and Investment Fund Specialist at Hillbreak, a consultancy firm that focuses on ESG and combines strategy, foresight, risk management and advocacy.
“They’re becoming increasingly demanding in terms of credible reporting of real-world outcomes from the investments that they make. A few years ago, CSR [corporate social responsibility] or ESG reporting often involved glossy reports about a few cherry-picked examples of investments or decisions that they had made. They’re now expecting to see much more rigour around institutionalisation of risk management and measurement of the outcomes of their investments.”
Doubling up
One example McGill draws on is in the relationships between listed real estate companies and their partner banks.
“We’re seeing some really good examples of companies coming forward with their own sustainable finance frameworks and challenging their partner banks to go further in terms of what the business itself is going to achieve with the money that they borrow.
“In doing so, they’ve often furthered the banks’ own understanding of some of the relevant best practice in terms of specific ESG issues and terminologies, which has been a really good thing.
“The other change we’re seeing is that pension funds as investors are increasingly putting more muscle into their own internal capability to assess ESG risk. Investors are starting to challenge their investment managers in terms of their performance on stewardship and engagement. They’re also challenging managers on technical issues such as the level of exposure to the physical risks of climate change within their portfolios,” McGill continues.
“There’s a definite risk of reputational damage if banks are not living up to the commitments they make.”
Caroline McGill, Hillbreak
“Rather than, as would have been the more traditional approach, effectively asking the manager what they do and being happy or otherwise with that, savers are asking specific questions about the risk management and performance of the portfolio and assessing whether that’s good enough, in line with their own views on climate and social risk.
“Investors are becoming very switched on to the fact that ESG is relevant to the performance of their assets. It’s not just a marketing tool. It’s not a ‘nice to have’, it’s a set of risks that, if not properly understood, affects how appropriately the portfolio can be managed.”
A pressure cooker?
With this growing pressure on banks to accelerate sustainable processes and practices – and communicate this to a range of stakeholders – comes risk. Claims around climate-linked activity are sometimes overplayed or, in the recent argument made by former BlackRock employee Tariq Fancy, are “fallacies”.
Fancy, BlackRock’s former Chief Investment Officer for Sustainable Investing, said in an online essay The Secret Diaries of a ‘Sustainable Investor’, posted in August that sustainable investing is “a dangerous placebo that harms the public interest”.
“Green bonds, where companies raise debt for environmentally friendly uses, is one of the largest and fastest-growing categories in sustainable investing, with a market size that has now passed $1 trillion. In practice, it’s not totally clear if they create much positive environmental impact that would not have occurred otherwise, since most companies have a few qualifying green initiatives that they can raise green bonds to specifically fund while not increasing or altering their overall plans. And nothing stops them from pursuing decidedly non-green activities with their other sources of funding.”
In April this year, UN Special Envoy on Climate Action and Finance Mark Carney found himself in hot water
after making claims around the carbon-accounting methods used by Brookfield Asset Management – a firm of which he is the Vice Chair. Carney told attendees at a Bloomberg conference that Brookfield was “net zero” across its entire $600bn portfolio due to its “enormous renewables business that we’ve built up, and all of the avoided emissions that come with that”.
Climate experts were quick to label the claims ‘greenwashing’, and Carney was forced to backtrack and admit that avoided emissions don’t count towards science-based targets (SBTs).
Living up to commitments
What is the risk, then, of whistleblowers – both internal and external – calling out discrepancies around ESG claims, and how can organisations best prevent it?
“The whistleblower question is an interesting one,” says McGill. “With regards to external whistleblowers, it is certainly a huge reputational risk that if an organisation is making claims of what they do from an ESG perspective and are found not to be, then the reputational damage can be very quick.
“There are so many activist shareholders and other organisations that are really on top of pointing out any failure to live up to the expectations that organisations set for their stakeholders. And we’ve seen that with Brookfield where Mark Carney’s been challenged on some of the net-zero claims that he’s made – and since corrected. We’ve seen it with BlackRock being challenged on their voting records and engagement records, so it happens to some of the biggest and more sophisticated organisations that are really trying to tackle ESG risk head-on,” she adds.
“There’s a definite risk of reputational damage if banks are not living up to the commitments they make. Likewise, there’s a huge risk of reputational damage if financial institutions are falling behind in terms of social expectations of the commitments that they should make.
“We saw that with the Insurance Rebellion demonstrations in the City a few months ago. People were campaigning outside Lloyd’s of London to stop the underwriting of a railway that was going to service the Adani coalmine in Australia. The reputational risk is large and only getting larger.
“The way to mitigate that is to have a comprehensive policy, strategy and processes and procedures in place that ensure the integration of ESG risk management into the way money is managed.”
Natural capital
As organisations move to ensure they have processes in place to prevent whistleblowing claims being made around disparities in their practice or reporting, the focus needs to remain on the climate challenge, along with ‘natural capital’.
“The obvious priority at the moment, and I think it will continue to be, is in regard to climate change,” says McGill. “The next step is management and monitoring of the use of natural capital. As a sort of crossover from everyone’s focus on carbon and climate, there’s increasingly an understanding that biodiversity, the health of the oceans and reforestation and deforestation have a huge impact on climate change. Therefore, investors are getting much more savvy about understanding natural capital. It’s not just greenhouse gas emissions that are relevant to the climate risk of their portfolio.”
“The way to mitigate that is to have a comprehensive policy, strategy and processes and procedures in place that ensure the integration of ESG risk management into the way money is managed.”
Caroline McGill, Hillbreak
Litigation and activism
The other major risk that clients are being made all too aware of, says McGill, is litigation.
“There’s been a huge surge in litigation brought by private individuals and charities recently, challenging states as well as corporates in terms of their management of climate change risk. The broad trend is for those challenges to be successful. There’s not only the risk that investments will not perform as expected because of climate change, but that the social activism around it will multiply the effect of that on the bottom line.
“The regulatory environment around this is increasingly complex for any organisation that’s participating in the capital markets, because the regulation of one part of the capital markets impacts not just on that part, but also indirectly on other parts of the capital markets. As a result, banks are increasingly having to respond to the ESG requirements of their investors and, likewise, their borrowers are seeking well-thought-through sustainable finance products. But the regulation is not consistent across different jurisdictions,” she continues.
“The EU has gone ahead, and the UK and the US are playing catch-up in terms of ESG terminology and regulation of investment claims and marketing in this respect. The issue is going to be that there will be some inconsistency across multiple sets of regulation that are written by different regulators. It’s really important that every player in the capital markets is aware not only of what’s going on in their own specific vertical, but what’s going on for others and what are the requirements going to be of their stakeholders and the other actors with which they interact through the capital markets.”