When Credit Suisse announced its second quarter results on July 30 it unveiled a new sustainability, research and investment solutions function, highlighting its executive board leadership under Lydie Hudson.
This marked an attempt to coordinate sustainability initiatives across the bank and was accompanied by some tangible changes to policy. Credit Suisse aims to provide at least SFr300 billion ($332 billion) of sustainable financing over the next 10 years; it will no longer provide lending or capital market underwriting to companies deriving more than 25% of their revenue from thermal coal extraction and power, or finance oil and gas projects in the Arctic; and the bank intends to reposition its corporate oil and gas business to support companies in their own energy transition.
The announcement of board level leadership for the new sustainability function was something of a public relations sleight of hand, however. Hudson was already on the executive board in her capacity as head of compliance for Credit Suisse and her new role conveniently avoids a possible demotion for one of the few high-ranking women at the bank as a result of a merger of its risk and compliance functions, which was also announced on July 30.
ESG results and inflows have been impressive, but much of the recent outperformance came from avoidance of exposure to energy companies
Hudson is an experienced executive who previously worked as chief operating officer for the global markets division at Credit Suisse, but the appointment of a compliance head to run the new sustainability function at the bank is arguably a reflection of how ESG investing has been viewed historically by the financial services industry.
That may be changing as the market grows and diversifies to the point of confusion.
ESG investments performed well during the worst of the Covid-19-related market turbulence this year, with both equity and fixed income products providing slightly better returns than their market benchmarks. This has encouraged an acceleration in the growth of key product lines in what is now a $40 trillion market when broadly defined.
Rating agency Moody’s on August 17 forecast that social and sustainable bond issuance could total $150 billion this year – roughly a tripling from the total seen in 2019.
And figures from consultant ETFGI, released on August 21, suggest that the ESG exchange-traded fund and product (ETF/ETP) market could see a similar increase of around 300% this year. Assets invested in ESG ETFs and ETPs had broken through the $100 billion milestone by the end of July and net inflows of $38.78 billion were just over three times the $12.37 billion gathered at the same point last year.
ESG results and inflows have been impressive, but much of the recent outperformance came from avoidance of exposure to energy companies, which have suffered from a collapse in prices due to the Covid crisis and a disastrously timed oil price war between Saudi Arabia and Russia.
Conceptual challenges
As with many aspects of socially-responsible investing and lending, it is not difficult to envisage conceptual challenges from an approach that focuses mainly on exclusion of negative risk factors. Outperformance of broad benchmarks cannot be guaranteed by simply picking market sectors, for example.
Negative screening of undesirable investments has a long history, with vehicles that excluded tobacco and arms companies popular in the 1980s and 1990s.
The newly branded ESG industry developed momentum in the past decade with an updated version of this approach, by adopting a more complex cancel culture that gives companies scores on their performance against ESG goals.
These [US] banks are nothing if not adaptable, however, and social debt issuance could help them to muscle aside European rivals in the market for sustainable finance revenues
This allowed relatively quick screening of large groups of companies and as a side-effect created a burgeoning market in data and rating service provision. The scale and diversity of this data gathering effort now poses its own challenges.
Many large companies, including firms that operate in industries that create obvious environmental damage, such as oil and gas extraction and mining, are happy to pay a levy to have metrics known as key performance indicators (KPIs) monitored.
Whether this trend marks a genuine commitment to change or a cynical move to pay off critics of their business models can only be known by executives at the companies (unless ill-advised electronic communications leak, of course).
Unlikely evangelists
There is a growing appreciation among bankers of both the likely demand for new business approaches by the consumers of the future and the potential for fees from this shift. Consulting firm Oliver Wyman recently predicted that the revenue pool from sustainable financing could hit $150 billion in the next 10 years.
This is enticing enough to attract some unlikely evangelists of environmental and social change in the form of the biggest US banks.
European banks developed a substantial lead in ESG underwriting and structuring when the market was focused on environmental initiatives such as green bond issuance. European firms were relatively quick to make changes to their own environmental policies, including lending, while US banks were exposed to an obvious charge of hypocrisy when attempting to market green products, given their leading role in financing the oil and gas industries.
Energy financing revenues aren’t what they were, however, which has encouraged US banks to commit to less involvement in the sector. And the shift towards greater issuance of social products during the Covid crisis this year could play into the hands of US banks, if only by further confusing the criteria by which ESG improvements can be measured.
The KPI metrics for environmental and governance criteria are relatively well established. Carbon emissions and risk management procedures for boards are widely used, for example, even if both have potential for abuses such as managing towards self-decided goals.
The newer market for social KPIs is far less developed. Employee health and safety is likely to emerge as a key metric, but there are dozens of other potential factors that could be even harder to monitor – and easier to game.
A $5.75 billion social bond deal by Alphabet on August 3 highlighted the extent to which a move into sustainable debt issuance by giant US companies could instantly deliver ESG market share to US banks. The social bond from the Google parent (former motto: “Don’t be evil”) is the biggest corporate sustainable deal yet and featured Goldman Sachs, JPMorgan and Morgan Stanley as lead managers.
Goldman and Morgan Stanley were historically the leading commodity traders among banks, JPMorgan was the top fossil fuel lender in the wake of the 2015 Paris accord on climate change and all three firms played a lead role in last year’s $29.4 billion Saudi Aramco IPO.
These banks are nothing if not adaptable, however, and social debt issuance could help them to muscle aside European rivals in the market for sustainable finance revenues.
A past emphasis on excluding negative ESG factors in the European sustainable investment market may also hamper attempts by regional asset managers and banks to retain market share, if a move towards accentuating positive developments – or ESG momentum – becomes more popular.
The most significant development in the ESG market this year is the rollout of the European Union’s taxonomy on sustainable finance.
Few will miss the irony if 2020 also turns out to be the year when US banks use loose definitions of social financing as a lever to start displacing European firms from ESG market share.
