The social media-led transparency revolution is prompting banks and ECAs to strengthen their focus on sustainability, but how is this reflected on business processes? Melodie Michel reports.
Though the concept has been around for decades, corporate social responsibility (CSR) is a term that gained in popularity on the back of the financial crisis, when banks looked to clean up their tarnished reputations by emphasising their ‘good deeds’. In fact, the Equator Principles, a voluntary framework for environmental and social risk management in project finance, saw a wave of new signatories between 2007 and 2010 – with banks including ABN Amro, Santander, BNP Paribas, Lloyds and Natixis joining the list.
But while the trend for more ethical banking is widely commended, the need for a CSR function within banks has been questioned: Is this just a PR exercise? How seriously do banks take it, and what are the implications in terms of availability of financing for deals that don’t have a CSR angle? Is it even the bank’s responsibility to check for sustainability risk in a borrower’s supply chain, and if so, should it be regulated?
The idea of corporate social responsibility has evolved greatly in the past few years: Initially largely focused on environmental issues, it now encompasses human rights, anti-corruption and, for some, sustainable lending.
“As an ECA we also look at what we call sustainable lending, which is an agreement between the IMF, the World Bank and the OECD for ECAs not to provide guarantees for financing to highly indebted poor countries unless it’s within the IMF debt limits and part of the country’s development plan,” says Karl-Oskar Olming, head of CSR and international relations at EKN.
The sectors under scrutiny have also expanded, with Olming mentioning telecoms as an area of concern, yet poorly covered by existing multilateral CSR guidelines.
“With telecom transactions, there are some inherent risks to privacy and freedom of speech that are not covered in the IFC Performance Standards [another CSR framework observed by most financial institutions], which were originally more developed towards resource extraction, mining, oil and gas and so on. That’s a challenge for us as we have a lot of telecom deals, and therefore we have to find our own way. We also want to promote Freedom on the Net, a Swedish priority and a part of EKN’s instruction. Currently we’re working with the Institute for Human Rights and Business, which helps us to further develop our due diligence for telecom transactions,” he says.
In terms of implementation, large banks have taken CSR a lot more seriously in recent years. Commerzbank, for example, has a reputational risk department that completed 5,000 transaction assessments last year. The bank is also a member of the Roundtable on Sustainable Palm Oil and uses a risk-based approach, for example to vet all its timber transactions.
However, Commerzbank head of product management, trade services and issues, Rüdiger Geis, explains that transaction value is a factor in how much due diligence a bank can do: “We have a standard system implemented, but how far should our responsibility go? If we have a US$100mn transaction, for sure we should dig deeper. If it’s a transaction for US$5,000 where we make US$50, we can’t fly to the other side of the world to check. That’s why we need alliances to believe that they are doing it in the proper way.”
According to him, Commerzbank declines transactions based on CSR risk “on a daily basis”.
Sustainability concerns, coupled with KYC requirements, are driving a focus shift further up the supply chain, particularly for large corporates, which are held responsible for what goes on across their whole supplier network. Banks are following this trend to a certain extent, but the line marking the end of a bank’s responsibility in that area is not all that clear.
“I think it’s very difficult to put all the emphasis on banks to do all the due diligence all the way through the supply chain,” says Barclays head of ECA and capex financing solutions Gabriel Buck.
The issue with deals that present a CSR risk is that the potential damage to the bank’s reputation is the same no matter the size of the transaction. And with the advent of social media as a tool for activism, transparency has become more crucial than ever.
“The world is undergoing a transparency revolution at the moment. It will be more difficult to hide sustainability issues in the future, be it corruptive behaviours or other issues, because it’s easier and easier to get information out, even for those who earlier were disadvantaged and are now getting mobile phones. It’s creating a new way for everybody to relate to these things,” says Olming.
Buck explains that for each transaction he looks at, he asks himself whether the bank would be able to justify the financing if the deal ended up on the front page of a newspaper.
“As a business head I have a citizenship lens when I look at potential projects. I always say to myself: Is this the type of project that Barclays should be involved in from a reputation point of view? All banks are taking a much closer look in terms of the type of transactions they are working on and the stakeholders within those transactions,” he tells GTR.
Most institutions are training all their underwriters to detect CSR risks, with EKN even appointing a ‘sustainability champion’ in each team. This increased focus has resulted in a degree of harmonisation that makes it easier to close multi-bank deals.
“Historically everybody had their own approach to this, but in the financial sector, the IFC Performance Standards have really helped in developing a common language and way of dealing with transactions. Many of the large international commercial banks are part of the Equator Principles network, which are very much aligned with the Common Approaches that the ECAs in the OECD have agreed on. It means that in any large transaction where you have ECAs and Equator Principles banks involved, it makes things much easier to manage. A smooth collaboration between ECAs, banks and exporters on sustainability issues is fundamental to successful financing solutions these days,” says Olming at EKN.
However, he points to some discrepancies in the way banks approach CSR, despite them having similar policies. “It’s very transaction-specific: sometimes they can be very detailed and thorough, while in other cases the commercial focus is so important that the sustainability part might be difficult to push as we would expect them to do.”
In an effort to push harmonisation further, Commerzbank recently launched a report titled Five drivers of sustainable trade, which looks, among other things, at the role of banks in promoting sustainability in the sector.
It identifies innovative finance and bank initiatives as “a key driver”, with increasingly stringent sustainability requirements becoming a condition for importers and exporters to secure financing.
Geis explains: “If you talk to politicians, bankers, NGOs: everyone uses different words and has a different level of awareness. So we tried to bring everything together. There should be a business case for sustainability: You can make money and be more sustainable at the same time. We have to raise awareness in society and that’s what we are trying to do with that report.
“As a sector, banks have to create new products and follow the demand from corporates. We might not be able to give a better price for sustainable transactions, but longer tenors for example can help to enable companies to change towards a more sustainable way of doing business.”
What remains to be seen is the pace at which non-OECD ECAs and banks will catch up with western CSR requirements for a level competitive playing field and a more ethical trade sector in general.
“There’s been debate around the competitiveness of EU and OECD companies which have to comply with these best-in-class sustainability regulations. Most studies point to a small negative impact in terms of the cost and time needed to comply, but they also show that this direct cost is balanced by investments in efficiencies,” says Mark Elsner, senior adviser at Oxford Analytica, which produced the report jointly with Commerzbank.
In a February 2015 paper published in Global Policy, George Otieno, CEO of the African Trade Insurance Agency (ATI), makes the case for global CSR standards as a way to increase import options in developing countries, “providing them with choices based on quality and price, rather than simply on the CSR terms of export credit support”. He adds that harmonisation would enhance transparency and deconstruct the perception that CSR negatively impacts competitiveness.
“Rather than limiting growth, I argue that adherence to global CSR standards would instead give the competitive edge to those who embrace them. The broader implication is that perhaps with this shift towards more explicit emphasis on CSR, ECAs may in fact begin to build even stronger relationships with the emerging markets where they do business – precisely because there will be an added layer of trust, supported by global CSR standards, built into the transactions,” the paper reads.
Though it undeniably helps financial institutions format their CSR policies, the push for ever more guidelines can have a negative impact. For example, NGOs are putting pressure on governments to limit ECAs’ ability to finance coal-fired power stations, which could lead to limited funding for projects that have certain social benefits.
“There is a lot of lobbying going on trying to limit the scope of ECAs. I personally find that challenging to accept because I don’t think it’s the role of government and ECAs at this moment in time to be that prescriptive. For example, in Africa, the fact of the matter is there is a large need for energy generation using coal-fired power stations. African power generation companies have coal and are keen to provide power for industry, hospitals, schools etc. So what’s the lesser of the two evils? Coal-fired power stations or not having energy to enable your country to grow? There needs to be a balance; we need to be pragmatic,” says Buck.
The truth is, sustainability risks are not always as black and white as the public might think: Geis mentions a hydro power project Commerzbank declined because it learned that it would involve thousands of people having to leave their homes. “In a lot of cases it’s hard to define what’s good or bad. If instead of having a nuclear power plant you use a big dam for water energy but a lot of people have to leave their land, is it good or bad?”
Making sustainable choices also requires purchasing power, and in many cases the urgent need for infrastructure and energy overrides the sustainability concern.
“They are nice transactions to be involved in, but there are not many of them. We would like to do more, but in reality they’re not your bread and butter in terms of the volumes of business that you do,” says Buck at Barclays.
Despite the need for harmonisation, the case for less regulation and more of a common-sense, case-by-case approach to CSR risks is convincing.
Current regulations have their limits: For example, the OECD Common Approaches that ECAs abide by only cover projects in certain risk sectors that are over US$12-13mn and with a tenor of more than two years. When EKN assessed its annual transactions it turned out that such transactions represented less than 1% of the total number of transactions, and the ECA had to create its own framework for the remaining 99%.
“We realised that we needed a much more holistic approach to all our transactions; a way of looking at every transaction from a risk-based approach. If there’s an inherent sustainability risk in this transaction, we look further at it. That’s how we have built our system: not around rules of the Common Approaches, but by the risk-based approach that we have developed ourselves for our portfolio and still in line with the Common Approaches” says Olming.
Additionally, sustainability laws can lead to what the Commerzbank report calls ‘green protectionism’, undermining competition in trade under sustainability pretences.
According to Buck, CSR should not be seen as just “ticking boxes”, but more as an embedded cultural approach that is evenly applied throughout the industry.
“I think it’s just about thinking: what makes sense, are you asking the right questions? Are the stakeholders’ motives aligned? I don’t think we need more CSR guidelines.
“My personal viewpoint is that there’s so much regulation that people are not thinking clearly for themselves on some of these issues. When there’s less regulation then it forces banks to think more broadly about what they’re doing,” he adds.