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Post-truth reputational risk: the Wells Fargo saga

Americas / 16-03-17 / by
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At the end of February, the City of Seattle decided to end a 17-year banking relationship with Wells Fargo, citing the bank’s fake account scandal and involvement in the controversial Dakota Access Pipeline as its main motivations. GTR investigates the events that led to the decision to determine whether reputational risk for banks has just been kicked up a notch.

It has been a tough year for Wells Fargo: in the third quarter of 2016, it became apparent that since around 2011, its employees had opened up to 1.5 million deposit accounts and issued 500,000 credit card applications for unsuspecting clients, without getting customers’ authorisation. The scandal led to lawsuits, thousands of layoffs and US$190mn in fines and settlement fees.

Around the same time, protests against the construction of the Dakota Access Pipeline escalated, leading to police violence and human rights violations.

Activists for the environment and indigenous rights argue that the pipeline risks damaging sacred burial sites, and polluting waters in the Standing Rock Indian Reservation. They started putting pressure on the bank to stop financing the project and its developer, Energy Transfer Partners.

All of this came to a head in February: Seattle council members Tim Burgess and Kshama Sawant sponsored a bill to pull US$3bn of annual municipal business from Wells Fargo – representing about US$1mn of profits (or around US$400,000 after tax) for the bank. The bill was universally approved by the rest of the council.

Delayed reaction

The decision, which was copied by a small California town and considered by many others, including New York, raises a number of questions.

First, it was made a little too late: the loan agreement for the Dakota Access Pipeline (DAPL) was signed in August 2016. After that, banks involved in the project were contractually obligated to provide the funds.

There was a little delay in the disbursements as then President Barack Obama ordered a pause in the pipeline’s construction until further environmental assessments were made. President Trump, however, lifted the block via executive order as soon as he came into power in January, and by February, all the funds had been disbursed.

By this stage, the project was already 98% complete.

“Before the last part of the loan was disbursed, such pressure was useful to at least try to make the banks hold on to their last tranche and put pressure on the company, but that’s all too late now. I don’t know exactly what brought the City of Seattle to make that decision, they know full well that it’s not going to change the situation on the ground but it’s a signal to banks that if you enter that kind of loan agreement, that’s the consequence,” Johan Frijns, director of BankTrack, an NGO, tells GTR.

For Rebecca Adamson, founder and president of First Peoples Worldwide, a lobby group representing indigenous people, it’s important to put pressure on banks so that they in turn pressure the project developer. In this case, the pressure was applied to Energy Transfer Partners (ETP) to come to a resolution with the aggrieved tribe.

“We’ve been asking that they [the lenders] support the tribe’s decision for a re-route, and while we also asked them to pull their money, it’s clear that these are loans with terms and conditions that they can’t just change.”

This pressure has had some results: various lenders (including Wells Fargo), hired an independent human rights law firm, Foley Hoag, to advise them on the project and and to review various matters related to the permitting process, including compliance with applicable law related to consultations with Native Americans. Some also agreed not to provide any further financings to ETP as a result of the controversy.

Wells Fargo is also one of seven banks (the others are Citi, Crédit Agricole, DNB, ING, Société Générale and TD) that immediately agreed to hold meetings with the Standing Sioux tribe to hear their concerns. In contrast, four banks declined the meetings (BayernLB, BNP Paribas, Mizuho and Suntrust) and six did not respond to the request at all (Bank of Tokyo-Mitsubishi UFJ, BBVA, ICBC, Intesa Sanpaolo, Natixis, and Sumitomo Mitsui Banking Corporation).

But more importantly, Wells Fargo is one of 17 banks involved in the DAPL syndicate and did not take a lead role, representing only 5% of the loan amount. Citi was the lead bank on the transaction, and the Bank of Tokyo Mitsubishu UFJ, Mizuho and TD Securities acted as co-mandated lead arrangers.

For all these reasons, not to mention the fact that the Dakota Access Pipeline is located 1,000 miles away from Seattle, with no potential consequences for its inhabitants, one can wonder how the project played such an important role in the city’s decision.

Wells Fargo’s government and institutional banking head Phil Smith tells GTR: “Singling out a bank that financed 5% of the pipeline and is not the lead lender is not a very thoughtful approach. It’s a slippery slope, because if a city pulls its banking services from all banks involved in projects with potential consumer, environmental, or indigenous peoples’ issues, it won’t have any major banks to work with. Is that an effective strategy in running a city?”

 

Seattle changes its tune

When the Seattle council voted on the bill, it was clear that DAPL was a major reason. In fact, council member Sawant’s started her post-vote speech by saying: “As far as I know, Seattle is the first city to have divested from Wells Fargo. The example that we have set today can be a beacon of hope to activists all around the country, looking to change the economic calculus of corporations who think that investing in the DAPL will be good for their bottom line. We’re making it bad for their bottom line.”

But the fact that 17 banks, including two major US banks, are involved in the project may make it difficult for Seattle to find a non-contentious replacement for Wells Fargo.

As the bidding process for the city’s banking services grew nearer, the city’s stance began to shift. At the end of February, Seattle Mayor Edward Murray received a letter from Wells Fargo’s Smith, lamenting the termination and listing facts about DAPL.

In his response, the mayor did not mention the pipeline concern, citing only “the enforcement actions issued against Wells Fargo by the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency, City and County of Los Angeles, and Department of Justice”. In other words, the settlement case.

When GTR asked the Seattle governors whether or not banks with DAPL exposure would be excluded from the bidding process, a representative said that “one thing that shouldn’t be lost is that the city first took action in the fall after the fraudulent accounts issue, and traces this decision back to that”.

Even if we focus purely on the settlement case as the main reason for cutting ties with the banks, Seattle’s reaction is considered to be excessive by Wells Fargo.

Smith explains: “It’s hard to see how the Council followed a fact-based approach. They didn’t ask us how the settlement actually impacted Seattle residents. The fact is that less than 1% of Seattle citizens were impacted, and we have already refunded any fees associated with those accounts. In its public deliberations, the Council never weighed our mistake against our positive corporate citizenship over the past 160 years in the local community. They didn’t consider the potential consequences of its decision to change banks on local taxpayers. And they didn’t seem to give any weight to the personal contributions of our thousands of local team members – many of whom were born and raised in Seattle.”

The truth is, Seattle’s decision appears to be a knee-jerk reaction – most likely with political motivations – more than a well thought-out step to benefit the city’s residents.

In fact, it will probably cost them, as the process of swapping banking providers will come at a price, and if the council wants to exclude banks with exposure to DAPL, it may have to pick a smaller-scale (and therefore more expensive) institution.

Other cities’ reactions to the scandal are another indication that Seattle may have overreacted. For example, New York mayor Bill de Blasio sent a letter to the 17 banks involved, highlighting concerns over the financial and reputational risks associated with financing the project.

“I urge you to withdraw your financing, or failing that, to use your position as a lender to press your client to negotiate a reasonable resolution that removes the threat to the tribe’s concerns,” the letter reads, without threatening to withdraw business from any of the institutions.

Smith adds: “There are several other instances of elected officials around the country considering the Seattle strategy. City Council members initially got a lot of national media attention when they made this decision, so other aspirational politicians are following along. Since we sent our letter to the Seattle mayor, and the facts about the settlement and the pipeline have become clearer, we are starting to see other communities be more thoughtful in their approach.”

It is worth noting that the letter was widely reported as a “threat” to Wells Fargo alone, rather than a warning to all 17 banks, emphasising the extent to which Wells Fargo has been made the villain of the piece.

Consequences for the industry

The Dakota Access Pipeline caused such outrage for a number of reasons, but an important one is the developer’s reputation. Adamson at First Peoples Worldwide says that ETP is the defendant in 11 state lawsuit for contaminated groundwater.

“This is going to be the company that builds the Dakota Access Pipeline, under the water?” she asks, incredulously.

There is no doubt that the escalation of protests and the violence of the response by police (using tear gas, rubber bullet guns and water cannons) and the company, which notably unleashed of guard dogs on peaceful protesters, added fuel to the fire.

If other DAPL lenders are worried about a similar backlash to the one experienced by Wells Fargo, they are not admitting it. GTR’s request for comment on the situation was declined by most of the syndicate, with only BNP Paribas responding with a vague official statement about environmental due diligence.

Most banks have expressed a certain regret about not noticing the risk of controversy before signing the contract.

“The European banks, including ING, came out with letters of support saying they would not provide any new financings. Most of the reactions have been ‘we wished we had known this sooner’. Our reaction has been ‘you signed the Equator Principles, you’re supposed to be competent professionals in due diligence and you should have seen this coming’,” adds Adamson.

She and Frijns at BankTrack believe the one positive effect that could derive from this fiasco would be a change in due diligence processes for such projects, but unless the UN modifies the terms of the Equator Principles, it seems as though banks will continue to deem their adherence to these sufficient.

“We think we have a very thoughtful approach and follow the Equator Principles already, so I don’t expect our due diligence policy to change based on the City Council’s decision,” Smith says.

What banks are most likely concerned about is ETP’s ability to pay them back: a November 2016 joint report by the Institute for Energy Economics and Financial Analysis and the Sightline Institute called the financing “high-risk”, flagging the overbuilding of the Bakken shale oil transport infrastructure at a time when investment in oil itself is dwindling.

ETP missed its project completion deadline of January 1, 2017, after which companies that have committed to ship oil through the pipeline at 2014 prices had the right to rescind those commitments. The report’s authors expect oil shippers to attempt to renegotiate the terms of their contract with ETP based on the oil price decline experienced since they signed it in 2014.

The company is overleveraged, and without the revenue from DAPL, it may well be unable to repay its debtors.

“ETP has been in a phase of rapid, high-risk growth, which has required it to raise capital quickly. Its total assets grew from US$4.4bn in 2005 to US$12.1bn in 2010 and then to US$65.2bn in 2015. In June 2016, Moody’s placed ETP on a ‘negative outlook’ for its high leverage. ETP, in short, is under extreme financial pressure to [ensure] that its investments generate cash for its investors,” the report reads.

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