Week in Impact

Banks, and “ESG,” have had a bad week

“The first rule of ESG: Don’t talk about ESG.” - BlackRock, maybe. Plus, banks have a bad week.

In the world

🇺🇸The first rule of ESG: Don’t talk about ESG. In his annual missive to investors, BlackRock’s Larry Fink censored the term entirely. (‘Climate’ and ‘sustainable’ make the cut). Unofficial zeitgeist, the letter’s contents, or lack thereof, signal a deepening political crisis for US ESG.

🇺🇸 In her first speech to the Climate-related Financial Risk Advisory Committee, US Treasury Secretary Janet Yellen warned that the financial impacts of climate change are “playing out now,” pointing to a five-fold increase in annual billion-dollar disasters in the last five years.

🇺🇸 US companies are gearing up for a proxy season forecast to be “the most challenging yet.” Expect yet more anti- and pro-ESG shareholder proposals, rising on the back of partisan politics, economic challenges, and the SEC’s newly implemented universal proxy rule.

🗺️ Corporate counsels are bracing for an explosion of ESG-related lawsuits, according to law firm Norton Rose Fulbright. Of the in-house lawyers surveyed, 28% have exposure to legal action on issues such as disclosures and emissions, relative to just 2% of respondents in 2022. 

🇬🇧 During its Spring Budget, the UK announced that nuclear will be classified as ‘sustainable’ under its impending green taxonomy. By providing renewable-level incentives, the UK hopes to unlock nuclear investment and capacity it frames as “vital” to national net-zero obligations.

🇪🇺 Urged by the European Commission to “go beyond the usual stress tests,” EU regulators are testing the financial sector’s resilience to and ability to fund the climate transition. Recently, they also called for “enhanced climate-related disclosures” for structured finance products.

🇪🇺 Cerulli finds European pension schemes are flocking to “more sophisticated” customised sustainability mandates to meet “burgeoning demand” and mitigate greenwashing risk. Within tailored portfolios, impact and ESG are approached as “separate areas of focus.”

🇪🇺 Article 9 inflows continue to beat the market even as their number shrinks, per Bloomberg data. Flows were positive in every month of 2022, though it failed to lift the freeze on issuance by fund providers. The number of generic sustainability funds, meanwhile, grew nearly 90%.

🇨🇳 In cooperation with the IFRS, China is working towards mandatory ESG disclosures for domestic public firms. Meanwhile, Beijing is reportedly struggling to reconcile its “blunt” commitment to coal with an ambitious vision for carbon neutrality and renewable deployment.

In the spotlight

Banks have had a Bad week. 

The first of 57 news cycles started last Friday, when Silicon Valley Bank (SVB) failed after a run on its deposits. Plenty has been said and written and WhatsApped about the crash and its idiosyncrasies, of which there are several. 

For instance:

  1. That it happened. The second-largest bank failure in US history is, by definition, unusual.
  2. How it happened. 

The collapse wasn’t precipitated by hedge funds or investment banks tinkering with exotic financial instruments so inscrutable that few could even see the risks. It was caused by several basic risk-management failings that a) should have been captured by internal controls — or, at the very least, by reliable regulation — and b) proved cataclysmic when bundled together. 

For instance:

  1. Failure to diversify its customer base
  2. Failure to hedge its duration exposure
  3. Failure to prepare for rising interest rates

Note that the list above does not include ‘too much diversity of thought’ or ‘too much governance and risk management’. That would be a weird and illogical thing to say. People are, of course, saying it anyway.

ESG at SVB is the wrong issue on which to focus.

Putting aside the specifics of SVB risk controls and ESG policies and how did we end up in a place where a major national publication is insinuating that a crash might have been avoided had there been more straight white men on the board — putting aside all of that, for one moment, there’s a logistical flaw in the argument against measuring environmental, social, and governance risk factors. 

Implicit is the idea that things like global warming and governance failures, which have multi-trillion-dollar ramifications globally, are not only irrelevant, but that banks can only deal with so many risks at a time before losing focus. If that were the case, presumably the bigger problem than the type of risk would be the capacity of the financial sector to manage it.

Transition and physical (and legal and reputational and regulatory) risks pose a very real threat to the dollar value of bank portfolios — as, indeed, they do to insurance and investment portfolios. You may be of the opinion that society has grown too preoccupied with those issues, but a) it doesn’t stop the naturally occurring ones from existing, and b) the rest are financially relevant precisely because society is preoccupied with them. 

Refusing to engage is no more likely to alleviate the costs than is making public and empty declarations of allegiance to sustainability. This is the new face of risk management for financial institutions.

This year, banking regulators in the US, UK, Canada, and EU are rolling out and ramping up climate stress tests. If the banking crisis deepens (and even if it doesn’t) backlash and claims of ‘extraneous distractions’ are almost guaranteed — which would be weird and illogical, given there’s no stronger case for comprehensive risk management than a problem created in its absence.

Less than a year ago, Bloomberg opened a story about climate stress tests with the line “regulatory checkups by the Federal Reserve are one reason no one’s talking about a financial crisis today.” Had it had more of those, SVB might not have become a household name this week.

As we consider all of the arguments being made this week, our question is, have industry insiders been asking the right questions?”