The cost of going green
Corporate and social responsibility are the new buzzwords for banks. But how committed to it are they really, and how big are the costs attached
Within their corporate and social responsibility (CSR) remit, the environment is every bank’s favourite subject. It’s something that affects us all, it’s an issue that NGOs love to make noise about and some of the banking sector’s most profitable projects can make a profound mark on it.
But how much does the success of a trade finance transaction really hinge on its eco-credentials
- Helen Castell reports.
- What are the risks that environmental awareness is injecting into deals and are inter-bank efforts like the Equator Principles really making a difference
- Impact in Asia
Environmental considerations impact on a number of trade finance sectors in Asia, says Asif Raza, head of Asia Pacific trade and logistics management at JPMorgan in Singapore. For example, higher environmental risk industries like palm oil plantations, coal, metals, mining and oil projects may often be project financed but also require an element of trade finance.
“If you as a bank are financing those elements of the project, you need to make sure these are in compliance with the environmental guidelines that you have put forward within the organisation. And that’s happening across the board,” he says.
Fuelling this compliance drive is a whole host of factors: shirty shareholders, peer pressure, pragmatism and even genuinely fuzzy feelings.
In countries such as Belgium and the Netherlands, where NGOs do ask questions, banks’s environmental compliance gets more media attention, notes Paul Schuilwerve, managing director and global head of commodities at Fortis Bank in Rotterdam.
“We’re not slaves to every fringe group who may come up and chuck ‘environmental’s rocks at any particular deal – often having jetted in for the purpose,” adds John MacNamara, managing director, structured commodity trade finance, Deutsche Bank, in Amsterdam. “But we do take environmental compliance and responsibility very seriously. It is a social responsibility, it does affect syndication risk and it does affect shareholder value.”
Whenever Deutsche deals are targeted by environmental or anti-globalisation lobbies the issues are discussed at the shareholders’s meeting and the board is briefed. “From our perspective that’s quite a powerful disincentive,” he says. “You don’t do anything you’re going to regret later.”
And in syndicates, the common denominator rules, meaning that if one bank has high standards everyone has to comply.
Meanwhile, “you have to consider the use of ‘environmental’s arguments in economic nationalism,” says MacNamara. “It wouldn’t be unknown for governments to exploit lack of environmental compliance for their own ends, so that’s another reason for being as ‘clean’s as possible – to minimise the risk profile.”
Banks’s CSR officials also are “genuinely in the culture of looking after the planet,” he argues. “Most of us have children and we all want to live in a nice place, so there’s a lot of sympathy for the ethics of the concept.”
Clearly there’s something in this for the banks themselves. Recent studies suggest companies that are able to manage their environmental and social sides to their business outperform competitors in the longer term, notes Schuilwerve.
“We’re not doing this because it makes us feel better as an organisation – we’re doing it because we think it makes business sense,” says Richard Burrett, head of sustainability at ABN AMRO in London. “We think it helps us understand the world in which we operate, make better risk decisions and exploit new business opportunities at an early stage.”
Whatever their reasons, environmental considerations are moving higher up many banks’s agendas and they have needed to decide fast on what approach they will take, how to build their own environmental expertise, and to what extent they will rely on a burgeoning breed of environmental consultant.
Matter of principle
The Equator Principles, a set of environmental and social benchmarks for managing environmental and social risks in project finance, have been credited for much of that sector’s new eco-friendly face – and whether to sign up is a big issue for banks.
The obligations the principles place on them in terms of due diligence and eco-training can be immense, but for some banks being outside the club could ultimately be more costly. But how relevant are the Equator Principles to trade finance and could it ever be directly applied
- “Equator certainly has been influencing the way ECAs look at trade finance so far as that is directed to capital goods in projects. And so, even though Equator Principles are limited to project finance, there is definitely a spill-over,” says Motoko Aizawa, head, policy and standards unit, environment and social Development department, at the IFC in Washington, DC.In big projects that have a trade finance element, the presence of Equator banks in a syndicate also creates a ripple effect, she says. Whether banks in cross-border deals have joined Equator or not, they are usually part of a syndicate that includes at least one Equator member. “They can’t really say ‘we are ring-fencing ourselves out’, so they are effectively all applying the Equator Principles.”
And as well as broadening its geographic spread, Equator-like concepts are increasingly applied to other forms of financing. “Some banks already apply Equator to corporate finance, some banks are trying to figure this into their smaller businesses, financing medium-sized, smaller-sized enterprises.”
Equator’s main achievements have been to mainstream environmental and social considerations and to help banks integrate them into their day-to-day lending decisions, says Aizawa.
“The way that the number of Equator banks has jumped from the original 10 to 52 is something that IFC and the original Equator banks are incredibly proud of,” says Georgina Baker, senior manager, global financial markets department at IFC in Washington, DC “And we are trying to really bring in those few outliers – some of the European banks that haven’t yet joined – because we want all the major banks to be a part of this.”
Equator is specifically project finance-based, and can only be applied to some trade or commodity finance deals – for example export credit-backed project financing or pre-export financing for a particular oil project or field, notes Burrett.
But as Equator banks have started looking at how these environmental and social risks could be brought into their other products, “indirectly the Equator Principles have had an impact,” he says. “Equator has been the catalyst for them to look at how they manage these risks in other areas of their business.”
Citigroup for example created an internal policy that if they knew what the proceeds of a loan would be used for they would aim to do due diligence on an Equator-like basis. ABN AMRO meanwhile developed industry-based policies in sensitive industries such as oil and gas, mining, forestry, gambling, animal testing and defence.
Equator banks may not be directly applying the principles to their trade finance businesses, but are starting to incorporate their policy requirements into their due diligence process, agrees Greg Radford, chief environmental advisor at Canadian export credit agency EDC in Ottawa. “Their financial officers are performing more environmental screening, where they may not have been asking those questions before.”
“They’re starting to take a more strategic look, a more pragmatic look, at higher-risk sectors such as the extractive sector,” and more advanced banks have introduced environmental training programmes for financial officers.
Equator has helped create a “level playing field” for banks, stripping environmental considerations out of how they compete for deals, he adds. “I’ve seen a real evolution over the past several years where commercial banks are starting to have common environmental requirements. And Equator Principles has helped this a great deal.”
Started in project finance
Fortis adopted the Equator Principles in February 2006 and decided to initially limit their scope to project finance. “However, the process of adopting the principles and training account managers, risk managers and credit analysts has led to a greater awareness of environmental and social issues across other business units, including commodities,” says Schuilwerve.
“This has resulted in greater scrutiny of the environmental and social aspects of certain trade and commodities deals,” he adds. Although the bank does not yet have a systematic policy of screening all trade and commodity transactions, its merchant bank environmental and social unit provides ad hoc support to analyse commodities transactions deemed environmentally high risk.
“I expect that a more formal and systematic process of screening clients and transactions for environmental risks will be developed as the years progress. Internal discussions on how to do this in a practical and meaningful way are now ongoing.”
Who’s telling the truthAs part of their credit process, some banks have started sending out environmental questionnaires to clients, especially producers and manufacturers, quizzing them on their emissions and what they are doing to ensure the government doesn’t shut them down, says David Sullivan, CEO of Trade Finance Corp in Hong Kong.
However, “when you give that to the manager of some Chinese zinc smelter, who smokes a tonne of cigarettes and sits watching the chimney at his plant every day, he answers it, but is he answering it in a meaningful way
- ,” he continues. “Whilst the banks have begun to ask the questions, I’m not sure about the complete integrity of the answers they get back in return. And how is the bank going to be able to check that anyway
- “A blind eye is a great English expression because it probably sums up what is happening.”While leading companies in environmentally sensitive sectors tend to have substantial in-house expertise, Fortis needs to work more closely with small and medium-sized clients, Schuilwerve says.
Fortis has recently adopted a set of environmentally-focused core values for agricultural commodities that it aims to comply with in its own business and expects clients to meet. These have been applied so far to the bank’s palm oil business, with plans to roll them out across more agricultural products in 2007 and ultimately into our metals and energy portfolio.
For the palm oil policy, each Agri Core Value has been translated into 13 specific criteria or indicators, which differ depending on client type and are implemented through client questionnaires.
“We have a group of dedicated professionals who are specialising in environmental issues and whose day-to-day job is just to work on this,” says Raza. “The reward for going an extra mile is enormous and so we definitely don’t want to be compromising on this.”
However much internal expertise banks build though, “if you’re looking at a complex oil and gas project, you will have to rely on external consultancies. But you always did in reality,” says Burrett. “All Equator has done is to give banks a public framework which is transparent and which consultants can use to ensure the deals are Equator-compliant.”
“The problem is that these environmental consultancies traditionally have advised companies – project’s proponents – and they don’t necessarily understand the banking business,” says Aizawa. “So I think there is a challenge here.”
Foreign consultancies may also have a harder time in emerging markets, says Sullivan. On a recent Chinese deal that Trade Finance Corp was involved in, the lending bank requested a report from three or four named consultancy companies. However, “in 90% of emerging markets, like China, the producer is not going to pay for such a report from an international consultancy,” he notes. And “before it ever gets to the stage where people recognise they need environmental consultants, I think China will be developing its own”.
ECAs lead the way
More important than consultants, ECAs have played perhaps the biggest role in investment in clean energy upgrades and in promoting environmentally-aware financing, bankers say.
“They were very quick off the mark to make environmental improvement a recognised objective in itself,” MacNamara says.
While not yet a signatory to Equator, EDC is part of the OECD’s Common Approach on Environment and has had its own formal environmental policy since 1999 plus an environmental department staffed with full-time specialists that is one of the largest among ECAs, says Radford.
“We’re quite proud of acting as a leader among ECAs in the area of the environment,” he says. “We’re internalising the environmental due diligence and making decisions as to whether projects meet international standards. We work with consultants when they’re involved with projects, but we ensure that the appropriate level of due diligence is done as part of our credit approval process.”
As a non-profit-oriented organisation, Japan Bank for International Cooperation (JBIC) can be tougher on its environmental requirements than a commercial bank, says Kohei Toyoda, its representative in London. It has not signed up to the Equator Principles but in 2003 was early to formulate its own environmental guidelines, which he says are equivalent in stringency to the World Bank’s .
“We are quite advanced in this area,” he says. “In some cases the cost for checking compliance is high. We are, however, making our best effort to minimise negative effects on our clients.”
Pick your market
Whatever approach financiers take, there are always going to be some markets that are more of a challenge – the energy industry for example, or some emerging markets where the environment is either overlooked, or hijacked as a political tool.
Governments in countries like China, Vietnam and the Philippines have introduced more strict pollution controls, meaning that producers, particularly in China, often need to receive annual environmental clearance without which they cannot operate, notes Sullivan.
And whether a plant receives its government-stamped certificate is sometimes more reliant on who its managers know, and whether Beijing has other motives for encouraging or discouraging that sector, than for its true environmental credentials, he says.
This means that banks, especially those that deal with mid-cap clients, now have a new risk to factor in. They need to monitor whether their client is certified by the government, as well as the likelihood of them retaining that status in future years, he says.
The next big challenge will be taking Equator-like risk management into developing countries, says Burrett. “We helped to get Equator rolled out in Brazil and a number of the Brazilian banks are on board.” But in countries like China and India, which have enough domestic liquidity to finance commodity and trade deals, selling Equator-like risk management models will be harder. The social and labour-related elements that are built into the IFC’s performance standards may put Chinese banks off, he notes.
“Greater attention is needed in emerging markets, where local regulatory requirements can sometimes be less stringent, or not consistently enforced,” says Schuilwerve.
The question also of whether some clients are portraying their environmental impact accurately “is of course an issue,” he says. “But let’s remember that five, 10 years ago, probably no one was even asking these questions. So by starting this process, by having discussions with your clients, we are making a change.”
Ultimately, the environment is something that is going to have an increasing impact on trade finance and whether it’s lip service or not, most bankers argue that the fact they are talking about it has to be good news.
“We’re going through that stage at the moment where it’s a bit functional – the bank is getting their form filled out because they have to, because the head office wants it, and the client is getting their environmental certificates, but quite often getting them stamped without having to worry too much about it,” says Sullivan. However, “this is just where we are at the moment.
“You could relate this to where China was heading in the mid-90s, when they first brought in foreign exchange controls. The rules were there but nobody paid any attention. And I think the same will happen with the environment.”
“We’ve come a long way since the 1990s when you’d go upcountry in Russia and all the snow would be purple and the sunset would be green because of the pollution,” says MacNamara.
“As recently as 2001 we were negotiating our ‘environmental law clause’s with a top-tier Russian metals company and their stance was ‘yes, we are in full compliance with all environmental laws to which we are subject: we pay all our environmental fees on time? ,’” he adds. “However, about that time also you could go upcountry to see firms like MMK in Magnitogorsk or Severstal at Cherepovets, or Norilsk, and already the snow was white and clearly a lot of capex had been spent on scrubbing and filtering emissions.”
“There is already personal responsibility for anti-money laundering infraction and I can foresee a time when there’ll be personal responsibility for environmental infraction as well,” says MacNamara. “I don’t rule out that happening within my career.”